Posts tagged ‘pullback’
End of the World or Status Quo?
If you were the chief executive of a newspaper, television, or magazine company, what headline stories would you run to generate the most viewers and readers? Which subjects will you choose to make me impulsively grab a magazine in the grocery line, keep me glued to the television news, or suck me in to click-bait advertisements on the web? For example, what topics below would you select to grab the most attention?
· Hurricane or Sunshine?
· High Speed Car Chase or Cat Saved from Tree?
· Bloody Murder or Baby’s Birthday?
· Messy Divorce or Wedding Celebration?
· Impeachment or Bipartisan Legislation
· End of the World or Status Quo?
If you selected the first subject in each pair above, you would likely gain much more initial interest. In choosing a winning topic, the saying goes, “what bleeds, leads.” In other words, scary or controversial stories always grab more attention than feel-good or status quo narratives. And that is why the vast majority of media outlets are drawn to negativity, just as mosquitos are attracted to bug zappers. This phenomenon can be explained in part with the help of Nobel Prize winner Daniel Kahneman and his partner Amos Tversky, who conducted research showing the pain from losses is more than twice as painful as are the pleasures experienced from gains (see chart below).
The significant volatility seen in the stock market recently from the Russian war/invasion of Ukraine is further evidence of how this fear dynamic can create short-term panics.
Although the stock market as measured by the S&P 500 index has gone gangbusters over the last three years, almost doubling in value (2019: +29%, 2020: +16%, 2021: +27%), the S&P 500 has hit an air pocket during the first couple months of 2022 (-8%), including down -3% in February. The year started with turbulence as investors became fearful of a Federal Reserve that is entering the beginning stages of interest rate hikes while cutting stimulative bond purchases. And then last month, the Russian-Ukrainian incursion made investors even more skittish. Like always, these geopolitical events tend to be short-lived once investors realize the impact turns out to be less meaningful than initially feared. As you can see below, the worst economic impact is forecasted to be felt by Russia (consensus on 2/24/22 of approximately a -1.0% hit to economic growth), more than twice as bad as the -0.2% to -0.4% knock to growth for the U.S., Europe, and the world (see chart below). The Russian hit will likely be worse after accelerated sanctions.
As it relates to Ukraine, many Americans don’t even know where the country is located on a map. Ukraine accounts for about only 0.14% of total global GDP (i.e., a rounding error and less than 1% of total global economic activity). Russia, although larger than Ukraine, is still a relative small-fry and represents only about 3% of total global economic activity. If you live in Europe during the winter, you might be a little more concerned about Vladimir Putin’s recent activities because a lot of Europe’s energy (natural gas) is supplied by Russia through Ukraine. For example, Germany receives about half of its natural gas from Russia (see chart below).
Russia, on the other hand, is larger than Ukraine, but the red country is still a relative small-fry representing only about 3% of total global economic activity. When it comes to energy production however, Russia is more than a rounding error because the country accounts for about 11% of global energy production (#3 country globally behind the United States and Saudi Arabia). By taking all these factors into account, we can confidently state that Russia and Ukraine have a very low probability of solely pulling the global economy into recession.
If history repeats itself, this conflict will turn out to be another garden variety decline in the stock market and an opportunity to buy at a discount. It’s virtually impossible to predict a short-term bottom in stock prices has been reached, but over the long-run, stock investors have been handsomely rewarded for not panicking and staying invested (see chart below).
At the end of the day, the daily headlines will continually attempt to sell the negative story that the world is coming to an end. If you have the fortitude and discipline to ignore the irrelevant noise, the status quo of normal volatility can create more exciting opportunities and better returns for long-term investors.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2022). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing 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.
Movie Deja Vu – Coronavirus
I have seen this movie before. I love the stock market, but I do actually have other outside interests, including seeing movies. What better indoor winter activity than watching movies?! The Hollywood excitement continues this Sunday for the 92nd Academy Awards. My popcorn consumption has been generous this year as I have seen seven of the nine Best Picture nominated films with the exception of Jojo Rabbit and Little Women.
With a lifetime of movie watching under my belt, there is no shortage of redundant movie themes, whether it’s happy endings in romantic comedies, triumphant patriotism in war flicks, or gory blood spatters in horror films. Just as repetitive as these story lines have been in films, the redundant theme of pandemic health panics continues to plague investors every time a new contagious disease is announced. The newest debut is coronavirus. While coronavirus is playing on the big screen, the presidential impeachment trial, and January 31st Brexit deadline have been sideshows. Stay tuned for that breaking news!
Doctor Wade’s Diagnosis
Although I have not added M.D. to my list of professional credentials (CFA, CFP), Dr. Wade has enough medical experience to identify historical patterns. Most recently, the media covering the Wuhan coronavirus originating in the central Chinese province of Hubei (see map below) has unnecessarily terrorized the global masses with F.U.D. (Fear, Uncertainty, Doubt). While we likely know the ending of this health scare movie (i.e., humanity survives and life goes on), the timing, and scope remain uncertain.
2020: Sickness After Healthy Start
After an healthy start to the 2020 stock market show (S&P 500 index zoomed +3.3% higher), investors viewing the coronavirus plot unfold subsequently were sickened with an S&P decline of -3.4% to finish the month slightly down from year-end (-0.2% from December 31st to January 31st). The Dow Jones Industrial Average was hit slightly worse, down 282 points for the month to 28,256, or -1.0%.
How do we know this infectious coronavirus disease scare shall too pass? Well, over the last few decades, there have been many more lethal diseases that have been put to bed. Here’s a list of some of these high profile, safely-controlled infectious diseases:
- Severe Acute Respiratory Syndrome (SARS)
- Middle East Respiratory Syndrome (MERS)
- Ebola
- Zika Virus
- Bird Flu
- Swine Flu
- H1N1 Virus
- Mad Cow
- Hoof-and-Mouth
A chart comparing the severity and timing of some of the major viruses can be seen below.
While the human impact has been tragic, coronavirus has also struck a blow to the global economy. The pandemic prequel that mostly closely matches coronavirus is SARS, which also originated in China during 2003 in the province of Guandong. Most notable to me is the fatality rate for coronavirus of just 2.2% versus 9.6% for SARS. While coronavirus is less deadly than SARS, coronavirus is objectively more contagious than SARS and could have an incubation period of 14 days (significantly longer than SARS, which could increase the rate of infections). In fact, there were more confirmed cases of coronavirus in one month than all the reported cases of SARS identified over a span of nine months. Even so, as the chart shows, coronavirus deaths remain the lowest.
Economic Impact
The damaging economic impact of the coronavirus pandemic continues to escalate rapidly on a daily basis as governments, global health agencies, corporations, and individuals respond. Even though coronavirus appears to be much less lethal than SARS, we can scale current economic estimates based on the relative costs incurred during SARS. Some reports show the 2003 SARS situation costing the global economy $40 – $60 billion and 2.8 milllion Chinese jobs, while the potential hit in lost global growth from coronavirus could total $160 billion, according to Warwick McKibbin, a Australian National University economics professor.
The Chinese government fully realizes the amount of financial destruction caused by the SARS outbreak, and therefore is not sitting idly as it relates to the coronavirus. Back during SARS, the government did not institute quarantine measures nor publish the SARS’ genome (necessary to test and track virus) until four months had passed. After the first coronavirus patient was diagnosed around December 1st (two months ago) and the spread of the virus accelerated, the Chinese local governments expanded mandatory factory shutdowns for the Lunar New Year from January 31st to February 9th. What’s more, Wuhan, a city of 11 million residents at the epicenter of the illness, recently closed the area’s outgoing airport and railway stations and suspended all public transport. Chinese government officials have since extended the travel ban to 16 neighboring cities with a combined population of more than 50 million people, including Huanggang, a city next to Wuhan with 7.5 million people, essentially placing those cities on lock down.
Private companies are taking action as well. Companies such as Disney, Tesla, Amazon, Google, Apple, McDonalds, Starbucks, and more than a dozen airlines, cruise lines, casinos, and other global companies with significant footprints in China are suspending operations, temporarily shutting factories and instituting travel restrictions.
No Need to Panic Yet
Before you quarantine yourself in your basement, and take full-body showers in hand sanitizer, let’s take a look at some of those annoying things called facts:
- There have been zero (0) coronavirus deaths in the United States, and eight diagnosed cases (at time of press).
- There have been approximately 10,000 Americans killed by the flu since October 2019.
Apparently casual American observers are unable to filter out the true signals being lost in the avalanche of blood-curdling, panicked virus headlines. Tufts Medical Center infectious disease specialist Dr. Shira Doron highlighted this message when she stated the following, “The likelihood of an American being killed by the flu compared to being killed by the coronavirus is probably approaching infinity.” Of the limited number of coronavirus deaths thus far, one study of 41 Wuhan coronavirus death cases showed the median age is around 75 years old. For most people (i.e., those who are not elderly or young children), I guess the moral of this story is to turn the TV off, go get your flu shot, and fall asleep with few worries.
There may be some more coronavirus pain and suffering ahead until this tragic human and economic pandemic comes under control. During the SARS outbreak (November 2002 – July 2003), peak-to-trough stock prices temporarily fell by -16% before marching upwards to new record highs. However, if this movie finishes like so many other similar infectious diseases, the coronavirus fever should break soon enough, and investors will be satisfied with new opportunities and another happy ending to the story.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 3, 2020). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFS) and DIS, TSLA, AMZN, GOOGL, AAPL, and MCD, but at the time of publishing had no direct position in SBUX 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.
Stocks Take a Breather after Long Sprint
Like a sprinter running a long sprint, the stock market eventually needs to take a breather too, and that’s exactly what investors experienced this week as they witnessed the Dow Jones Industrial Average face its largest drop of 2013 (down -2.2%) – and also the largest weekly slump since 2012. Runners, like financial markets, sooner or later suffer fatigue, and that’s exactly what we’re seeing after a relatively unabated +27% upsurge over the last nine months. Does a -2% hit in one week feel pleasant? Certainly not, but before the next race, the markets need to catch their breath.
By now, investors should not be surprised that pitfalls and injuries are part of the investment racing game – something Olympian Mary Decker Slaney can attest to as a runner (see 1984 Olympic 3000m final against Zola Budd). As I have pointed out in previous articles (Most Hated Bull Market), the almost tripling in stock prices from the 2009 lows has not been a smooth, uninterrupted path-line, but rather investors have endured two corrections averaging -20% and two other drops approximating -10%. Instead of panicking by locking in damaging transaction costs, taxes, and losses, it is better to focus on earnings, cash flows, valuations, and the relative return available in alternative asset classes. With generationally low interest rates occurring over recent periods, the available subset of attractive investment opportunities has narrowed (see Confessions of a Bond Hater), leaving many investing racers to default to stocks.
Recent talk of potential Federal Reserve bond purchase “tapering” has led to a two-year low in bond prices and caused a mini spike in interest rates (10-year Treasury note currently yielding +2.83%). At the margin, this trend makes bonds more attractive (lower prices), but as you can see from the chart below, interest rates are still relatively close to historically low yields. For the time being, this still makes domestic equities an attractive asset class.
Source: Yahoo! Finance
Price Follows Earnings
The simple but true axiom that stock prices follow earnings over the long-run is just as true today as it was a century ago. Interest rates and price-earnings ratios can also impact stock prices. To illustrate my argument, let’s talk baseball. Wind, rain, and muscle (interest rates, PE ratios, political risk, etc.) are factors impacting the direction of a thrown baseball (stock prices), but gravity is the key factor influencing the ultimate destination of the baseball. Long-term earnings growth is the equivalent factor to gravity when talking about stock prices.
To buttress my point that stock prices following long-term earnings, consider the fact that S&P 500 annualized operating earnings bottomed in 2009 at $39.61. Since that point, annualized earnings through the second quarter of 2013 (~94% of companies reported results) have reached $99.30, up +151%. S&P 500 stock prices bottomed at 666 in 2009, and today the index sits at 1655, +148%. OK, so earnings are up +151% and stock prices are up +148%. Coincidence? Perhaps not.
If we take a closer look at earnings, the deceleration of earnings growth is unmistakable (see Financial Times chart below), yet the S&P 500 index is still up +16% this year, excluding dividends. In reality, predicting multiple expansion or contraction is nearly impossible. For example, earnings in the S&P 500 grew an incredible +15% in 2011, yet stock prices were anemically flat for that year, showing no price appreciation (+0.0%). Since the end of 2011, earnings have risen a meager +3%, however stock prices have catapulted +32%. Is this multiple expansion sustainable? Given stock P/E ratios remain in a reasonable 15-16x range, according to forward and trailing earnings, there is some room for expansion, but the low hanging fruit has been picked and further double-digit price appreciation will require additional earnings growth.
Source: Financial Times
But stocks should not be solely looked through a domestic lens…there is another 95% of the world’s population slowly embracing capitalism and democracy to fuel future dynamic earnings growth. At Sidoxia (www.Sidoxia.com), we are finding plenty of opportunities outside our U.S. borders, including alternative asset classes.
The investment race continues, and taking breathers is part of the competition, especially after long sprints. Rather than panic, enjoy the respite.
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.
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