Feb 13 2019
Over the past six weeks, global stocks have staged a significant comeback. After being down nearly twenty percent in late December (bear market territory), indexes have climbed half-way back to their previous highs (see chart below). Much of this recent gain can be attributed to the Federal Reserve being more sensitive to what is now obvious: the global economy has been decelerating along with corporate profits, neither good for stock prices.
In addition to the Fed’s accommodation, there is swirling speculation (mostly optimistic) that another US government shutdown and harmful trade negotiation outcome can be averted. I have taken a more defensive position during the past few months – which can be trying given the most recent upward trending market. Is the recent market strength a sign that “all is well” and we should be once again fully invested (up to your asset allocation)? Or is the recent strength just a temporary “relief” rally to be followed by a decline? Let’s look at some data points.
Short Term Trends and Fiduciary Responsibility
Although the recent market strength is welcome, investors should be careful about assuming that short term price movements dictate the health of the underlying economy and corporate profits. Short term (weeks) movements in stock prices should also not be used to predict the health or future direction of stocks, as tempting as it may be. For instance, a decline in stocks during a bull market can appear to lead one to consider selling, just as a temporary rise in stocks in an unhealthy market can lead one to go “all in” – both bad ideas.
In my view, investors would be best served by confirming that the basic fundamentals of a healthy economy and stock market justify being fully invested in the stock market.
The Slowing Economy and Profits Picture
If the global economy can slow down to a consistent “cruising speed” of 2% annually and the Fed stays accommodative, we believe that – with corrections along the way – stocks can go higher this year.
However, at this point, the downtrend in economic growth and earnings has not shown signs of slowing. Today, for instance, the big industrial company Caterpillar warned of weaker than expected sales. In my view, a continuation of weaker than expected economic statistics and profits can easily send markets lower and your first priority for your assets is to mitigate significant downside risk. I will be watching all the data points in the coming days and weeks for signs of stability.
Trade, D.C., Brexit, etc.
Each of these factors played a role in the market’s decline and subsequent recent market strength – depending on nothing but short term speculation. Investors would be wise to consider the potential negative impact that these events could have on the health of the economy. I will also be watching these data points over the course of the coming days and weeks.
Is Recent Market Strength Sustainable? Is a Market Correction Overdue?
In a bull or bear market, stock indexes have periods of short term strength (rallies) and weakness (corrections). Interestingly the recent strength in stocks has not been accompanied by any clarity on the issues discussed above, except for positive Federal Reserve commentary. The strength, however, has been significant and has reached a point by many measures I consider to be overextended. So yes, a correction or decline in stock prices is probably overdue at this point.
Should You Buy Shares in Great Companies During the Next Market Correction?
If the economy and profits appear to be on better footing and trade and government shutdown risks dissipate, the answer is YES. A moderate stock market correction, with better fundamentals, would remove recent underperformance and allow you to buy some of the world’s best companies at great prices. On the other hand, in the face of continued deterioration in market fundamentals, continue the tact of keeping “safer than sorry.”
A Profitable 2019
It is important to recall those periods of tough economic climate and bad markets are not long affairs (months not years). In my view the stock market will soon – if it already hasn’t done so – discount the worst-case scenario for the economy and corporate profits, leaving you plenty of time to make great strides in growing your wealth during the course of the year ahead and the many years beyond.
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Jan 22 2019
Is Recent Stock Market Strength a Sign of Safety…or Danger?
Since early October there has been a “bear market” in stocks, both here and abroad. Though some indexes declined approximately 20% from their highest point, most stocks were down much more until just recently. In the past few weeks, stock indexes have rallied about 10% providing some relief for investors, but far from the peak reached in late September.
This is a good time to explore if the recent strength in indexes is the beginning of a better stock market or just a short-term advance leading to further trouble ahead. As you know we have kept your portfolio defensive during this period, with less stock exposure and less volatile stocks. Though this is effective during market declines, it can be a bit trying in the face of the recent market strength.
How can we determine if there is further downside ahead or if the recent rally is the beginning of a real recovery? Let’s review the data points that were the cause of the tough market. In my view, we need these data points to stop trending downward or to become more clarified, before we take a more “risk on” growth posture.
The economy and stock market are co-dependent. The first sign of economic weakness at the end of the third quarter is what sent stock prices into the downward trajectory. Since that time most leading economic indicators continue to be in a downtrend. Investors need global economic growth to stabilize stock prices to stage a meaningful long-term recovery. If economic growth can stabilize – albeit at a lower rate – stocks could still do very well and better than most investment alternatives. However, we need to see clearer signs of stability on this front.
Corporate Profit Growth
Economic growth is directly tied to the profitability of companies both here and abroad. We are now at the beginning of earnings season and need to see companies meeting or exceeding the lowered expectations that analysts have adjusted downward since the fourth quarter. Some of the most recent warnings and reports have not been positive, including Apple, JP Morgan, Macy’s and Ford – all of which have been negative.
However, the earnings season has just begun and we have some big bellwether companies reporting over the next few weeks including domestic heavyweights Boeing and Caterpillar. These upcoming reports should shed further light on the sustainability of the market’s recent advance.
Lastly, when it comes to earnings reports, it is very important that investors realize that these reports are about what happened last quarter and are not a precursor to what may happen going forward. This is why we also want to consider the following three policy challenges. These policy issues need to be better clarified before markets can be on more sound footing.
Federal Reserve (Fed) Policy
The Fed has raised rates nine times over the past two years in an effort to prevent the economy’s growth (inflation) from accelerating too quickly. As we have written before, this effort comes with the risk that the Fed can mistakenly “overshoot” their estimate of interest rate increases versus growth and turn an otherwise sound economy into a recession.
This concern is real and is one of the reasons investors have been selling shares. Fortunately, the Fed has recently backed away from being so adamant about further rate hikes. In the short run, this has soothed investor’s fears. However, I would like to see further clarity in the Fed’s message and a willingness to reverse course if necessary. The next Fed meeting at the end of this month may provide this.
Global Trade Policy
Tariffs and other impediments to trade with China and other global trading partners are a negative for global and domestic growth. On this front “no news is bad news.” Economic data from China is slowing and they remain an important trading partner for the US and global economy. A trade deal that turns out to be better than earlier perceived would go a long way to alleviate investor fear and support both economic growth and global corporate profitability. We will be watching these negotiations carefully.
Government Shut Down
Though short-term government closures have been stock market nonevents in the past, we are now in uncharted waters. Previous government shutdowns have been measured in days while this one is now more than a month old. This has a negative effect on a number of sectors of the US economy and some of our country’s largest corporations. Investors would be wise to consider the shut down as a further risk to stock prices. As with the other policy challenges, any sign of improvement or positive outcome to this standoff would be supportive of a better stock market environment.
Clearly, there is no shortage of bad news and challenges on the domestic and global front – for the sake of brevity, we left Brexit and US debt levels out of the discussion. At times the stock market “discounts” all of the bad news by lowering the price of shares. We are not sure that the stock market has fully priced in some of these current risks, particularly given the more recent elevated level of share prices. However, if it turns out that the recent strength is the beginning of the recovery – coupled with some clarity on the issues described above – a re-test or normal correction from these levels would be expected, allowing us an opportunity to invest at more attractive prices in the very near future.
Keep in mind that bear markets often demonstrate periods of short term strength which are followed by declines back to the old lows or even lower. This was the case with the market rally in November that resulted in a further 10% decline in indexes. If this recent strength is just another temporary rally in the bear market – given that all major indexes still remain in long-term downtrends – I want to make sure your assets are safe. In that spirit, I continue with my recent, ongoing mantra of “better to be safe than sorry” when it comes to the bulk of your liquid net worth. Keep in mind that historically bear markets last just 6-8 months and this one is already entering its fourth month. Over the next few weeks and months I will be continuing to monitor the data points and view any pullback in stock prices as a possible re-entry point, but one that will need to be validated by better fundamentals.
I am excited about the prospect of re-investing in a significant global stock market recovery.
Jan 05 2018
In terms of investment performance it is almost sad to say goodbye to 2017. Global politics, tragedies and dramas aside, it was an unusually great year for stock market investors. The global economy had just the right ingredients to make for stellar stock market returns – a global economic and profit cycle recovery, coupled with historically low interest rates, and a large crowd of underinvested institutional and individual investors. Historically, this rare combination delivers above average stock price performance and 2017 did not disappoint! It was a particularly good year for global investors as foreign markets outperformed US indexes. However, can we expect more of the same for 2018?
Though we would welcome a repeat of ‘17 in ’18, we find it highly doubtful based on my research and historical precedent. As we discussed one year ago, the first year of a global economic recovery and profit cycle can produce tremendous stock price performance and we would suggest most of that is now behind us. Many of the data points that sent stock prices soaring over the past 18 months – namely better economic and corporate profit growth – were a surprise to most investors. This coupled with a large crowd of underinvested institutions and individuals caused a huge appetite for stock purchases and this tremendous demand for stock itself is the primary reason for the “way better than average” return of stocks. At this point the element of significant positive surprises on the economic and profit fronts are quite slim and most of the underinvested have put their funds to work. Does that mean that the party is over for stock market returns? No way. The party is just likely to be more subdued, and much better than the bond market could muster in terms of return.
I have suggested that we have been at the beginning stages of a new business cycle and bull market for over a year now, and that the bull market of 2009-15 died with the 20 percent decline in equities during ‘15-‘16. This was not and is still not conventional wisdom. As I follow my theory, I see no reason why the current economic, profit cycle and bull market cannot continue for a number of years. Unlike the media and many other investors today, I believe that the stock market is reasonably priced and that economic growth and corporate profits will continue to expand, supporting even higher stock prices as we move forward. However, the stock price trajectory of 2017 will most likely shift down a few notches in 2018 to a level more in tune with profit growth in the 8-12% range, still far superior to just about any other liquid investment! In terms of volatility 2017 exhibited one of the least volatile years in history with no corrections of 3% or more! Investors would be wise to expect normal volatility (8-10% corrections) to return in 2018 as both foreign and domestic stocks churn higher. It should be a good and more normal year for stock investors.
As you may be aware Janet Yellen, the Federal Reserve chair, raised interest rates four times in the past 12 months and she and her replacement Jerome Powell will likely continue this policy to normalize interest rates. Expect two to three rate hikes in 2018 assuming the economy and profit growth stay on course. These rate hikes pose risks to bond mutual fund and bond Exchange Traded Funds – areas that I always avoid. A significant rise in rates could cause these bond funds to fall in value and create massive selling and significant volatility in these instruments. That risk (which we are not subject to) aside, a higher interest rate environment is welcome to those of us that buy individual bonds and can lock in these higher yields. Hopefully, a healthy economy will bring attractive bond yields to your portfolio in the coming year.
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