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Welcome to the third government shutdown of 2018! Did you forget about the first two? In January, there was a three-day closure, and then in February, there was the one-day sequel. In both of those instances, investors shrugged off the news and stocks actually edged up during those days-long shutdowns.
2016 started with a stock sell off and full-blown correction (down 10 percent from the recent peak), challenging investors to remain calm and stick to their game plans. Then Brexit came along and once again, rattled nerves. Today the Cassandra's are out again with an old worry: the Fed will kill the stock market rally. The reignited jitters have been attributed to a few central bank officials hinting that the improving economy may justify an interest rate increase as soon as next week’s Fed meeting. Previously, there seemed to be little doubt that the central bank would wait at least until the December meeting. While most believe that December is still more likely, the selling acknowledges that the most recent leg up in stock prices occurred NOT because the economy is humming and companies are making a lot of money; rather the buying has been a sign that big investors feel with interest rates so low, stocks are the only assets that can deliver any potential for gains. As Federal Reserve Governor Daniel Tarullo recently acknowledged “There's no question...when rates are low for a long time that there are opportunities for frothiness and perhaps over-leverage in particular asset markets.” (Emphasis added!)
In other words, when rates stay so low for so long, investors look past fundamentals, drive prices higher and can become complacent. One sign of that complacency can be seen in the VIX index, which is a measure of the expected swings in the S&P 500 over the next thirty days. Recently, the 30 day annualized volatility (of daily changes) in the S&P 500 fell to its lowest level since 1994. Friday’s selling may simply be proof that people periodically remember that the risks they previously accepted, may no longer feel so great, especially considering the age of the bull market. But as the analysts at Capital Economics note, “The fact that volatility was low in the mid-1990s did not preclude equity prices from rising for several years as a bubble inflated.”
Still, when you hear dire predictions, it’s hard not to feel butterflies. Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions: when to sell and then when to buy back in, something that is nearly impossible. After all, even if you sell and manage to steer clear of the bear by staying in cash, you will not be able to reinvest dividends and fixed-income payments at the bottom and you are likely to miss the eventual market recovery. The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you are a long-term investor and you do not have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon and do not be reactive to short-term market conditions, because over the long term, this strategy works. It’s not easy to do, but sometimes the best action is NO ACTION.
If you are really freaked out about the movement in your portfolio, perhaps you came into this period with too much risk. If that’s the case, you may need to trim readjust your allocation. If you do make changes, be careful NOT to jump back into those riskier holdings after markets stabilize.
I hate to bring you back to a scary time, but seven years ago this week; U.S. stock markets plunged to their worst levels of the entire bear market 0f 2008-2009. Although the entire financial system almost went over the cliff in September and October of 2008, it wasn’t until March 9, 2009 that stocks hit rock bottom. On that day, the Dow closed at 6547; the S&P 500 fell to 676; and the NASDAQ was at 1268. Thankfully, markets have charged higher since those dark days, but with recent volatility and market corrections, now seems like a perfect time to review those painful bear market lessons.
1. If want to take the ride, you have to prepare for ups and downs. The first time I went on the Dragon Coaster at Rye Playland, I learned this lesson, but that ride lasted just about two minutes. Unfortunately, the investor roller coaster spans a lifetime. If you plan to own securities to fund future obligations, you must accept that bear markets are part of the process. The good news is that not all bear markets are as awful as the last one, which was the most severe since the 1930’s.
2. Bear Markets are GOOD for long-term investors. Plunging markets are tough on the nerves, but if you are still saving for retirement or college, take solace in the fact that you are buying shares, which will eventually be seen as being on sale. As Warren Buffett once said, “Prospective purchasers [of stocks] should much prefer sinking prices.”
3. Borrowing can be dangerous. Whether it’s a house or a dot-com stock, one lesson is just because some bank/investment company is willing to lend you a lot of money, does not mean that you should take it. Too much leverage can be a scary thing, both for individuals and for companies. That’s why some basic rules of thumb exist—to keep us out of trouble!
For example, putting down a 20 percent down payment for a house is prudent, because just in case the housing market collapses, you have more built-inequity. A corollary of the debt warning is to read the fine print on all documents. There were too many instances when borrowers really did not understand the terms of the loans that they were assuming. Although many regulations now require more transparency and disclosure, we must be vigilant in reviewing documents to protect ourselves.
4. Emotions are your enemy. There's no better event to learn the lesson of how investor fear can lead you astray than the recent bear market. From the beginning stages in 2008 through the bear market low and then for months – even years – later, many investors wanted to sell everything and hide under the bed. That was an understandable feeling-it really was scary!
The big problem with selling when conditions are grim is that very few investors have the wherewithal to get back into the fray. When they do, it is usually long after markets have clawed their way back up. Acting on fear often ends up prompting you to sell low, buy high and take unnecessary overall losses in your portfolio.
5. Cash is King. Those who entered the financial crisis and ensuing bear market with a safety net (6 to 12 months of expenses and up to two years for retirees) were aptly rewarded. The bear can come at any time and if you had ample emergency reserves, you were able to refrain from selling assets at the wrong time and/or from invading retirement accounts.
It has been a rough year for investors. U..S stock indexes have plunged into correction territory (down 10 percent from the recent peak) for the second time in six months and the big swings are testing every investor’s internal fortitude. The bad start to the year is causing a bit of déjà vu all over again, especially given the dire predictions of some economists and analysts. The current situation is not like 2008, primarily because there is no financial crisis brewing. In fact corporate balance sheets (outside of the energy sector), including those of financial services companies, are in decent shape. Additionally, despite slowdown fears, the U.S. economy, while not strong, is still growing by about 2 percent annually. That means in a year like 2015, you have soft quarters like Q1 and Q4 where there is barely any growth (+0.6 percent and estimated +1 percent) and the recession calls are abundant, and stronger ones like Q2 and Q3, where the economy seems fine (+3.9 percent and +2 percent).
Still, when people hear big banks, like RBS saying “The downside is crystallizing. Watch out. Sell (mostly) everything” it’s hard not to feel butterflies. Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions: when to sell and then when to buy back in, something that is nearly impossible. After all, even if you sell and manage to steer clear of the bear by staying in cash, you will not be able to reinvest dividends and fixed-income payments at the bottom and you are likely to miss the eventual market recovery.
In fact, data from Dalbar confirm that when investors react, they generally make the wrong decision, which explains why the average investor has earned half of what they would have earned by buying and holding an S&P index fund. We’ll see if the folks at RBS can beat the odds.
The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you are a long-term investor and you do not have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon and do not be reactive to short-term market conditions, because over the long term, this strategy works. It’s not easy to do, but sometimes the best action is NO ACTION.
If you are really freaked out about the movement in your portfolio, perhaps you came into this period with too much risk. If that’s the case, you may need to trim readjust your allocation. If you do make changes, be careful NOT to jump back into those riskier holdings after markets stabilize.
If you have cash that is on the sidelines and are nervous putting it to work as a lump sum, you should take heart in research from Vanguard, which shows that two-thirds of the time, investing a windfall immediately yields better returns than putting smaller, fixed dollars to work at regular intervals.
But, if you are the kind of investor who is less concerned with the probability of earning and more worried about losing a big chunk of money immediately, you may want to stick to dollar cost averaging. Vanguard notes “risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline.”
The first two weeks of the year have been the worst ever for US stock indexes. Indexes are now in correction territory for the second time in six months and the big swings are testing every investor’s internal fortitude and begging the question: will the correction lead to the first bear market in nearly seven years? Understandably, this period may cause a bit of déjà vu all over again, but the current situation is not like 2008 for many reasons. The first of which is that there is no financial crisis brewing and the second is that US economy, while not strong, is still growing by about 2-2.5 percent annually. Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions, when to sell and then when to buy back in, something that is nearly impossible. The data show that when investors react, they generally make the wrong decision, which explains why the average investor has earned half of what they would have earned by buying and holding an S&P index fund.
The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you’re a long-term investor, who doesn’t have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon -- one that is not reactive to short-term market conditions, because over the long term, it works. It’s not easy to do, but sometimes the best action is NO ACTION.
Where the markets will go throughout the rest of 2016 depends on the answer to the following six questions:
1) Will Chinese growth accelerate? The cause of the early part of the New Year's sell-off was anxiety over a slowdown in China (sometimes referred to as a “hard landing”), which sent stocks there into a bear market, down 20 percent since the December high. This is not a new fear—investors have believed that a downshift in growth in the world’s second largest economy would inflict pain on the rest of the world, especially as China shifts from an economy that relies on government investment in building and infrastructure as well as manufacturing to one that is more consumer-based.
2) How many Fed Rate increases? The central bank pledged to raise rates gradually—according to its own projections, there are likely to be four quarter-point increases in 2016. But the bond market thinks that there will only be two, due to slower growth. If the Fed is correct, it would mean that US growth continues to accelerate and that inflation will rise towards the target 2 percent; if the bond market is correct, growth and inflation will likely stall in 2016.
3) Will crude oil steady/fall further/rise? Oil’s shaky start (down about 20 percent in the first two weeks of the year), comes after last year’s 30 percent drop and 2014’s 46 percent plunge. Crude is now down over 70 percent over the past 18 months. With Chinese demand cooling and supply remaining high -- the world is producing 1 million barrels of oil more than it’s consuming, which is pushing prices down. That’s good news for consumers, who will either save or spend the savings at the pumps, but bad news for energy companies, whose earnings are going to get shellacked.
4) Will US Economic Growth Accelerate? GDP growth last year is likely to come in around 2.25 percent, matching the results of the previous three years. Analysts are expecting growth of 2.5 percent in 2016, with some thinking that a recession is imminent. Part of the answer to this question may also be found in the movement of the US dollar, which in trade-weighted terms, is close to a ten-year high. With anxiety in China and emerging markets pushing capital to the US, the dollar could continue to rise, which would be bad news for US manufacturers and likely keep inflation too low in the eyes of the Federal Reserve.
5) Will Wages Finally Rise? The economy added 2.65 million jobs in 2015, the second best year for job creation in the past 15 years. (The best was 2014). While there was progress on job creation and the unemployment rate (5 percent), wage growth has lagged. With a tightening labor market, employers may have to dig deep and pay up to attract and retain qualified talent. That would be good news for workers, but not so hot for corporate America.
6) Will the Bear Emerge? The current bull market in US stocks turns seven years old in March, making it the third longest in history (1987-2000 is the winner, followed by 1949-1956). Just because the bull is aging, does not mean that it is doomed. However, it does mean that the pressure is mounting for companies to deliver earnings growth in a year when their compensation expenses are likely to rise, but they are unable to pass on those additional costs to customers.
By the way, since the end of World War II (1945), there have been 12 full-blown bear markets (with losses of 20% +). Statistically they occur about 1 out of every 3.5 years, and last an average of 367 days.
MARKETS: All three indices are in correction territory and the Russell 2000 index of small stocks, as well as certain other indexes like the Dow transports, is already in a bear market, defined as a 20 percent decline from the highs. For the Dow, which would be 14,681; for the S&P 500, it would be 1,708; and the NASDAQ would be in bear market territory if it hit 4,185.
THE WEEK AHEAD:
Mon 1/18: US Markets closed for MLK Day
Tues 1/19:
Morgan Stanley, Bank of America, IBM, Netflix
China Economic Data: Q4 GDP, industrial production, retail sales
10:00 Housing Market Index
Weds 1/20:
Goldman Sachs
8:30 CPI
8:30 Housing Starts
Thursday 1/21:
Starbucks, Schlumberger
Friday 1/22:
General Electric
10:00 Existing Home Sales
The first week of trading was the worst ever for the Dow (down 6.2 percent) and the S&P 500 (down 6 percent), but fear not: the U.S. economy is alive and well! Look no further than to the December jobs report, which came in stronger than expected. The economy added 292,000 jobs and the previous two months were revised higher, which made 2015 the second best year for job creation since the 1990’s. For all of the anxiety over markets and the global economy in 2015, there were 2.65 million jobs created, or a monthly average of 221,000, shy of the 2014 level of 260,000 per month, but solid nonetheless. The unemployment rate remained at 5 percent, the lowest level since the spring of 2008.
The top line results do not mean that all is perfect with the US employment landscape. Indeed, there are still stubborn problems that persist. For example, wages slid by a penny in December and it was only because December 2014 wages were so weak that the year over year increase came in at 2.5 percent. We’ll need to see 2016 data before understanding whether employers are paying more in compensation.
The number of long-term unemployed (those jobless for 27 weeks or more) was unchanged at a still-high 2.1 million in December and has shown little movement since June. Thankfully, there was improvement in the first half of the year, so the number of long term unemployed was down by 687,000 in 2015. It was a similar story for the 6 million part-time unemployed – there was little movement in December but over the year, their ranks shrank by 764,000.
The civilian labor force participation rate, which is the percentage of the working age population in the labor force, edged up in December to 62.6 percent, but too close to 40-year lows for anyone to feel good about it. While about half of the post-recession decline in the rate is due to demographics, the low level indicates that many Americans have left the labor force because they are frustrated.
What does this report tell us about the state of the US economy as we closed out 2015? Although growth is certainly not stellar—GDP likely advanced by 2.25 percent last year, matching the previous three years’ rate—it was strong enough to produce a slew of jobs in a variety of sectors. Annual gains were robust for in professional and business services (+605K), construction (+263K), health care (+480K), and food services and drinking places (+357K).
The weakest parts of the economy are those that are associated with energy and manufacturing. With crude oil down by over 30 percent in 2015, the mining industry lost 129,000 jobs during the year. And with the strength of the US dollar and weakness in Asian economies, manufacturing employment was little changed (+30,000), following strong growth in 2014 (+215,000).
A rotten first week for stocks notwithstanding, fears over the US economy falling over a cliff may be overblown. According to Capital Economics, while growth in the fourth quarter probably slowed to a pokey pace of 1 to 1.5 percent annualized, the stock market is a bit wobbly, the massive surge in employment in December illustrated that “there is no reason to believe that this is the start of a more serious downturn.”
MARKETS: Don’t look now, but the average stock in the S&P 500 is already in a bear market—down 22.6%, according to Bespoke Investment Group.
THE WEEK AHEAD: No rest for the weary…after the bear took a bite out of investors last week, earnings season begins!
Mon 1/11: Alcoa
Tues 1/12:
10:00 Job Openings and Labor Turnover Survey
Weds 1/13:
2:00 Fed Beige Book
Thursday 1/14:
JP Morgan Chase
8:30 Import/Export Prices
Friday 1/15:
Wells Fargo
8:30 PPI
8:30 Retail Sales
8:30 Empire State Manufacturing Index
9:15 Industrial Production
10:00 Consumer Sentiment
“Why did the market drop?” asked the radio anchor, after the market’s nasty drubbing on Thursday. My response was simple, “There were more sellers than buyers.” Sometimes, there is no particular reason for a sell-off. Sure, financial talking heads love to gin up explanations, but at the end of a rough session, sometimes simplicity works. For the past six weeks, a slow wave of selling has hit the once high-flying sectors of the market, pushing many components of the NASDAQ into a bear market (a drop of more than 20 percent from the recent peak). The NASDAQ Biotech index (NBI) is down 21.1 percent from its February 25th closing high; the Global X Social Media ETF (SOCL) has dropped 21.5 percent from the March 6th closing level; and the NASDAQ Internet index (QNET) is not quite in bear market territory (down 16.8 percent from March 6th), but its close enough that you get the point.
Meanwhile, the NASDAQ and the Russell 2000 are flirting with corrections (a drop of more than 10 percent), down 8.2 and 8 percent respectively since their early March highs. The broader S&P 500 is down just 4 percent from its all-time closing high reached on April 2nd. The big question is whether the selling represents the start of another technology-led total market meltdown? It’s not clear yet, but a review of the numbers is helpful to determine where markets stand.
The stocks that have seen the steepest declines also enjoyed the biggest run-ups. For example, prior to its recent sell-off, the Biotech Index saw an 87 percent gain over the prior 12 months. Even with the 21 percent sell-off, the index is still UP by 35 percent from a year ago. Of course that doesn’t mean that the selling will abate, which is why many are looking for clues from 14 years ago, when the dot-com bubble imploded.
In 2000, investors were coming off a long expansionary economic period and a huge bull market, which had driven up the valuations of stocks. According to Birinyi Associates, the S&P 500 was trading at 29 times its component companies' earnings for the prior 12 months. Today, The S&P 500 trades at 17 times earnings, slightly above average but well below those 2000 levels. The highflying sectors are indeed stretched, but not nearly as much as they were in 2000. The S&P 500 biotech index trades at 29 times component companies' earnings, which is above its median of 26 but far below the level of 57 at which it traded in 2000.
What appears to be happening is that investors are wising up a bit: taking their profits from the stocks that churned out big gains over the past year, paying their due to Uncle Sam and then rotating the proceeds into more value-oriented large stocks. In a world where emotions often rule the day-by-day action, that process seems positively rational.
MARKETS:
THE WEEK AHEAD: Earnings season kicks off in earnest, with low expectations for S&P 500 company earnings. Profits are expected to drop by 1.2% from the same quarter a year ago, according to FactSet Research, which would be the first contraction since the third quarter of 2012, though Thomson Reuters is slightly more optimistic, projecting growth of 1.1%. Revenue is seen rising only 2.3%.
Mon 4/14:
American Airlines, Citigroup
8:30 Retail Sales
10:00 Business Inventories
Tues 4/15: TAX FILING DEADLINE!
Charles Schwab, Intel, JNJ, Coca Cola, Yahoo
8:30 CPI
8:30 Empire State Manufacturing
10:00 Housing Market Index
Weds 4/16:
Abbott, American Express, Bank of America, Capital One, Google, IBM
8:30 Housing Starts
9:15 Industrial Production
2:00 Fed Beige Book
Janet Yellen to speak at Economic Club of NY
Thurs 4/17:
Blackrock, DuPont, General Electric, Goldman Sachs, Morgan Stanley, Pepsi
8:30 Weekly Jobless Claims
10:00 Philly Fed Survey
Fri 4/18: US MARKETS CLOSED IN HONOR OF GOOD FRIDAY
(Markets also closed in Australia, Brazil, Canada, Hong Kong, Singapore, and the UK)
Time flies when you are recovering from a housing boom and bust, a financial crisis and the worst recession since the Great Depression. Five years ago, stock market indexes bottomed out and began a new bull market that has charged through a Flash Crash, a rolling European financial crisis, the Arab spring, a few Congressional showdowns and the Polar Vortex. Over the past 60 months, the S&P 500 has gained a stunning 177 percent, and has more than tripled if you include dividends. After such robust performance, intrepid investors would be wise to ponder whether the end is nigh. According to the Stock Trader’s Almanac, since 1921, the average bull market lasted 62 months, while the median bull market extended for 50 months. The current bull’s performance matches that of the average performance of all bull markets during that time frame, which might make some feel like the sky’s the limit on the upside (we are well-above average, right?)
If you watch the financial media, every buy-side cheerleader is out there saying that the bull has legs and that 2013/2014 is lining up to be 1996/1996 redux: In 1995, the S&P 500 gained 37.2 percent, followed by a 22.7 percent increase in 1996, powered by a technology revolution. (In today’s scenario, just replace search engine and e-commerce with social media and apps.) These “pundits,” who often make a lot more money if markets rise, also point to the fact that in those years, there was a government shutdown and unusually bad weather in January – what a coincidence!
So should ordinary investors strap in and get ready for the rocket-ship ride higher in stocks? Maybe the bull market does have more room to run, but it might be wise to keep the celebrations at bay and stick to a diversified portfolio, just in case. The usual suspects are lurking beneath surface of the record-setting pace: retail investors are jumping back into the fray, like they often do at or near market tops; bearish sentiment and volatility indexes are dropping, signaling complacency; higher price to earning ratios are being discounted; and evidently enough time has passed for some to have forgotten the pain they endured in 2008 and 2009.
MARKETS:
THE WEEK AHEAD:
Mon 3/10:
Tues 3/11:
10:00 JOLTS
Weds 3/12:
2:00 Treasury Budget
Thurs 3/13:
8:30 Weekly Jobless Claims
8:30 Retail Sales
8:30 Import/Export Prices
10:00 Business Inventories
The Senate Banking Committee considers the nominations of Stanley Fischer, Jerome Powell, and Lael Brainard for the Federal Reserve Board
Fri 3/14:
8:30 PPI
9:55 Consumer Sentiment
