Posts filed under ‘Financial Markets’
“In the middle of every difficulty lies an opportunity.” ~Albert Einstein
It was a painful week for bullish investors in the stock market as evidenced by the -1,018 point drop in the Dow Jones Industrial Average, equivalent to approximately a -6% decline. The S&P 500 index did not fare any better, and the loss for the tech-heavy NASDAQ index was down closer to -7% for the week.
The media is attributing much of the short-term weakness to a triple Chinese whammy of factors: 1) Currency devaluation of the Yuan; 2) Weaker Chinese manufacturing data registering in at the lowest level in over six years; and 3) A collapsing Chinese stock market.
As the second largest economy on the planet, developments in China should not be ignored, however these dynamics should be put in the proper context. With respect to China’s currency devaluation, Scott Grannis at Calafia Beach Pundit puts the foreign exchange developments in proper perspective. If you consider the devaluation of the Yuan by -4%, this change only reverses a small fraction of the Chinese currency appreciation that has taken place over the last decade (see chart below). Grannis rightfully points out the -25% collapse in the value of the euro relative to the U.S. dollar is much more significant than the minor move in the Yuan. Moreover, although the move by the People’s Bank of China (PBOC) makes America’s exports to China less cost competitive, this move by Chinese bankers is designed to address exactly what investors are majorly concern about – slowing growth in Asia.
Although the weak Chinese manufacturing data is disconcerting, this data is nothing new – the same manufacturing data has been very choppy over the last four years. On the last China issue relating to its stock market, investors should be reminded that despite the massive decline in the Shanghai Composite, the index is still up by more than +50% versus a year ago (see chart below)
Fear the Falling Knife?
Given the fresh carnage in the U.S. and foreign markets, is now the time for investors to attempt to catch a falling knife? Catching knives for a living can be a dangerous profession, and many investors – professionals and amateurs alike – have lost financial fingers and blood by attempting to prematurely purchase plummeting securities. Rather than trying to time the market, which is nearly impossible to do consistently, it’s more important to have a disciplined, unemotional investing framework in place.
Hall of Fame investor Peter Lynch sarcastically highlighted the difficulty in timing the market, “I can’t recall ever once having seen the name of a market timer on Forbes‘ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”
Readers of my blog, Investing Caffeine understand I am a bottom-up investor when it comes to individual security selection with the help of our proprietary S.H.G.R. model, but those individual investment decisions are made within Sidoxia’s broader, four-pronged macro framework (see also Don’t be a Fool, Follow the Stool). As a reminder, driving our global views are the following four factors: a) Profits; b) Interest rates; c) Sentiment; and Valuations. Currently, two of the four indicators are flashing green (Interest rates and Sentiment), and the other two are neutral (Profits and Valuations).
- Profits (Neutral): Profits are at record highs, but a strong dollar, weak energy sector, and sluggish growth internationally have slowed the trajectory of earnings.
- Valuation (Neutral): At an overall P/E of about 18x’s profits for the S&P 500, current valuations are near historical averages. For CAPE investors who have missed the tripling in stock prices, you can reference prior discussions (see CAPE Smells Like BS). I could make the case that stocks are very attractive with a 6% earnings yield (inverse P/E ratio) compared to a 2% 10—Year Treasury bond, but I’ll take off my rose-colored glasses.
- Interest Rates (Positive): Rates are at unambiguously low levels, which, all else equal, is a clear-cut positive for all cash generating asset classes, including stocks. With an unmistakably “dovish” Federal Reserve in place, whether the 0.25% interest rate hike comes next month, or next year will have little bearing on the current shape of the yield curve. Chairman Yellen has made it clear the trajectory of rate increases will be very gradual, so it will take a major shift in economic trends to move this factor into Neutral or Negative territory.
- Sentiment (Positive): Following the investment herd can be very dangerous for your financial health. We saw that in spades during the late-1990s in the technology industry and also during the mid-2000s in the housing sector. As Warren Buffett says, it is best to “buy fear and sell greed” – last week we saw a lot of fear.
In addition to the immense outflows out of stock funds (see also Great Rotation) , panic was clearly evident in the market last week as shown by the Volatility Index (VIX), a.k.a., the “Fear Gauge.” In general, volatility over the last five years has been on a declining trend, however every 6-12 months, some macro concern inevitably rears its ugly head and volatility spikes higher. With the VIX exploding higher by an amazing +118% last week to a level of 28.03, it is proof positive how quickly sentiment can change in the stock market.
Not much in the investing world works exactly like science, but buying stocks during previous fear spikes, when the VIX level exceeds 20, has been a very lucrative strategy. As you can see from the chart below, there have been numerous occasions over the last five years when the over-20 level has been breached, which has coincided with temporary stock declines in the range of -8% to -22%. However, had you held onto stocks, without adding to them, you would have earned an +84% return (excluding dividends) in the S&P 500 index. Absent the 2011 period, when investors were simultaneously digesting a debt downgrade, deep European recession, and domestic political fireworks surrounding a debt ceiling, these periods of elevated volatility have been relatively short-lived.
Whether this will be the absolute best time to buy stocks is tough to say. Stocks are falling like knives, and in many instances prices have been sliced by more than -10%, -20%, or -30%. It’s time to compile your shopping list, because valuations in many areas are becoming more compelling and eventually gravity will run its full course. That’s when your strategy needs to shift from avoiding the falling knives to finding the bouncing tennis balls…excuse me while I grab my tennis racket.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including emerging market/Chinese ETFs, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (August 3, 2015). Subscribe on the right side of the page for the complete text.
It’s summertime and the stock market has taken a vacation, and it’s unclear when prices will return from a seven month break. It may seem like a calm sunset walk along the beach now that Greek worries have temporarily subsided, but concerns have shifted to an impending Federal Reserve interest rate hike, declining commodity prices, and a Chinese stock market crash, which could lead to a painful sunburn.
If you think about it, stock investors have basically been on unpaid vacation since the beginning of the year, with the Dow Jones Industrial Index (17,690) down -0.7% for 2015 and the S&P 500 (2,104) up + 2.2% over the same time period (see chart below). Despite mixed results for the year, all three main stock indexes rebounded in July (including the tech-heavy NASDAQ +2.8% for the month) after posting negative returns in June. Overall for 2015, sector performance has been muddled. There has been plenty of sunshine on the Healthcare sector (+11.7%), but Energy stocks have been stuck in the doldrums (-13.4%), over the same timeframe.
Source: Yahoo! Finance
Chinese Investors Suffer Heat Stroke
Despite gains for U.S. stocks in July, the overheated Chinese stock marketcaused some heat stroke for global investors with the Shanghai Composite index posting its worst one month loss (-15%) in six years, wiping out about $4 trillion in market value. Before coming back down to earth, the Chinese stock market inflated by more than +150% from 2014.
Driving the speculative fervor were an unprecedented opening of 12 million monthly accounts during spring, according to Steven Rattner, a seasoned financier, investor, and a New York Times journalist. Margin accounts operate much like a credit card for individuals, which allowed these investors to aggressively gamble on the China market upswing, but during the downdraft investors were forced to sell stocks to generate proceeds for outstanding loan repayments. It’s estimated that 25% of these investors only have an elementary education and a significant number of them are illiterate. Further exacerbating the sell-off were Chinese regulators artificially intervening by halting trading in about 500 companies on the Shanghai and Shenzhen exchanges last Friday, equivalent to approximately 18% of all listings.
Although China, as the second largest economy on the globe, is much more economically important than a country like Greece, recent events should be placed into proper context. For starters, as you can see from the chart below, the Chinese stock market is no stranger to volatility. According to Fundstrat Global Advisors, the Shanghai composite index has experienced 10 bear markets over the last 25 years, and the recent downdraft doesn’t compare to the roughly -75% decline we saw in 2007-2008. Moreover, there is no strong correlation between the Chinese stock market. Only 15% of Chinese households own stocks, or measured differently, only 6% of household assets are held in stocks, says economic-consulting firm IHS Global Insight. More important than the question, “What will happen to the Chinese stock market?,” is the question, “What will happen to the Chinese stock economy?,” which has been on a perennial slowdown of late. Nevertheless, China has a 7%+ economic growth rate and the highest savings rate of any major country, both factors for which the U.S. economy would kill.
Don’t Take a Financial Planning Vacation
While the financial markets continue to bounce around and interest rates oscillate based on guesswork of a Federal Reserve interest rate hike in September, many families are now returning from vacations, or squeezing one in before the back-to-school period. The sad but true fact is many Americans spend more time planning their family vacation than they do planning for their financial futures. Unfortunately, individuals cannot afford to take a vacation from their investment and financial planning. At the risk of stating the obvious, planning for retirement will have a much more profound impact on your future years than a well-planned trip to Hawaii or the Bahamas.
We live in an instant gratification society where “spend now, save later” is a mantra followed by many. There’s nothing wrong with splurging on a vacation, and to maintain sanity and family cohesion it is almost a necessity. However, this objective does not have to come at the expense of compromising financial responsibility – or in other words spending within your means. Investing is a lot like consistent dieting and exercising…it’s easy to understand, but difficult to sustainably execute. Vacations, on the other hand, are easy to understand, and easy to execute, especially if you have a credit card with an available balance.
It’s never too late to work on your financial planning muscle. As I discuss in a previous article (Getting to Your Number) , one of the first key steps is to calculate an annual budget relative to your income, so one can somewhat accurately determine how much money can be saved/invested for retirement. Circumstances always change, but having a base-case scenario will help determine whether your retirement goals are achievable. If expectations are overly optimistic, spending cuts, revenue enhancing adjustments, and/or retirement date changes can still be made.
When it comes to the stock market, there are never a shortage of concerns. Today, worries include a Greek eurozone exit (“Grexit”); decelerating China economic growth and a declining Chinese stock market; and the viability of Donald’s Trump’s presidential campaign (or lack thereof). While it may be true that stock prices are on a temporary vacation, your financial and investment planning strategies cannot afford to go on vacation.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
After an obituary of Mark Twain had been mistakenly published in the United States, Twain sent a cable from London stating, “The reports of my death have been greatly exaggerated.” Similar reports about the death of the stock market have been prematurely published as well. If you were to listen to the talking heads on TV or other self-proclaimed media pundits, the prevailing opinion is that rising interest rates will murder the stock market. In reality, the benchmark 10-Year Treasury Note has risen a whopping 0.23% so far this year. Could this be a start of a more prolonged increase in interest rates? It is certainly possible. Most investors have a very short memory because we have seen this movie before. It was just two short years ago that we witnessed a near doubling of 10-Year Treasury yields exploding from 1.76% to 3.03% in 2013. Did the stock market crater? In fact, quite the contrary. The S&P 500 index catapulted higher by a whopping +30%.
Even if we go back a litter further in recent history, interest rates were quite a bit higher. For example in early 2010, 10-Year Treasury yields breached 4.0%. Where was the Dow Jones Industrial index then? A mere 11,000 vs 17,850 today. Or in other words, when interest rates were significantly higher than today’s 2.40% yield, the stock market managed to climb +62% higher. Not too shabby, eh? As I have talked about in the past (see Don’t Be a Fool, Follow the Stool), there are other factors besides interest rates that are contributing to positive stock returns – primarily profits, valuations, and sentiment are the other key factors in determining stock prices. Suffice it to say, over the last five years, stocks have survived quite well in the face of multiple interest rate spikes; the 2013 “Taper Tantrum”; and the subsequent completion of quantitative easing – QE (see chart below).
Yield Curve on the Side of Bulls
Despite the trepidation over a series of potential Fed rate hikes, stocks continue to grind higher. If the fears are based on the expectation of a slowing economy on the horizon, then we would generally see two things happening. First, rising short-term interest rates would cause the yield curve to flatten, and then secondly, the yield curve would invert (typically a leading indicator for a recession). Currently, there are no signs of flattening or inverting. Actually, the recent better than expected jobs report for May (280,000 jobs added vs. estimate of 226,000) created a steeper yield curve – long-term interest rates increased more than short-term interest rates. Just as I wrote in 2009 about the recovery (see Steepening Yield Curve Recovery), right now the bond market is flashing recovery…not slowdown.
In the face of the mini-interest rate spike, bank stocks are also signaling economic recovery – evidenced by the 2.75% surge in the KBW Bank Index (KBX) last week. If there were signs of dark clouds on the horizon, a flattening yield curve would squeeze bank net interest margins and profits, which ultimately would send bank investors to the exit. That phenomenon will eventually happen later in the economic cycle, but right now investors are voting in the opposite direction with their dollars.
The media, economists, strategists, and other nervous onlookers will continue fretting over the Federal Reserve’s eventual rate increases. As long as dovish Janet Yellen is at the helm of the Fed, future rate increases will be measured, and rather than murdering the stock market, the policies will merely reflect a removal of the economy from artificial life support.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on ICContact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (June 1, 2015). Subscribe on the right side of the page for the complete text.
Despite calls for “Sell in May, and go away,” the stock market as measured by both the Dow Jones Industrial and S&P 500 indexes grinded out a +1% gain during the month of May. For the year, the picture looks much the same…the Dow is up around +1% and the S&P 500 +2%. After gorging on gains of +30% in 2013 and +11% in 2014, it comes as no surprise to me that the S&P 500 is taking time to digest the gains. After eating any large pleasurable meal, there’s always a chance for some indigestion – just like last month. More specifically, the month of May ended as it did the previous six months…with a loss on the last trading day (-115 points). Providing some extra heartburn over the last 30 days were four separate 100+ point decline days. Realized fears of a Greek exit from the eurozone would no doubt have short-term traders reaching for some Tums antacid. Nevertheless, veteran investors understand this is par for the course, especially considering the outsized profits devoured in recent years.
The profits have been sweet, but not everyone has been at the table gobbling up the gains. And with success, always comes the skeptics, many of whom have been calling for a decline for years. This begs the question, “Are we in a stock bubble?” I think not.
Most asset bubbles are characterized by extreme investor/speculator euphoria. There are certainly small pockets of excitement percolating up in the stock market, but nothing like we experienced in the most recent burstings of the 2000 technology and 2006-07 housing bubbles. Yes, housing has steadily improved post the housing crash, but does this look like a housing bubble? (see New Home Sales chart)
Source: Dr. Ed’s Blog
Another characteristic of a typical asset bubble is rabid buying. However, when it comes to the investor fund flows into the U.S. stock market, we are seeing the exact opposite…money is getting sucked out of stocks like a Hoover vacuum cleaner. Over the last eight or so years, there has been almost -$700 billion that has hemorrhaged out of domestic equity funds – actions tend to speak louder than words (see chart below):
Source: Investment Company Institute (ICI)
The shift to Exchange Traded Funds (ETFs) offered by the likes of iShares and Vanguard doesn’t explain the exodus of cash because ETFs such as S&P 500 SPDR ETF (SPY) are suffering dramatically too. SPY has drained about -$17 billion alone over the last year and a half.
With money flooding out of these stock funds, how can stock prices move higher? Well, one short answer is that hundreds of billions of dollars in share buybacks and trillions in mergers and acquisitions activity (M&A) is contributing to the tide lifting all stock boats. Low interest rates and stimulative monetary policies by central banks around the globe are no doubt contributing to this positive trend. While the U.S. Federal Reserve has already begun reversing its loose monetary policies and has threatened to increase short-term interest rates, by any objective standard, interest rates should remain at very supportive levels relative to historical benchmarks.
Besides housing and fund flows data, there are other unbiased sentiment indicators that indicate investors have not become universally Pollyannaish. Take for example the weekly AAII Sentiment Survey, which shows 73% of investors are currently Bearish and/or Neutral – significantly higher than historical averages.
The Consumer Confidence dataset also shows that not everyone is wearing rose-colored glasses. Looking back over the last five decades, you can see the current readings are hovering around the historical averages – nowhere near the bubblicious 2000 peak (~50% below).
Even if you’re convinced there is no imminent stock market bubble bursting, many of the same skeptics (and others) feel we’re on the verge of a recession – I’ve been writing about many of them since 2009. You could choke on an endless number of economic indicators, but on the common sense side of the economic equation, typically rising unemployment is a good barometer for any potentially looming recession. Here’s the unemployment rate we’re looking at now (with shaded periods indicating prior recessions):
As you can see, the recent 5.4% unemployment rate is still moving on a downward, positive trajectory. By most peoples’ estimation, because this has been the slowest recovery since World War II, there is still plenty of labor slack in the market to keep hiring going.
An even better leading indicator for future recessions has been the slope of the yield curve. A yield curve plots interest rate yields of similar bonds across a range of periods (e.g., three-month bill, six-month bill, one-year bill, two-year note, five-year note, 10-year note and 30-year bond). Traditionally, as short-term interest rates move higher, this phenomenon tends to flatten the yield curve, and eventually inverts the yield curve (i.e., short-term interest rates are higher than long-term interest rates). Over the last few decades, when the yield curve became inverted, it was an excellent leading indicator of a pending recession (click here and select “Animate” to see amazing interactive yield curve graph). Fortunately for the bulls, there is no sign of an inverted yield curve – 30-year rates remain significantly higher than short-term rates (see chart below).
Stock market skeptics continue to rationalize the record high stock prices by pointing to the artificially induced Federal Reserve money printing buying binge. It is true that the buffet of gains is not sustainable at the same pace as has been experienced over the last six years. As we continue to move closer to full employment in this economic cycle, the rapid accumulated wealth will need to be digested at a more responsible rate. An unexpected Greek exit from the EU or spike in interest rates could cause a short-term stomach ache, but until many of the previously mentioned indicators reach dangerous levels, please pass the gravy.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in SPY and other certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (May 1, 2015). Subscribe on the right side of the page for the complete text.
Looking back, in the race for financial dominance, the U.S. economy sprinted out to a relatively quick recovery from the 2008-2009 financial crisis injury compared to its other global competitors. The ultra-loose monetary policies implemented by the Federal Reserve (i.e., zero percent Fed Funds rate, quantitative easing – QE, Operation Twist, etc.) and the associated weakening in the value of the U.S. dollar served as tailwinds for growth. The low interest rate byproduct created cheaper borrowing costs for consumers and businesses alike for things like mortgages, refinancings, stock buybacks, and infrastructure investments. The cheaper U.S. dollar also helped domestically based, multinational companies sell their goods abroad at more attractive prices.
However, those positive dynamics have now changed. With the end of stimulative bond buying (QE) and threats of imminent interest rate hikes coming from the Federal Reserve and its Chairwoman Janet Yellen, the tailwinds for the U.S. economy have now transitioned into headwinds. The measly +0.2% growth recently reported in the 1st quarter – Gross Domestic Product (GDP) results are evidence of an economy currently sucking wind (see chart below).
As it relates to the stock market, the Dow Jones crept up +0.4% for the month of April to 17,841, and is essentially flat for all of 2015. Small Cap stocks in the Russell 2000® Index (companies with an average value of $2 billion – IWM), pulled a muscle in April as shown by the index’s -2.6% tumble. A slight increase in the yield of the 10-Year Treasury to 2.05% caused bond prices to contract a modest -0.5% for the month.
Beyond a strengthening dollar and threats of rising interest rates, debilitating port strikes on the West Coast and abnormally cold weather especially back east also contributed to weak trade data and sub par economic performance. Although a drop in oil and gasoline prices should ultimately be stimulative for broader consumer and industrial activity, the immediate negative impacts of job losses and declining drilling in the energy sector added to the drag on 1st quarter GDP results.
The good news is that many of the previously mentioned negative factors are temporary in nature and should self-correct themselves as we enter the 2nd quarter. One positive aspect to our country’s strong currency is cheaper imports. So, as the U.S. recovers from its temporary currency cramps, foreigners will continue pumping out cheap exports to Americans for purchase. If this import phenomenon lasts, these lower priced goods, coupled with discounted oil prices, should keep a lid on broader inflation. The benefit of lower inflation means the Federal Reserve is more likely to postpone slamming the brakes on the economy with interest rate hikes. The decision of when to lift interest rates will ultimately be data-dependent. Due to the lousy 1st quarter numbers, it will probably take some time for economic momentum to reemerge, and therefore the Fed is unlikely to raise interest rates until September, at the earliest.
The great thing about financial markets and economics is many of these swirling monetary winds eventually self-correct themselves. And during April, we saw these self-correcting mechanisms up close and in person. For example, from March 2014 to March 2015 the U.S. dollar appreciated in value by about +25% versus the euro currency (FXE). However, from the peak exchange rate seen this March, the value of the U.S. dollar declined by about -7%. The same self-correcting principle applies to the oil market. From the highs reached in mid-2014 at about $108 per barrel, crude oil prices plunged by about -60% to a low of $42 per barrel in March. Since then, oil prices have recovered significantly by spiking over +40% to about $60 per barrel today.
Competitors Narrow the Gap with the U.S.
As I’ve written many times in the past, one of the ultimate arbiters of stock price performance is the long-term direction of corporate profits. And as you can see from the chart above, profits have hit a bump in the road after a fairly uninterrupted progression over the last six years. The decline is nowhere near the collapse of 2008-2009, but given the rise in stock prices, investors should be prepared for the bears and skeptics to become more vocal.
And while the U.S. has struggled a bit, European and Asian shares have advanced significantly. To that point, Asian equities (FXI) spiked an impressive +16% in April (see chart below) and European stocks jumped a respectable +4% (VGK) over the same timeframe.
Bolstering the advance in China’s shares has been the Chinese central bank’s move to cut the amount of cash that banks must hold as reserves (“reserve requirements”). The action by the central bank is designed to spur bank lending and combat slowing growth in the world’s second largest economy. The Europeans are not sitting idly on their hands either. European central bankers have taken a cheat sheet page from the U.S. playbook and have introduced their own form of trillion dollar+ quantitative easing (see Draghi Provides Beer Goggles) in hopes of jump starting the European economy. Given the moves, how is the European business activity picture looking? Well, based on the Eurozone Purchasing Managers’ Index (PMI), you can see from the chart below that the region is finally growing (readings > 50 indicate expansion).
The economic winds in the global race for growth have been swirling in all directions, and due to temporary headwinds, the dominating lead of the U.S. has narrowed. Fortunately for long-term investors, they understand investing is a marathon and not a sprint. Holding a globally balanced and diversified portfolio will help you maintain the stamina required for these volatile and windy economic times.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), FXI, VGK, and a short position in FXE, but at the time of publishing, SCM had no direct position in IWM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.