What’s Going on in the Markets June 7, 2020

Over the past week, the stocks of American Airlines, United Airlines and Delta Airlines were up 77%, 51% and 35% respectively. In addition, the stocks of Norwegian Cruises, Carnival Cruises and Royal Caribbean Cruises were up 43%, 37%, and 34% respectively.

But none was more bizarre than the stock of Hertz Car Rental, which was up a whopping 157% on the week. Now it’s not unusual for a cheap stock trading for $1.00 a share to double or triple in a week. But it is unusual when the company has already declared bankruptcy, meaning that stockholders will likely receive nothing in the reorganization.

In what I can only describe as a bit of overexuberance in a world where many don’t plan to get on an airplane in the next 12 months, and others who say they’ll never step foot on a cruise ship in their lifetimes again, can I say that the recent rally is getting a little “bubblelicious”?

That’s all to say that I cannot remember a time when I’ve seen such a widespread disparity between what is happening in the economy and what is happening in the stock market.

Let’s take a few moments to briefly outline the situation using hard data.

  • The unemployment rate soared to a post-depression high of 14.7% in April, while the survey of businesses by the U.S. Bureau of Labor Statistics revealed a loss of 20.5 million jobs in April, the worst monthly reading since records began in 1939.
  • In a single month, nearly all of the jobs created after the financial crisis disappeared, at least temporarily.
  • Then on Friday we got the May Jobs report and we were surprised that the economy had created 2.5 million jobs and the unemployment rate had actually declined to 13.3%. While 13.3% unemployment is a “depression-like” number, it was far better than numbers projected by economists: a loss of 7.5 million jobs and a 20% unemployment rate. To paraphrase Yogi Berra: “forecasting is hard, especially when it’s about the future”.
  • April’s 11.2% drop in industrial production, a metric the Federal Reserve has tracked since 1919 – is the biggest monthly decline on record. Furthermore, consumer spending in April fell 13.6%, the biggest decline ever recorded (U.S. BEA, data back to 1959).
  • The Institute for Supply Management’s (ISM) Manufacturing Index and the ISM Services Index both showed a slight improvement in May; however, both segments remain deep in contraction territory.
  • Record layoffs continue, with the number of first-time claims for unemployment insurance topping 40 million over a 10-week period ending May 23. Put another way, nearly one in four working Americans have experienced a job loss.

If there is any good news, it is that the number of first-time filings has been declining, and the number of individuals who re-certify on a regular basis in order to continue receiving jobless benefits is about half the number of first-time filings.

This would suggest that the economic injury disaster loans and payroll protection program loans are kicking in, and re-openings are encouraging businesses to recall furloughed workers.

Let’s Back Up Again for a Moment

  • In April, in just a three-week period, the number of first-time claims for jobless benefits totaled an astounding 17 million. For perspective, during the 18-month-long 2007-2009 recession…first-time claims totaled 9.6 million.
  • Yet the Dow Jones Industrial Average added 2,107 points over the three Thursdays when the massive number of new claims were released.
  • Since then (April 9), the Dow has added 3,600 points, or 15.0%. It is up 49% since its near-term March 23 bottom.
  • The broader-based S&P 500 Index eclipsed 3,000 by the end of May and has rebounded nearly 46% from its March 23 low to near 3,200.
  • Meanwhile the tech-heavy NASDAQ Composite has added 48%, is back above 9,800, and has already surpassed its all-time high.

Simply put, economic activity is falling with depression-like speed, but the major averages are in the midst of an historic rally.

Here’s one more piece of performance data:

  • During the financial crisis, the S&P 500 Index lost nearly 57% from its October 2007 peak to the bottom in March 2009. This year, in about one month, the S&P 500 Index shed 34% before hitting a near-term bottom on March 23.

The adage “stocks climb a wall of worry” has never been more appropriate amid economic devastation and an outlook that remains incredibly murky.

A Closer Look at the Wall Street/Main Street Disconnect

A combination of factors has fueled the rally since late March.

The response by the Federal Reserve has far outpaced its 2008 response, which has lent a tremendous amount of support to stocks. The same can be said of government fiscal stimulus.

Investors are also keeping close tabs on state re-openings, which will re-employ furloughed workers, help stabilize the economy, and set the stage for a possible economic rebound later in the summer. Talk of possible vaccines has also helped.

You see, investors don’t simply look at today’s data, which in many cases is backward-looking. Instead, they are forward-looking as they attempt to price in economic activity, the level of interest rates, corporate profits, and more over the next 612 months.

An Approaching Dawn

If we look at what is called “high-frequency economic data” (daily or weekly reports), we are starting to see signs of stability.

Daily gasoline usage has rebounded (Energy Information Administration), daily travel through TSA checkpoints is up, hotel occupancy is off the bottom, and the same can be said of weekly box office receipts (Box Office Mojo).

In addition, the weekly U.S. MBA’s Purchase Index (home loan applications) registered its fifth-best reading over the last year (as of May 22), suggesting that low-interest rates and some confidence that the U.S. economy is set to recover are lending support to housing.

Of course, these are highly unconventional measures of economic activity and are industry-specific. Outside of the Purchase Index, each remains well below previous highs, but the turnaround suggests we may be seeing some light at the end of a very dark tunnel.

Collective Wisdom

Any given level of a major stock market index represents the collective wisdom of tens of millions of stock market investors. It is not simply an opinion, but an opinion with money behind it. That’s an opinion worth listening to.

When stocks were in a free fall in March, investors were anticipating a devastating blow to the economy. Tragically, the data did not disappoint.

But has the rally been too much, too quickly?

Even in the best of times, economic forecasting can be difficult (refer to earlier Yogi Berra quote). Today, the outlook is clouded with a much greater degree of uncertainty.

  1. Will the virus lay down over the summer?
  2. How will re-openings proceed?
  3. How quickly can a readily available vaccine and treatment be developed?
  4. What might happen to COVID-19 next fall and winter?
  5. How quickly will consumers venture back in public and resume prior spending patterns?

These are difficult questions to answer.

I don’t expect a return to a pre-COVID jobless rate anytime soon. But investors are betting that an economic bottom is in sight or has already occurred.

I understand the uncertainty facing all of us and I don’t underestimate the enormous amount of work that has to be done or the difficulties we’ll encounter in getting back to “normal”. We are grappling with an economic and a health care crisis, not to mention recent civil unrest. It’s a combination none of us have ever faced.

A New Bull Market or the Most Epic of all Bear Market Rallies?

For our clients’ portfolios, I know that I will spend years analyzing the last few months and scrutinizing our moves. I’m pleased that we entered 2020 with a defensive stance that served us well. I’m also pleased that we followed our rules in further reducing portfolio risk and increasing hedges as we saw fit as the decline kicked into high gear. I’m very pleased that we held firm with our core holdings, never wavering from our belief that our core assets would ultimately be just fine, dividends would continue to accrue and that the foundation of our portfolios remained intact.

As we moved through the crash methodically with a steady hand and calm head,  I’m also pleased that not a single client panicked, and those that stuck with their investment plans and did not decide to tinker with their portfolio risk “on the fly” fared the best among our clients. Those that paid attention to the media (who regularly try their best to scare us witless), and who insisted on reducing their risk near the bottom and not follow their own investment plan still fared OK but cost their portfolios dearly. 

So I guess I’ll say it again: Neither they, you, or I know what’s going to happen next, no matter how smart we are. All we can do is watch the price action, put probabilities in our favor, and pay heed to risk. Ultimately, we’re in the risk management business, not the prediction business.

What I’m not as pleased about is that we didn’t more aggressively buy the panic that ensued in the market. Of course, this is easy to say in hindsight. It was my plan to do so, but the bounce proceeded too quickly and the shallow pullbacks did not allow for the necessary low-risk entries that I was planning for. While we bought some investments lightly on the way down and also on the way up, with the benefit of hindsight, we could have more aggressively reduced hedges and ramped up buying. 

I’m also not pleased that I underestimated the power of the Federal Reserve and found myself being overly moderate. Of course, the next few months could prove my current sentiment to be completely wrong and the gains quickly reverse. As it stands, it is my plan to increase our overall investment levels based on the “quality” of the next pullback.

Towards that end, if this is truly a new bull market, and the recession turns out to be one of the shortest ones on record, then the next pullback should be of the 5%-10% variety, and will give us a low-risk way to increase stock market exposure further.  If instead, this has been the “mother” of all bear market rallies, then our continued defensive stance will serve us quite well. Only time will tell.

Short-term, the market is a bit overheated, so a pullback could ensue any day now. For those who are phasing back into the market, or who need to rebalance their portfolio, it may be advantageous to wait for the pullback.

As we move forward from here, I’ll be the first to admit that I still have no idea how this all plays out into the remainder of 2020. From the coronavirus, we have now moved to national demonstrations and riots which are affecting cities all across America. In just a few months we’ll be heading directly into a presidential election. If that’s not a recipe for elevated volatility for the rest of the year, I don’t know what is.

On the investment horizon, I can tell you that this bust/ boom cycle we’ve just witnessed has solidified, more than ever, just how important it is to have a portfolio diversification not only in different asset types, but also across time-frames (i.e., short term, medium-term and long-term investments). It has solidified the idea that a client’s risk tolerance is much more important than age-based risk tolerance, and that I plan to spend more time in client meetings making sure that clients truly understand and accept their overall risk. As a firm, we’ll continue looking to do more of the things that have worked for us and less of the things that didn’t.

Bottom Line

Fueled by record amounts of stimulus in both monetary and fiscal policy, stocks have continued to move higher in spite of the ongoing economic damage. This disconnect between the economy and the stock market has confounded many analysts due to the fact that there is typically a tight link between the two. And while it’s key to understand the additional dynamics which affect the stock market, this divergence (between the economy and stock market) represents a high degree of risk which continues to warrant a defensive portfolio stance.

As always, I’m honored and humbled that you’re devoting time to read what I’m writing and/or given me the opportunity to serve as your financial planner/advisor. If you have any questions or would like to discuss any financial matters, please feel free to give me a call.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets March 28, 2020

The unprecedented market volatility continued as Friday’s downside action capped off an otherwise strong week. A robust three-day bounce of about 20% from Monday’s lows saw us give back roughly 1/4 of the weekly gains on Friday.

Still, in all, it was a great week for the bulls. The stock market, as measured by the S&P 500 index, gained about 10.25%, reclaiming about 1/3rd of the bear market losses incurred over the prior four weeks. This doesn’t mean, however, that the bulls are out of the woods and ready to run free in the fields. Bear markets rarely end after only five weeks, especially when volatility remains as high as it currently is.

So far what we’ve witnessed this week seems to be classic bear market action. Whenever the markets get so far stretched to the downside, just like a rubber band, some sort of snap-back action is to be expected. Indeed, as I’ve described in previous postings, a “wicked rip your face off rally of 20-50%” was to be expected. So yes, we could get more upside in the short term.

What we have experienced in the markets over the past five weeks is a “waterfall” decline followed by a robust bounce that gets many investors to think that the worst may be over. Most of the time, after convincing many that it’s safe to jump back in, we get a reversal of the bounce. If, in turn, the reversal plays out in traditional fashion, then the lows that were hit this past Monday will eventually be revisited and tested to see if they’ll hold.

If the lows don’t hold, then anyone buying into the bounce will be holding “losers” and will likely join the selling with anything they bought into the bounce and then some. If the lows do hold, then we will likely see a more durable (lasting) rally which may confirm that the worst of the decline is over for the intermediate-term. That may be the “safer” time to make more meaningful additions to your portfolio (but check with your investment advisor or talk to us).

The optimists are hoping that the massive fiscal and monetary stimulus will backstop stocks and prevent that retest from occurring, or that Monday’s lows will hold. The pessimists are concerned that the uncertainty of the coronavirus and its economic consequences will keep buyers on the sidelines, and that more sellers will emerge.

The response of both the Federal Reserve and the federal government has been unprecedented. The Federal Reserve outright stated this week that it’s willing to provide unlimited monetary stimulus, announcing program after program, as its balance sheet exceeds $5 trillion for the first time. That’s $5 trillion with a “T”.  Yes, $5,000,000,000,000. Pause for a moment and let that number sink in. I’ll wait.

Similarly, the $2 trillion stimulus package passed by Congress and signed by the President on Friday is more than double the $800 billion package passed in 2009 to ease the Great Recession. These efforts will dampen the economic fallout that has already begun to take place, but the full impact that will be realized is still largely unknown. I believe that more stimulus is going to be necessary.

The somewhat expected explosion in jobless claims on Thursday to a record 3.3 million (it had been averaging about 220,000-230,000 for many weeks) coupled with Friday’s sharp drop in reported Consumer Sentiment (no surprise given what’s going on in the world) indicates that the ongoing economic damage will likely be significant.

While Monday may possibly have marked an intermediate-term bottom in the market, it remains to be seen if the risks which were identified in prior posts (e.g., stock market and real estate overvaluation, low-quality corporate debt levels at a record high, yield curve inversion) will be unwound or not. The excesses that have been built up over the course of this economic cycle in terms of stock market overvaluations, inflated housing prices, and low-quality corporate debt remain in place for the most part and are clearly risks going forward. The depth and duration of this recession will be determined primarily by what happens in these key areas of vulnerability.

As we navigate through this extreme volatility, we will depend on key technical indicators to confirm whether or not Monday’s low was the bottom. Because I have serious doubts that this is the case, we used the bounce this week to reduce our overall investment allocations to stocks and exposure to riskier corporate bonds for clients. The next several weeks should provide valuable insight into whether breadth (the number of stocks going up versus the number of stocks going down) and leadership are truly stabilizing, and just how much of the economic risk is actually behind us.

While we are seeing unprecedented government support, we are also experiencing an unprecedented event that will have ramifications for every single person in the world. It would be quite foolish to believe that this monumental event can be priced into the market very quickly or easily.

At some point, there will be exceptional opportunities and they will be even better if we remain patient and wait for sustained positive price action to develop. While this extreme volatility may be good market action for very short-term stock market traders, if you’re looking to build longer-term positions, it is still too early to put any substantial capital at risk.

Nibbling a little on stocks “here and there” is OK, but I recommend that you never buy a full position at once. Always ask yourself if you’re comfortable holding the position and adding to it if it went down by another 25-40%. If you’re not comfortable doing that, then it’s too soon for you to buy because you’ll likely sell at the worst possible time.

Enjoy the weekend and please stay safe. I am here to answer any questions you might have.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

What’s Going on in the Markets March 23, 2020

As if we didn’t have enough adjectives to describe the week before last’s market action (unprecedented, brutal, relentless), there must be no more words to describe the terrible equity markets again last week, as a massive 4000-point drop in the Dow Jones Industrial Average (DJIA) was second to only one other over the last nine decades.

The other indexes (S&P 500, NASDAQ, Russell 2000) didn’t fare much better either, as the losses posted by the average stock and every market gauge over the last month have been staggering. I’m not going to sugar-coat it: this has been one ugly market.

Indeed, we are now in Bear Market #26 over the last 90+ years, and though the speed of this sell-off has been unparalleled, the magnitude of the decline (at least for the S&P 500 index) at present is a bit less than average. Unfortunately, that doesn’t mean it can’t get worse, but it also doesn’t mean it can’t get better.

Over the past year, as I met with clients for our annual reviews, I sheepishly explained the large cash positions and growing hedges (options sold against the portfolio and bear market funds), why I and other portfolio managers felt that there were very few good values in the market and that we were under-invested for good reasons. Heck, even the most seasoned of portfolio managers weren’t buying the best value stocks out there, and growth stocks trounced the returns on value stocks for years. Stocks like Microsoft, Apple, Facebook, Tesla, Google, Amazon, Netflix all marched higher on a seemingly daily basis, while great blue-chip value stocks like Haliburton, Schlumberger, CVS, and IBM languished in the bargain bin.

As I met with prospects over the past year, I know that I lost the business of at least two of them that had 90%+ exposure to the stock market. When I was asked what my plan would be for their portfolios, I explained that their portfolio risk far outweighed their personal risk tolerance and that I would immediately and significantly lighten up on stocks and stock funds. Needless to say, when I heard back from them, they said my approach was too conservative and decided to “go in a different direction”. I can only hope that they heeded my warning.

Day after day, week after week, month after month (after the December 2018 low), the markets would question my defensive stance, and no doubt quite a few clients were unhappy being under-invested and not making as much money as the markets were. Every market pullback from a new record high was aggressively bought up, and we had no choice but to nibble here and there, knowing that we might have to stay close to the exits on those purchases. I’ve been doing this a long time, and as I’ve said before, I’ve not witnessed such persistent selling without a robust bounce ever in my career, making unscathed exits nearly impossible.

What’s Next?

That’s enough about what’s happened. Most are interested in what’s ahead. More pain or gain?

Unfortunately, the market loathes uncertainty, and with the COVID-19 shutdown of most swaths of the nation’s economy, uncertainty is what we have in droves. Stocks trade on corporate earnings forecasts, and to-date, most companies have withdrawn their forecasts because of so many unknowns.

The stock market is what’s known in portfolio management vernacular as “a forward-looking discounting mechanism”, where the crowd sniffs out what’s to come 6-12 months in the future. Everything you know as fact today is already factored into the market, or so goes what’s known as “Modern Portfolio Theory”. When the markets are rising, they’re looking ahead 6-12 months out and forecasting what’s to come, and they must be positive on the intermediate-term future. The opposite is true as well.

What we’re witnessing in the daily “thrashings” up and down in the stock markets is the manifestation of the uncertainty as everyone tries to price stocks for “what’s next”. My best guess is that we’re still in for a rocky bottoming period with new lower lows likely ahead.

But it’s not all gloomy. While last week’s markets closed on the lows, we did see some “green shoots” to indicate that the volume of selling was waning, and there was some risk appetite returning to the markets. The small-capitalization stocks, often the riskiest of stocks, outperformed their “peers” on Friday. The volatility index did not make a new high on Friday. The number of stocks hitting their 52-week lows did not expand into the end of the week. And the number of stocks going up versus those going down got better (it’s called breadth in this business).

When Should We Buy?

I’m heartened and encouraged that, among the calls and e-mails that I received last week, the preponderance of them were asking, “when should we buy?” It’s the right question now, as we continue to navigate this volatile bear market, of when it will be safe to start buying.  In that regard, history can provide valuable guidance.

The 1987 bear market is one historical precedent that is perhaps most like today’s. Major indexes came off an equally frothy rally (as we’ve seen since December 2018) with the S&P 500 showing a strong year-to-date gain leading up to the August 25, 1987 peak. The bear market unfolded quickly after the top, losing 20% in just 38 days (this one in 2020 took 19 trading days). The bear market bottomed in December 1987 as selling pressure abated significantly and buying pressure took over. That led to one of the longest-running bull markets in history.

The Financial Crisis from 2007 to 2009 was a more protracted downturn that lasted 18 months. The lessons from that bear market include the observation that there are often enticing rallies on the way down which are called “bull traps”, such as the rebounds in March and July of 2008. Don’t get sucked into them.

As market losses deepen, it’s crucial to remember that headlines are the gloomiest near the market bottom, so paying attention to the media in March 2009 would have kept you out of the market for months, and you would have missed out on a 50% rally within just a few months. This time it’s no different — the fear mongers are out in full force with their 50% negative growth forecasts and S&P 500 index going to 1100 (down 75%) prognostications.

Stock market leadership is one of the most reliable indicators that a bear market bottom is in place. As a new bull market emerged in 2009, abating selling pressure and emerging buying pressure again provided the timeliest signal to start buying. Our client portfolios back then were defensively allocated with an invested position of about 50% (of maximum risk) at the March 9 bottom. As the selling abated and buying pressure ramped up, we quickly stepped up to 77% and then moved to 97% invested in June 2009 as other proprietary indicators confirmed the buying opportunity of a lifetime.

The important lesson is: Don’t try to second guess the bottom and don’t try to anticipate it. With no evidence of selling pressure abating and buying pressure pretty much absent currently,  I will let the weight of evidence tell me when the time is right to start increasing our invested allocation. Now is not that time; it’s far too soon to buy in my opinion (and that could change, tomorrow, next week or the week after).

Today, unfortunately, every indication is that this bear market probably has further to run as the economy comes under increasing pressure. As I wait for the evidence to drop into place, our high cash and hedged positions are now two of the most valuable assets in our portfolio as we approach that future buying opportunity, probably the best one we’ve seen in over ten years. Meanwhile, try not to get sucked into bear market rallies-use them to lighten up on positions if you’re overallocated to the stock market.

Never lose sight of the Warren Buffet quotation, “Unless you can watch your stock decline by 50 percent without becoming panic-stricken, you should not be in the stock market,” and we know that bear markets are not an unusual part of the investment process. It’s the price we pay for superior returns over the long term.

Of course, legendary investor Peter Lynch said it best: “The real key to making money in stocks is not to get scared out of them.” I’ll add, as I paraphrase well-known TV host Jim Cramer, no one ever made money in the markets by panicking.

Please be safe and stay healthy during this difficult period of time in our lives. Don’t hesitate to contact me if you have any questions or if I can be of any help.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: Investech Research

What’s Going on in the Markets March 19, 2020

What a day. What a week. What a month.

The S&P 500 index lost another 5.2% yesterday – which is somewhat of a relief because it was down over 9% at one point during the day. The index did manage to close above Tuesday’s low. That is potentially bullish. It’s somewhat funny to say, but the NASDAQ 100 (QQQ) was the best performing of the major indexes, losing just over 3%. As daily swings of 3-5% become the norm, we become somewhat numb to them. Not fun.

Although there was no direct catalyst for the sell-off Wednesday, stocks erased nearly all of Tuesday’s big gains. Energy was massacred by another big drop in crude oil prices following reports that Saudi Arabia has said it will continue record-high oil production “over the coming months,” accelerating its price war with Russia. Oil prices have been sinking as the Covid-19 pandemic reduced demand, and Russia in recent weeks failed to agree to an OPEC proposal to reduce oil production. West Texas Intermediate crude on Wednesday plunged a shocking 22.7% to trade at $21 per barrel. It is now at the lowest level since 2002! The good news? Lower prices at the pump….if you can leave your home.

Stocks found no relief from reports that the White House is urging lawmakers for $1 trillion in stimulus to cushion American workers and the economy from the impact of the coronavirus. Lawmakers were warned by the Trump administration that US unemployment could jump to 20% if no financial aid measures were passed. Lawmakers aren’t wasting time getting stimulus to the markets and taxpayers, which is good news.

With the dual plight of an oil production glut and the coronavirus global pandemic, global commerce has been left at a virtual standstill and has undercut the lives and financial balance of millions of people who work in the service industry.

I have to say, this is one of the worst times I’ve ever seen in my 30-years in the markets.  Why? Because of the velocity and relentlessness of the selling. The Financial Crisis offered many opportunities to buy in, even while the market was falling overall.  Today’s market has been a one-way street. Fifteen of the last twenty days have been down. Back-to-back up days haven’t taken place since early February. Household names that would typically be the last ones to drop, have taken big hits.

On a positive note, all of the ingredients are in place for a large, multi-day oversold bounce. I’m not trying to paint a bright picture. Indeed, it is likely to take months of choppy or declining stock prices to work through the problems that have been exposed by the action over the past three weeks. But we will find a bottom, and I’m thinking sooner than later. All of the government stimulus and federal reserve easing being put out there is going to find its way into stocks one way or another.

Even during the worst bear markets, there are always very strong “rip your face off” rallies that work off the oversold conditions. We are on the cusp of one of those rallies.

At the lows yesterday, conditions felt worse than they did on the ugly markets of Christmas Eve, 2018. They also felt a lot like they did in October 2008. Back then, the S&P lost about 1/3 of its value in just three weeks. Then it exploded almost 20% higher in one week. In this market, we could get that in a day!

Of course, that wasn’t the end of the decline. That didn’t happen until March 2009. And, there were multiple swift declines and violent oversold rallies in the months in between. So, we’re probably in for something similar for the next several months.

But, for the next few days, the market is set up for a “rip your face off” oversold bounce. We could see a 20-25% “pop” from here – which would boost the S&P 500 index back up towards 2,900 or so. A really wild move could get the index back up to 3150.

The bigger point is that yesterday certainly felt like a seller’s exhaustion. That sets us up for an oversold bounce, which could be quite substantial. Following that, we’re in for a several month-long period of big declines and big bounces as we carve out a bottom. Be ready for it if you’re overexposed to the markets and have been “losing sleep”. Use the bounces to reduce exposure or hedge your portfolios. We can help.

Whatever you do, this is not a market to chase big moves in stocks or funds. You will surely get another chance to get into this market if the rally is sustainable, so if you miss an initial move, be patient. You’ll get many chances to buy back in. You don’t need to be the first one into the foxhole.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets – March 17, 2020

If you took a long hibernation nap starting on Christmas Eve 2018, woke up yesterday and looked at the markets, you’d think that nothing happened. As it turns out, the entire market rally since that day has been re-possessed in what has been the fastest 20%+ sell-off in history.

The Coronavirus infected market continued its downward ways as panicky investors dumped stocks in droves yesterday because of a feared economic recession. With the exception of treasury bonds, all stocks, sectors, industries, commodities (including gold and silver) were hit hard in yesterday’s trading.  We are now officially in a bear market, with a mild recession (two consecutive calendar quarters of negative growth) hitting in the next few months being a much stronger possibility.

We have seen a lot of bear markets unfold over the past 40 years, but this one is unique in several aspects:

1.     First, the trigger came from an external event (i.e., Coronavirus) that is totally unrelated to monetary policy. In fact, the Fed has been aggressively “supporting” the market since its policy reversal in December 2018.

2.     Second, there were virtually no confirmation flags of a probable or imminent recession. Instead, consumer confidence was holding near 50-year highs, and the Leading Economic Index had just broken upward to a new all-time high.

3.     Third, the selling has been extraordinarily intense and indiscriminate. In some aspects, this reflects the type of selling panic normally seen near the END of a bear market instead of at the beginning.

The bad news is that we do not have many –or any– historical precedents upon which to rely with respect to the Coronavirus pandemic. The good news is that our client portfolios were defensively positioned with a high cash reserve and bear market funds prior to this panic selling, and has successfully protected against over 30-50% of the downside loss. And with our more conservative sector weighting, it would have been more resilient if not for the universal selling.

With yesterday’s market closing on the low, the volatility is clearly not over. History indicates it would be a mistake to sell additional holdings into this waterfall decline – at least at this time and without any solid warning flags of recession. Nonetheless, if you’re worried about your portfolio and are losing sleep, then you probably have too big of an allocation to equities, and it would therefore be prudent to consider lightening up into any bounce that the market offers (which thus far have not lasted much more than an hour or two).

On Friday, President Trump declared the Covid-19 Coronavirus a national emergency, opening the door for an infusion of federal funds to ease the effects of the outbreak at home. In response, the DJIA (Dow Jones Industrial Average index) rallied more than 1400 points in the final 30 minutes of trading, erasing much of Thursday’s record down day.

Despite that positive reaction on Wall Street on Friday, this past weekend saw an escalation of Coronavirus impact and particularly of fear – with travel restrictions and business closures. Although this effect could still be transitory, it’s possible that the unwinding of the Fed’s moral hazard (false investor confidence) on Wall Street could have a more lasting impact on the economic and stock market outlook. Even a 1% emergency rate cut and $700B of stimulus offered by the federal reserve could not stop another record decline in the stock market yesterday.

With market conditions as they are, a robust multi-day rally is expected. Indeed, after a lock limit down on the markets again yesterday at 7% down, we had a 5% lock limit up rally in the overnight futures market (Monday night). That could provide for a nice turnaround Tuesday if the bounce carries through the trading day.

While I’m getting calls and e-mails from clients concerned about how far this decline has gone, I’m also getting a lot of calls and e-mails about buying into this decline. Based on what I’m seeing, it seems to be a bit too early to buy, and probably too late to sell. While I thought we might have seen investor capitulation to the downside on the open yesterday morning, that thought proved fleeting as we briefly bounced and came back to close on the lows. That is not encouraging price action. And the fact that so many people are still anxious to buy this “dip” leads me to believe that the bottom is not yet in.

Nibbling on some stocks or funds at these levels isn’t a terrible idea, but I prefer an approach that sees us bounce, see where the bounce runs out of steam, and watch for a re-test of yesterday’s lows (to see if they hold) at some point in the near future. If the re-test succeeds, then it might be “off to the races” for the markets. If it fails, then look out below.

For that reason, I tend to be patient in buying back into a vicious bear market that will fool you into thinking that the selling is all over, only to drop your recent stock or fund purchase by 20-25% in less than a day.  Averaging down sounds like a great idea until you’re down 25-50% on a position in a day or two. It’s often better to wait for the re-test of the lows rather than jumping in with both feet too soon. Sure, the market could make you whole and profitable in a matter of months, but if you’re looking to compound your annual returns at the highest rate possible, shortening the recovery period to get back to even makes patience essential.

In my opinion, it’s probably better to use short-term market strength to trim some positions if you’re overexposed to the markets and need to reduce overall risk. If you’ve been stressed out about your portfolio, IRA or 401(k), then use the bounces to reduce stock and bond exposure. It never hurts to reduce your risk, but please consult with your advisor (or me) before taking action.

According to Andrew Thrasher, CMT, comparing the current S&P 500 index decline to past bear markets, there hasn’t been a time in history that a bear market has begun with such a severe and speedy decline. Not the Great Depression. Not Black Monday in 1987. But out of every bear market before this one, a new bull market was born. This one will be no different. Just be patient as there will be plenty of time to jump into the next bull market.

Meanwhile, I hope you’ll stay safe and healthy during this health crisis. Take every precaution you can to keep your family and you as healthy as possible. Like every crisis before this one, this one too shall pass. If you have any questions, please don’t hesitate to get in touch with me.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: InvesTech Research

 

 

What’s Going on in the Markets – March 8, 2020

On Monday, March 9, the market celebrates its 11th anniversary of this long bull market with the bull appearing quite tired, coughing and wheezing into that milestone. Yes, believe it or not, we are still in a bull market.

Despite the wild swings in the markets last week, the major indexes managed to close positive on the week for a change. Unfortunately, it was a somewhat hollow victory given that the worries over the Coronavirus have not subsided and an oil price war was started on Friday (read more below).

Volatility in the major indexes continued last week following the worst week of this bull market. Every day last week had a move of greater than +/- 2% as bullish and bearish investors fought for control.

The latest economic reports started out on solid footing with the ISM Manufacturing Index unexpectedly remaining in expansion territory. Likewise, the ISM Services Index beat expectations by rising to the best level in over a year. Mortgage rates have hit a new all-time low in a continued benefit to the housing market, with construction spending growth accelerating to the fastest pace in nearly three years. In a show of strength in the economy, the labor market remains resilient. Employers added 273,000 jobs in February, while jobless claims are near the lowest level in 50 years.

Nonetheless, from a market technical standpoint, it continues to indicate an elevated level of risk as evidenced by the recent volatility.  Dismal market breadth (the number of stocks that are up versus those that are down) over the past week suggests that there will likely be a continuation of this period of high volatility. On a positive front, the short-term selling pressure has put the market into oversold territory, indicating that there should be another attempted rally in the days ahead.

The Federal Reserve (the Fed) flew into action last Tuesday, cutting interest rates by 50 basis points (0.50%) in the first emergency cut since the Financial Crisis of 2008. Despite this move from the Fed, the strength in the U.S. economic data at this time does not suggest that this is the start of a recessionary bear market. The markets are expecting a  further rate cut when the Federal Open Market Committee meets on March 17-18.

As I write this on Sunday night, the futures (overnight) markets indicate a rough opening for trading on Monday, as fears of the overall economic impact of the Coronavirus continues to be priced in. In addition, a major oil price war appears to be breaking out as Russia and Saudi Arabia failed to come to an agreement on reductions in oil production, causing a plunge in the price of oil on Sunday. That will no doubt have a negative effect on stock prices this week, especially energy shares.

Regardless, it appears that the market wants to re-test the lows that we saw on February 28th. This is a normal technical progression, and hopefully, the lows will hold this week and we kick off a multi-week, if not multi-month rally.

According to the folks at Sentimentrader.com – who keep track of such statistics – “The last 10 times pessimism towards US equities was this extreme, the S&P 500 rallied 100% of the time over the next two months.” That’s a pretty solid statistic.

It is going to be hard, perhaps painfully so, to watch as your portfolio holdings get hit with selling pressure along with the broad stock market. In this environment a little bit of selling pressure can do a lot of harm – especially when there isn’t much buying pressure to balance things out.

But this is a temporary condition. Think back to Christmas Eve, 2018 – the last time the market’s proverbial rubber band was this stretched so far to the downside, stocks snapped back within just a few weeks. And, selling into the downside panic was proven to be a mistake. We were back to record highs in a matter of months. As harrowing as this sell-off has been, by almost any measure except velocity, it remains a pipsqueak through Friday compared with the battering investors took at the end of 2018. In that episode, the S&P 500 plunged almost 20%.

I can’t say for sure the market will snap back now just as it did back then. Nothing is ever guaranteed in the stock market. But it’s probably too late to sell right now if you haven’t lightened up already. If you’re too heavily invested, wait for a market rally to do so. And if your favorite fund or stock has declined enough to make it attractive, you can consider lightly “nibbling” on some here. Of course, if I’m not your advisor, then you should consult with yours, as this is not a recommendation to buy or sell any securities.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

What’s Going on in the Markets for March 1, 2020

As you well know, investors just experienced one of the worst weeks in recorded history in the stock market as fears over COVID-19 (Coronavirus) ramped up, and the number of confirmed cases increased. Over the last week, we saw 3 out of 4 days in which declining stocks outnumbered advancing stocks by more than an 8:1 margin. That has not occurred since 1939!

Is it time to batten down the hatches and prepare for a bear market (a bear market is one that declines at least 20% from the last peak)? I don’t think so, at least not until we get more evidence pointing in that direction.

While I’m no medical student, Coronavirus could prove to be a temporary setback. But if it indeed accelerates the economy into a recession due to supply chain disruptions or causes demand for goods and services to fall off for more than 1-2 calendar quarters, then I think that we could fall into a bear market. Therefore, we cannot underestimate the potential effect of a disruption of the economic cycle.

At this point, we can only identify this as a probable market correction (something less than a 20% decline from peak to trough). In other words, we do not have definitive confirmation of a recession ahead, and we cannot yet say whether the final bull market top is in place.

From an economic standpoint, the risk of recession was low prior to the Coronavirus outbreak fears, and while there will undoubtedly be an economic impact from the virus, the signs of an economic contraction (negative gross domestic product or GDP) are still notably absent. In fact, Friday’s Consumer Sentiment report from the University of Michigan shows that optimism reached the second-highest level of this cycle in February. There will need to be a breakdown in confidence before a recession becomes probable.

On the market structure (technical) side, the data obviously deteriorated greatly last week in line with the correction in the market. The selling has been widespread and brutal. That being the case, the market has reached a deeply oversold reading, indicating that a robust rebound rally of some type should develop in the next few days, if not on Monday. The strength and breadth of that rally will be vital in assessing: 1) How much damage has been done to investor confidence, and 2) the probability that this bull market may be over.

If you are finding that your risk tolerance for this kind of market action is lower than you thought, then you should consider reducing your exposure to the stock market on any bounce. Of course, you should first consult with your financial advisor and not consider this investment advice or a recommendation to buy or sell any security.

Obviously, anything can change the landscape, especially a bazooka of money fired at the markets or a reduction in short-term interest rates by the federal reserve and other central bankers around the world. The markets were down much more on Friday before rallying hard in the last 30 minutes, a positive sign that we may be seeing the pace of selling slowing or abating.

Regardless, it is certainly possible that we may have seen the highs for the year (my crystal ball is still in the shop), but I’m open to what the market tells me. I’m not married to a single way of thinking (bullish or bearish) and neither should you. If the market can retrace over 60% of this decline on any sustained rally, then we might have a shot at targeting old highs. But that’s a tall order, and it’s going to take a while to happen if it does. Much of the technical damage has to be repaired, and a lot of disappointed regretful buyers are going to want their money back on any rally,  greatly increasing the supply of shares for sale in the short term.

Any first step in the right direction starts with arresting the current decline and successfully bounce this market for more than just a few hours or just a day. Based on the Sunday night futures markets, the current outlook looks to be for a positive open on Monday morning, despite the increase in the number of reported Coronavirus cases over the weekend. I suspect that market followers are expecting an announcement of an interest rate cut sometime on Monday.

For our client accounts, we have been reducing equity exposure for several weeks and adding hedges to our portfolios. We will continue to be defensive until we see signs that the market is stabilizing, and that a durable market low has been formed. For your part, don’t be a hero: it may be too late to sell and it may be too soon to buy (but it may be OK to nibble a little). Again, I cannot advise you personally unless you become an investment-management client :-).

Over the long term, the market has always moved up, but volatility has always been the cost of enjoying higher returns in the stock market. With risk highly elevated, it may be time to do very little. Just know that this too shall pass, and better times may only be a few days, if not a few weeks away.

For now, just keep washing those hands frequently and stay home if you’re sick. I can safely say that without needing a medical degree.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets for February 25, 2020

It wasn’t a pretty day for the stock market fans on Monday with one of the worst down days in over two years. Does that mean the market is doomed and that we’ve finally topped? Read on for some encouraging news on post-smack down days like Monday, with some help from my friend and fellow market writer Jon D. Markman.

Investors seemed to panic on Monday over a climb in corona virus infections outside of the Chinese epicenter and also started to discount the possibility that the Democrats might nominate capitalism antagonist Bernie Sanders.

The Dow Jones Industrials Average started with a gap down and 500-point slide, made a couple of feeble rebound attempts, then closed on its low at -1,031 points with a 3.5% loss. The S&P 500 fell 3.35%, the NASDAQ 100 fell 3.9% and the small-cap Russell 2000 index fell 2.9%. This puts us about 5% below all-time highs as measured by the S&P 500 index, a normal and frequent pull-back level.

It was a bad day for sure, but in no way historic. Slams of 3.5% occur about twice a year on average, with something like 100 instances since 1928. The Monday slide was just the 48th biggest one day drop for SPDR S&P 500 (SPY) since 1993. It was the worst Monday decline since way back on Feb. 5, 2018, when the SPY sank 4.18% for a reason nobody can quite remember.

Sure it’s sad that the corona virus has spread to Italy and other countries, but overseas events ranging from assassinations and full-blown wars to economic hardship and the ebola virus just don’t move the dial for U.S. investors, whose attitude is pretty much, “Sorry not sorry.”

This is a good time to remind you that the only reason markets care about the dreaded virus is that it could put a kink in global supply chains that reduce public companies’ recent guidance on future revenues and margins (i.e., overall corporate profits). So it’s really another recession scare, not a public health scare.

Investors are susceptible to the scare because global economic growth is already slow, with the latest annualized reading on eurozone GDP at just 1.4% and the U.S. not much better at 2.3%. That’s barely above stall speed, so it wouldn’t take much to knock the spinning top on its side. Nick Colas of DataTrek Research notes: “The combination of structurally low inflation, aging populations, and central bank balance sheet expansion has pulled long term interest rates lower, persistently signaling a brewing recessionary storm to market participants.”

As a result, investors ditched oil and gas assets in the wake of reports that the corona virus continues to infect more people worldwide. Iran, Italy and South Korea reported sharp increases in infections, according to Reuters. Italy now has the world’s third-largest concentration of corona virus cases and the economy is “vulnerable to disruption from the corona virus, being at serious risk of slipping into recession this quarter,” said analysts at Daiwa Capital Markets in a note Monday. I believe that a lot more evidence is needed to make the conclusion that we’re at risk of a near-term recession.

Besides, the market has gone up pretty much uninterrupted since the beginning of October 2018 and was very much overdue for a rest. Monday’s performance was a mere flesh wound to the charging bull (market).

The good news is that Bespoke (a market quantitative analysis firm) reports that 2%-plus drops on Mondays have historically been bought with a vengeance in the near term. Since March 2009, there have been 18 prior 2%+ drops on Mondays, and SPY (the exchange-traded fund that tracks the S&P 500 index) has seen an average gain of 1.02% on the next day – which is how “Turnaround Tuesday” got its name.

Even more impressive, over the next week, SPY has averaged a huge gain of 3.16% with positive returns 17 out of 18 times. And over the next month, SPY has averaged a gain of 6.08% with positive returns 17 of 18 times as well. Anything can happen, of course–this is the stock market we’re talking about here.

The analysts also studied big declines on each day of the week. Turns out that in the month after 2%+ drops on Mondays, SPY has averaged a huge gain of 4.5%.

No guarantees, but investors tend to buy the trip when big stumbles start a week. Sure, it might be short-term, but the pullback so far merely takes back all of the gains we accumulated in February 2020, so we’re still slightly up on the year as measured by the S&P 500 index. Can it get worse? Of course, it can, but we need more evidence that the long term uptrend is in jeopardy.

Those that haven’t yet hedged their portfolios during this entire bull market run should consider trimming positions or reduce risk in their portfolios on any bounce. It never hurts to take some money off the table, as no one knows if we’ve topped or we’re on our ways to make new all-time highs again. This is not a recommendation to buy or sell any securities-you should check with your advisor for the best approach that fits your goals, your risk tolerance and time-frame. For our client portfolios, we’ve done just that, and will do more of that should the pull-back deepen.

I think we’ll get a quick bounce back, and then the market tends to go back and test the lows after a few days. If that low holds, then that could signal that this short-term pullback is over. If it doesn’t, then more corrective work is needed to wring out some short-term excesses that are in the market.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

 

Broken Records or Records Broken?

Rearrange the two words “broken” and “record” and combined they have two totally different meanings. A broken record is akin to your financial planner repeating over and over again about saving more and spending less. A record broken conjures up images of olympic athletes taking their craft to higher, never before achieved heights.  We also hear it often when referring to never-seen before stock market levels.

We’ve all heard it said: “Records are made to be broken.” We celebrate record-breaking winning streaks from our favorite teams and athletes. Conversely, we hope to avoid a long string of losses.

The bull (up-trending) market that began in 2009 is not the best performing since World War II (WWII). That title still resides with the long-running bull market of the 1990s. But it is the longest running since WWII (St. Louis Federal Reserve, Yahoo Finance, LPL Research–as measured by the S&P 500 Index).

In the same vein, the current economic expansion is poised to become the longest running expansion since WWII. For that matter, it’s about to become the longest on record. According to the National Bureau of Economic Research, which is considered the official arbiter of recessions and economic expansions, the current expansion began in July 2009. It has run exactly 10 years, or 120 months, matching the 1990s expansion (see below table).

Economic Scorecard

Expansions Length in Months
July 2009 -? 120
Mar 1991 – Mar 2001 120
Feb 1961 – Dec 1969 106
Nov 1982 – Jul 1990 92
Nov 2001 – Dec 2007 73
  Average 64
Mar 1975 – Jan 1980 58
Oct 1949  – Jul 1953 45
May 1954 – Aug 1957 39
Oct 1945 –  Nov 1948 37
Nov 1970 – Nov 1973 36
Apr 1958  – Apr 1960 24
Jul 1980  –  Jul 1981 12

Source: NBER thru June 2019

Barring an unforeseen event, the current period is headed for the record books.

While the economic recovery is about to enter a record-setting phase, it has been the slowest since at least WWII, according to data from the St. Louis Federal Reserve. For example, starting in the second quarter of 1996, U.S. gross domestic product (GDP), the broadest measure of economic growth, exceeded an annualized pace of 3% for 14 of 15 quarters. It exceeded 4% in nine of those quarters (St. Louis Federal Reserve). Growth was much more robust in the 1960s, and we experienced a strong recovery from the deep 1981-82 recession.

Economic booms and long-running expansions can encourage risky behavior. People forget the lessons learned in prior recessions and overextend themselves. Consumers can take on too much debt. Businesses may over-invest and build out too much capacity. We saw euphoria take hold in the stock market in the late 1990s and speculation run wild in housing not too long ago.

That brings us to the silver lining of the lazy pace of today’s economic environment.

Slow and steady has prevented speculative excesses from building up in much of the economy. In other words, a mistaken realization that the good times will last forever has not taken hold in today’s economic environment.

Causes of recessions

In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). The long-running expansions of the 1960s, 1980s, and 1990s led to a mistaken belief that various policy tools could prevent a recession.

Yet, expansions don’t die of old age. A downturn can be triggered by various events. So, let’s look at the most common causes and see where we stand today.

  1. Rising inflation leads to rising interest rates. In the early 1980s, the Federal Reserve pushed interest rates to historically high levels in order to snuff out inflation. The Fed’s policy prescription succeeded, but led to a deep and painful recession.
  2. The Federal Reserve (The Fed) screws up. A policy mistake can be the trigger, for instance if the Fed raises interest rates too quickly and restricts business and consumer spending. This is a derivative of point number one. There were fears the Fed was headed down this road late last year. Credit markets tightened, and investors revolted until the Fed reversed course after the markets swooned nearly 20% in the 4th quarter of 2018.
  3. A credit squeeze can snuff out growth. In 1980, the Fed temporarily implemented credit controls that briefly tipped the economy into a recession.
  4. Asset bubbles burst. The 2001 and 2008 recessions were preceded by speculative excesses in stocks and housing.
  5. Unexpected financial and economic shocks jar economic activity. The OPEC oil embargo in the 1970s exacerbated inflation and the 1974-75 recession. The tragedy of 9/11 jolted economic activity in 2001. Iraq’s invasion of Kuwait pushed oil up sharply, contributing to the 1990-91 recession. Such events don’t occur often, but their possibility should be acknowledged.

Where are we today?

Inflation is low, the Fed is signaling its first possible rate cut this week, and credit conditions are easy as measured by various gauges of credit. For the most part, speculative excesses aren’t building to dangerous levels.

While stock prices are near records, valuations remain well below levels seen in the late 1990s (I’m using the forward price-to-earnings ratio for the S&P 500 index as a guide). Besides, interest rates are much lower today, which lends support to richer valuations. That doesn’t mean that swaths of stocks or sectors are not over-valued. That’s also not to say we can’t see market volatility. Stocks have a long-term upward (bullish) bias, but the upward march has never been and never will be a straight line higher.

As I’ve repeatedly stressed, your financial plan is designed, in part, to keep you grounded during the short periods when volatility may tempt you to make a decision based on emotions. Such reactions are rarely profitable.

A sneak peek at the rest of the year

The Conference Board’s Leading Economic Index, which has a good record of predicting (if not timing) a recession, isn’t signaling a contraction through year end. But one potential worry: a protracted trade war and its impact on the global/U.S. economy, business confidence, and business spending.

Exports account for almost 14% of U.S. GDP per the U.S. Bureau of Economic Analysis (BEA). It’s risen over the last 20 years, but we’ve never experienced a U.S. recession caused by global weakness.

By itself, trade barriers with China are unlikely to tip the economy into a recession. Per U.S. BEA and U.S. Census data, total exports to China account for just under 1% of U.S. GDP. Even with higher tariffs, exports to China won’t grind to a halt and erase 1% of GDP.

What’s difficult to model is the impact on business confidence and business spending, which in turn could slow hiring, pressuring consumer confidence and consumer spending. Simply put, there isn’t a modern historical precedent to construct a credible model. Hence, the heightened uncertainty we’ve seen among investors.

Is a recession inevitable?

It has been in the U.S., but other countries have more enviable records.

Earlier in June, the Wall Street Journal highlighted, “Australia is enjoying its 28th straight year of growth. Canada, the U.K., Spain and Sweden had expansions that reached 15 years and beyond between the early 1990s and 2008. Without the Sept. 11, 2001 terrorist attacks, the U.S. might have, too.”

If trade tensions begin to subside (a big “if”) and if the fruits of deregulation and corporate tax reform kick in, we could see economic growth well into 2020 (and with some luck, into 2021 and beyond). But, I’ll caution, few have accurately and consistently called economic turning points.

The Fed to the rescue?

Rising major market indexes for much of the year can be traced to positive U.S.-China trade headlines (at least through early May), a pivot by the Fed from tightening monetary policy to loosening, and general economic growth at home.

We witnessed a modest pullback in May after trade negotiations with China hit a snag. The threat of tariffs against Mexico added to the uncertain mood until June 4th, when Federal Reserve Chief Jerome Powell signaled the Fed would consider cutting interest rates to counter any negative economic headwinds.

While Powell is not exactly promising to deliver any rate cuts, one key gauge from the CME Group that measures fed funds probabilities puts odds of a rate cut at the July 31st meeting at around 100% (as of July 28 – probabilities subject to change).

I’ll keep it simple and spare you the academic theory explaining why lower interest rates are a tailwind for equities. In a nutshell, stocks face less competition from interest-bearing assets.

But let’s add one more wrinkle–economic growth.

Falling rates in 2001 and 2008 failed to stem the outflow out of stocks as economic growth faltered. And, rising rates between late 2015 and September 2018 didn’t squash the bull market.

During the mid-1980s, mid-1990s, and late 1990s, rate cuts by the Fed, coupled with economic growth, fueled market gains.

It’s not a coincidence that bear markets coincide with recessions and the bulls are inspired by economic expansions. Ultimately, steady economic growth has historically been an important ingredient for stock market gains.

Final thoughts

Control what you can control. You can’t control the stock market, you can’t control headlines, and exactly timing the market turns isn’t a realistic tool. But, you can control your portfolio.

While I would expect the market to continue higher over the intermediate term, it would not surprise me to have a mid-summer pullback as August-September tend to be weaker months of the year. Don’t let volatility shake you out of your positions, but if you haven’t done anything to take some money off the table up to this point, it would be prudent to consider taking some profits on certain positions and add some defensiveness to your portfolio. This is not a recommendation to buy or sell any stocks or other securities.

Your plan should consider your time horizon, risk tolerance, and financial goals. There is always risk when investing, but we tailor our recommendations with your financial goals in mind. If you’re unsure or have questions, let’s have a conversation. That’s what we’re here for.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

 

 

 

What’s Going on in the Markets: April 28, 2019

It’s no surprise to anyone paying attention to financial news that the stock market, as measured by the S&P 500 index, closed at an all-time high last Friday. It was one measly point away from the all-time intra-day high set on September 21, 2018 (2940.91). The technology heavy NASDAQ indexes have already surpassed their all-time 2018 highs.

You’d think at new all-time highs, the masses would be euphoric and pouring money into the stock market hand-over-fist. But alas, that’s not the case at all. The rise from what I like to call the “Christmas Eve Stock Market Massacre of 2018” has been one of the most distrusted and hated rallies I’ve ever seen in my over forty years of following the stock markets. Ironically, that’s what might keep the market from falling over and moving higher, at least temporarily.

I’ll be the first to admit that I personally haven’t fully embraced the 24% rally from the Christmas Eve bottom. It’s been a torrent advance that has given latecomers (as well as early sellers) very few low-risk opportunities to jump in. That’s to say, pullbacks since Santa Claus came calling have been shallow and fleeting. Bull markets tend to be that way. Virtually every portfolio manager and investor I talked to was over-invested going into the 4th quarter 2018 swoon, and under-invested during the 1st quarter 2019 relentless advance.

Such is life investing in the stock markets.

Pundits would say that it was the Federal Reserve Chairman’s walking back talk of planned interest rate hikes in 2019 as the proximate cause for the rally. Markets love low interest rates (cheap money) as companies borrow even more money to buy back their own stock. Lower interest rates for longer have always meant corporate earnings can grow a bit faster with less drag from servicing (paying down) debt and financing expansion plans.

If the promise of lower interest rates for longer is the proximate cause for the rally, then recent positive economic news might cause the “data dependent” federal reserve to rethink the interest rate pause. A federal reserve board meeting is scheduled for this week, though the chance of an interest rate hike announcement at this meeting is virtually nil.

Just this past Friday, what was widely forecast as a coming dismal 1st quarter 2019 gross domestic product figure (under 1%), turned out to be more than thrice as good, coming instead at 3.2%.

Also this past week, while existing home sales came in 4.9% below expectations, new home sales came in almost 4.5% above expectations. In addition, durable goods orders also came in much better than expected. Finally, weekly jobless claims continue to be low. The March monthly jobs report will be announced on Friday May 3.

Expected to be dismal as well, first quarter 2019 corporate earnings reports have also continued to surprise to the upside. So far, 230 of the S&P 500 have now reported Q1 2019 earnings, and the reported Earnings Per Share (EPS) growth rate for the index is up about 2%. Granted, when companies lower expectation ahead of time, beating them becomes the norm (games companies play!)

So should we throw caution to the wind, set aside all hedges and invest all idle cash since so little seems to derail this charging bull market (e.g., the still unsettled trade wars, the Mueller Report, rising debt levels, the never-ending Brexit debacle, slower global growth, higher gas prices, etc.)?

In a word, no.

While it appears that the markets will continue to move higher in the near term, the risk-reward ratio at these levels does not favor heavy deployments of capital. Getting to a previous market high doesn’t necessarily mean we’re going to smash through those old highs and rally another 5-10% immediately. After all, there are many regretful buyers from the 2018 highs who can’t wait to get out at even-money if given that opportunity (exclaiming the famous phrase anyone unexpectedly caught in a nearly 20% stock market drop “never again!”).

That incoming supply of shares from regretful buyers will likely cause a long battle around last year’s highs, making for a pause in the upward momentum. Besides, after a nearly 25% run, the market is way overdue for a break.

A Wall of Worry?

In addition to the still unresolved trade wars and ongoing Brexit discussions, we have the following worries on the table (acknowledging that the market likes to climb a wall of worry):

  1. Recession Fears: an inverted interest rate curve, where short term rates are higher than longer term rates, has historically been a warning flag for the economy, though the lead time to a recession has been 11 months on average. In fact, there has been only one instance where the yield curve inverted without a U.S. recession, in January 1966. It is worth noting, however, that there was still a bear market during that period, which began just one month after inversion.
  2. Inflation Fears: as inflation indicators have eased since the middle of 2018, investors and economists alike have pushed this all-important economic barometer to the back of their minds. However, inflationary pressures, in the form of wage hikes, could reemerge in the near future, forcing the Federal Reserve to again take action when they least want to do so.
  3. Corporate Debt: over the course of this economic cycle, business debt has skyrocketed as U.S. corporations have issued record amounts of debt.  Non-Financial Business Debt as a percentage of GDP is close to an all-time high, and well in excess of the levels reached at the beginning of the last three recessions. If the economy slips into recession, marginally profitable companies will be unable to pay back interest on their debt, let alone the principal.
  4. Small Business Optimism: both small business owners and CEOs are not as enthusiastic as consumers or investors. Small business confidence fell sharply in the closing months of 2018 and has shown little propensity to recover. Corporate CEO confidence experienced an even bigger hit, with the same inability to rebound from these depressed levels. Business owners are most likely feeling the pressures of a tight labor market, rising wages, and squeezed profit margins. That could spell trouble for earnings and business spending ahead.

So What To Do Now?

The economy is stable and employment is strong. At this point, blue chip indexes have surpassed or are very close to surpassing their previous highs, tempting investors to climb aboard for another potential leg upward. But should you?

The financial planning answer to that question is that it depends on your goals, time-frame and risk tolerance. But the more realistic answer is that it really depends on your current investment level and your confidence that we’re just going to sail higher. While in the long run the market trends higher, no one I know of is a fan of investing at a potential top.

I suggest that you think back to how you were feeling in December of 2018, and if you felt that you were over-invested, or were surprised or uncomfortable reading the balances on your year-end account statements, take this gift the market has given you and reduce exposure to the markets. Even if you weren’t, ask yourself this: should I be taking some profits off the table? This is not a recommendation to buy or sell anything; only you and your financial planner can make that decision (we can help!)

I’m personally not so confident we’re going to just continue to rally without a near term pullback, and therefore I continue to position client and my personal portfolios with a defensive tilt. Mind you, I see nothing in the price action to tell me that a pause is imminent, but severe downside action can change that and repossess weeks’ worth of gains in a matter of a day or two. This, however, should be meaningless to investors with a long-term investing horizon.

While we have participated robustly in this rally since 2018, I believe that the market’s ability to achieve notably stronger gains from here is somewhat questionable. And from a safety-first strategy viewpoint, the longer-term outlook is more ominous.

The recent inversion of the yield curve is a classic warning flag, regardless of whether it remains inverted over the intermediate term. And the simmering wage inflation pressures are not going to subside anytime soon, especially when initial claims for unemployment are hitting 50 year lows. That means the Federal Reserve might have to renege on their “no rate hike” promise before this year is over. Few on Wall Street are anticipating that the Fed might take away the low interest rate punch bowl again.

As Jim Stack of InvesTech Research warns, “One of the most difficult aspects of negotiating the twists and turns of a late stage bull market is keeping one’s feet objectively planted on firm ground. It’s hard to argue against positive economic reports, except with the historical knowledge that bull markets peak when economic news is rosiest. And with consumer confidence near the highest levels of the past 50 years, one would have to think that we are approaching a peak. That inherently leaves a lot of room for potential disappointment.”

Even if it means leaving a few dollars of market profits on the table, my safety-first approach leaves me cautious/defensive with an abundant level of cash and hedges for the time being. Now is a good time to take stock of your investment level, and decide for yourself whether you’re prepared for the next downturn.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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