I probably don’t have to re-hash for you what’s been happening in the markets over the past couple of weeks as we’ve suffered what feels like the worst decline in the markets since they recovered in March 2009. The media does a pretty good job of instilling fear and I don’t expect the newspaper headlines to be happy ones on Friday morning. So let me give you my take on what’s going on and what I’m expecting.
Coming into this week amid the uncertainty over the passage of the debt ceiling vote in Congress, we had already endured about seven days of selling in the markets that seemed to pick up steam on Monday. The euphoria on Sunday evening over a possible debt deal in Congress was over within minutes of Monday’s market open and the selling began in earnest. So what gives? If a deal was such a good thing, why did the markets sell off on the news and passage of the increase in the debt ceiling?
In reality, the significance of the debt ceiling vote was elevated by the media, and while it added to market anxiety, many were actually more concerned about the signs of slowing in the economy. The usual concerns over jobs, housing, spending and overall goverment regulation of business have been weighing on consumer and business confidence for a few months now. Downward revisions in the gross domestic product for past and future quarters haven’t help encourage companies to hire or spend on capital improvements. Once the focus was taken off the debt ceiling issue, the economic concerns were brought to the forefront.
Another Recession Already?
You’ll hear talk in the media about whether we’re heading for another recession this year, whether we’re already in a new recession or whether the recession never ended. As for the last two assertions, the economic statistics simply don’t support the notion that we’re in a recession. As for whether we’re heading for another recession in 2011, so far, the economic statistics don’t support that either (though some unfortunate members of the unemployed or those under water on their mortgages may not agree.) While we’re seeing a slowing of economic output, hiring and capital spending, we have not seen any evidence of negative or no growth. Could we see one in 2012? Anything’s possible, but no one can predict this; not even me.
My take on all this is that while the recovery has been anemic, I don’t believe that we’re heading for a recession this year. While I’m no economist, the Japan earthquake, Eurorpean and U.S. debt “crises” and other weather related factors have really thrown 2011 for an economic loop. When you consider that fiscal stimulus takes 18-24 months to make it out of the capital markets into capital spending, we may just be experiencing a temporary slowdown in growth.
As an example, commercial traders of lumber futures deny a slowdown in demand, and that usually doesn’t happen if a recession is around the corner. Corporate profits are at record highs (thanks to a dearth of hiring) and many are raising estimates of earnings for the next quarter. Credit is cheap and readily available, and companies are buying other companies and their own stock back at record levels. With the Federal Reserve on the side of the consumer, you’d be hard pressed to bed against them. So I believe that reports of an impending recession may be a bit exaggerated.
So What Happened Today?
To be honest, I came into my office today fully expecting an “up” day in the markets since we finally “bounced” yesterday. All technical indicators pointed to a severely “oversold” market (a market where selling is exhausted in the short term) that we were ready to bounce higher. In fact, I had prepared and positioned for it.
But overnight, Japan intervened in the capital markets to stem the seemingly unstoppable rise in the value of the Yen (which adversely affects their exports) right after Switzerland lowered their short-term interest rates to near zero yesterday (just like the United States). In addition, brewing concerns over Italian and other European debt problems were not helped by ambiguous comments made by the head of the European Central Bank on how they are dealing with their crisis. Suffice to say, with a 400,000 print in the weekly unemployment figures reported today, we were down from the start and never looked back.
As so often happens on a day when everyone starts to sell, the selling feeds upon itself and others join in. While we didn’t see any moments of panic, the selling was steady and relentless all day. What started out with gold and silver making highs in the morning ended the day with both at their lows.
Why? I believe it was because of forced selling and margin calls. When margin account balances need to be replenished, the most liquid of assets (like gold, silver and even Apple Stock) get sold off to cover the margin. So while there is nothing fundamentally wrong with many stocks and funds, they get sold along with everything else to raise cash for margin calls and for mutual fund shareholder requests for liquidations.
So Now What?
Despite the intense selling over the past couple of weeks, the S&P 500 is only 10% from the highs this year, just right in correction territory. You may recall that the markets corrected 16% last summer, and that’s never fun. Many then were predicting a double-dip recession around the corner and a return to a bear market. Neither of those happened; instead we moved up 30% to new highs in May. While past performance is no guaranteee of future results, I still don’t see any impending techincal signs that we are entering into a new bear market phase right now. If I did, I would be taking appropriate action. However, though this could change on any particular day, I believe this bull market still deserves the benefit of the doubt.
At the moment, as alluded to above, the market is extremely oversold and should bounce over the next few days. After that, it’s anyone’s guess what might happen, but I suspect that the remainder of the summer and into early fall will remain choppy, volatile and “lean” with a negative bias. While I expect more short-term downside, I don’t think panic selling is the right response now. While you may choose to cull some profitable positions, it may already be too late to sell most. As always, you should check with your financial advisor (or us) about the right course of action for your portfolio. Remember, no one can guess how high or low a market can go.
To be certain, I was not expecting the kind of response that we got from the market this week. But I could not foresee the actions and responses from central banks around the world either.
For our client portfolios, I’ve been keeping a good portion of investable funds in cash and had liquidated some positions ahead of this decline. Of course, I wish I had liquidated more, but alas, my crystal ball is still in the shop.
I’ve been wanting to put on some hedges via inverse ETF’s for some time now. But those funds are “too hot to handle” right now and with an oversold bounce overdue, they would only compound losses in the short term. Other hedges are also way too expensive right now as volatility is at 52 week highs. I usually like to wait for a bounce in the markets before putting on hedges, but the only bounce we got yesterday was a bit tepid and shorter than expected. I will look to put them on as soon as market conditions allow. If the selling continues in the short term as I expect, then I’ll look to lighten up other positions as appropriate as well.
On Friday, we’ll get the monthly jobs report for July, which is widely expected to be lousy and show a continued unemployment rate of 9.2%. Any selling that transpires in the morning will more likely result from margin call covering rather than a reaction the jobs number (or if we get more bad news overnight from Europe).
Please be sure to contact me if you have any questions or concerns about the markets. I’ll be happy to help, but please don’t take action based on the contents of this message. It’s not my intent to render actionable financial advice to anyone pursuant to investment advisor restrictions and regulations.
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