The calendar has turned to May. The April showers that were supposed to bring May flowers, have only brought more rain here instead. I am confident that the flowers will be here soon enough.
There is an old adage in the stock market - "Sell in May and go away". This saying came into being due to the fact that the period from May through October is notorious for being the seasonally weak six months of the year for the stock market. So as you can correctly infer, we have just completed the seasonally strong period for the market which ran from the close on October 31, 2018 through close of April 30, 2018. During this recent six months, the Dow Jones Industrial Average (DJIA) had a return of 5.88%. This gain does not even provide a hint to the amount of market turmoil that we experienced during this past seasonally strong period. I have to say that during 2018's fourth quarter the market felt anything but strong!
So why is May through November considered a weak period in the market? According to the Stock Trader's Almanac, the market performs far better during the November through April time period than it does from May through October. For the period from 1950 through 2018, the DJIA had a compound average annual return of 7.24%. If you only considered the seasonally strong periods of November through April in this time period, the compound average annual return was 7.02%. The seasonally weak periods (May through October) during that same time period had a compound average annual return of only 0.22%! I find these numbers to be interesting, but it is not a prudent way to manage your portfolio. Looking back at history, there have been down periods during the seasonally strong period, and there have been up periods during the seasonally weak period. Yes, there is a strong historical bias present here, but it is not a "be all, end all" means of portfolio risk management. We just should be aware of this simple historical tendency.
Let's consider the chart below. While this old stock market adage about selling your stocks at the close of April and then buying them back at the start of November may have once made some sense, things look a little different in the more recent past.
As you can see above, with the exception of 2008 and 2011, each of the weak periods had a positive return. So why aren't there more negative returns over the last sixteen years? One reason could be that the U.S. economy is less industrialized now than it was in the past. When the U.S. was more of an industrialized economy it was not uncommon for plants and factories to close for a month or longer in the summer to retool and allow employees to vacation. The theory was that companies would conduct less commerce in that six-month span, which would likely translate into lower earnings. Fast forward to today. Due in large part to globalization, the world is far more interconnected and competitive, and there is less room for downtime in company operations. Companies do not want to be left behind. Shutting down for the summer months is just not practical any longer.
While the average total return for the S&P 500 for the May-October periods in the above table was only 3.67%, it is far from a return that would be utterly disappointing. Couple that with the fact that thirteen of the sixteen top-performing sectors in the table posted total returns in excess of 10.00% during the May-October time period, and you have the potential for some decent returns. Certainly returns that you would not want to "Go away" from.
So while certain market adages may have had some truth in the past, managing your portfolio by blindly following them is not a prudent course of action. As we head into the month of May 2019, I continue to see positive signs across the U.S. equity market from the overall trend of the major indices to U.S. Equities continuing to be the strongest major asset class of the six that I analyze on a daily basis. So, while some may say that we are now entering the seasonally weak period in the market, it is definitely not the time to abandon ship.
It's hard to believe that it has been a little over four months since Christmas and the now infamous “Christmas Eve Massacre” when the S&P 500 lost 2.7% in one day! This decline capped off the 4th quarter sell-off, which saw the major US stock indices drop by about 20%. Things looked rather bleak at that moment. As the new year began, no one I am aware of was predicting that the S&P 500 would be within 1% of hitting a new all-time high by the end of April, yet that’s exactly where we find ourselves today.
Of course, the next "Big Scary Thing" is always right around the corner. Think back to the fears that were cited as the cause of the 4th quarter selloff; a global economic slowdown was coming, the Federal Reserve was raising rates too aggressively, and there was an impending U.S.-China trade war. Guess what? Those fears have now subsided and they have been replaced with headlines telling us what we should fear next. This is not too shocking. The financial news industry will always be constructing billboards with 10 foot tall, bold-faced type to highlight any potential bump in the road. After all, they earn a living by selling magazines and generating clicks. Think about it. No one would want to read an article titled “Everything’s Fine”. The old newsroom adage, “If it bleeds, it leads.” didn’t come into being by accident. Now that we are approaching all-time highs for the major US stock indices, the headline du jour appears to be - "Stocks Are Overvalued".
That headline could be right. But it also might be wrong. The point is that we can't try to adjust for every headline or potential bump in the road. It is important to remember that prudently constructed investment portfolios are not affected by headlines over the long-term. As surely as you can rely on the sun rising tomorrow, you can rely on the financial media to be hyping the next "Big Scary Thing". You can also rely on the fact that they are often going to be wrong. And even when the "Big Scary Thing" does happen, the consequences are usually not as dire as was predicted. Take a look at the image below which shows some of the "Big Scary Things" over the last ten years against the backdrop of the Dow Jones Industrial Average (DJIA) price chart.
As the chart shows, several "Big Scary Things" during this time period had little or no effect on the stock market - the DJIA didn't even blink during the March 2013 US Budget Sequestration Crisis. In June 2016, the financial media trumpeted the "Brexit" vote in Great Britain as the next "Big Scary Thing". Yawn. The DJIA recovered within a month after Britain voted to leave the European Union. The largest draw-down experienced during this time period was during the August 2015 Chinese Stock Market Crash. But looking back on it now, we can see that the DJIA was back near its May 2015 high by the beginning of November.
If you had hibernated in a cave from last September until this week, you would have missed a pretty extreme down-and-up ride in the stock market. But, if you judged the market's action by the value when you entered the cave for your nap and the value when you awoke, it would look like you had missed one of the most uneventful six months in the history of US stock market. We certainly know that this was not the case!
The point here is not that bad things or bear markets can't happen or that we would be better off utilizing a pure buy-and-hold strategy. No. The point is that the headlines are not a good barometer for the future value of your investments. Instead, having an objective rules-based system that can help you avoid falling prey to the noise, while remaining vigilant to the real signals that the market, not the media, are giving you will lead to longer term success. Please come back to the above image the next time you see or hear a "Big Scary Thing" headline. This one simple chart will provide you with a simple visual to demonstrate how overblown most of the so-called crises really are. One of the cardinal sins in investing is letting your emotions take over. The rules-based system that I employ to manage investments tells me what the market, not a financial talking head, is saying. It lets me know when it's time to alter our asset allocation or raise cash in a portfolio.
Today marks the 10-year anniversary of the S&P 500’s bottom during the global financial crisis. The 2008 Financial Crisis may still be fresh in many people's minds and therefore seem like it was only yesterday. From its pre-crisis record close of 1565.15 on October 9, 2007, the S&P 500 declined nearly 57% to its March 9, 2009 closing level of 676.53! The savings of millions of households were decimated in the process and the ramifications of which were exacerbated by the collapse of housing prices and the highest levels of U.S. unemployment in nearly 30 years.
On October 6, 2008 the S&P 500 was already down more than 32% from its 2007 peak. That morning on NBC's TODAY show, Jim Cramer was frantically heard saying, “Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.” While I have no way of knowing how many people actually followed Mr. Cramer’s advice that day, I do know that many investors threw in the towel sometime during the financial crisis and some became so fearful that they never reentered the stock market. That action alone has had devastating consequences to the financial wealth of many investors.
I recently discovered the chart below and boy was it an eye opener. This one picture sums up the negative impact of not having faith in your investment plan and abandoning it when the talking heads on TV tell you that; "The end is near!" "This time it's different!" "Sell everything and move to cash until the dust settles."
The above chart depicts what would have happened to a $100,000 investment in the S&P 500 that was made on September 30, 2007 - right before the market's high point. You then see how that investment was cut in half by the end of February 2009. What transpires next depends on how you would have reacted to this rather swift market plunge. If you had headed Jim Cramer's advice and moved to cash, your investment would be worth just under $52,000 on December 31, 2018. If instead, you moved your investment dollars to bonds, your investment would be worth just over $71,000 at the end of 2018. Both of those decisions would leave your portfolio well below your initial $100,000 investment.
Contrast that with the investor who ignored the urge to sell their S&P 500 investment in a panic and instead held on to their investment through this financial crisis. Their portfolio would have been worth over $208,000 at the end of 2018! Granted, with the benefit of hindsight, it’s easy to see the immense benefit of such a decision. However, at that time, there was a very real feeling among many people that the sky was indeed falling. Depending on where you were in life during this period, you may or may not have an appreciation for the pervasive fear that existed from Main Street to Wall Street. There were a number of events surrounding the financial crisis that had never occurred and/or were believed to be “impossible”. For example, the fall of Lehman Brothers and the nationwide collapse of home prices, which led to speculation that the global economy could collapse.
Even after the US equity market had hit what we now know was its bottom in 2009, there was still no shortage of headlines that would have given all but the most steely, disciplined investors qualms about deploying capital into the market. An April 3, 2009 New York Times headline read, “663,000 Jobs Lost in March; Total Tops 5 Million.” Chrysler filed for bankruptcy on April 30th, followed by General Motors in early June. All of this to say, that even as the recovery of the US equity market was underway, there were still plenty of reasons to be skeptical that the worst was over.
As the chart above shows, an equally important part of this equation is having a plan for re-entering the market. In an environment like the one that existed in 2009, making the call to get back in may be the part that requires more intestinal fortitude and why you need to have your plan for both halves of the equation worked out well in advance. As we’ve seen, only having a risk-off plan (ie. moving to cash or bonds) will probably be worse in the long-term than having no plan at all. Many investors become paralyzed by a rising market. They think, "Wow! The market has risen pretty quickly. I better not get back in now because it will probably fall from here." Then the market falls a little and they feel vindicated. Unfortunately, this cycle repeats itself over and over again all the while they are on the sidelines while the market trudges higher.
It's human nature to get nervous when your portfolio plunges quickly. Loss aversion (it hurts twice as much to lose a dollar as gain a dollar) is hardwired into human psychology. But history has proven there are three things all investors must do in order to use the incredible wealth compounding power of the market to achieve their financial dreams. The first is not to panic, and remember that corrections are normal, healthy parts of market cycles. They are usually over quickly and don't stop the market from rising in nearly 75% of all years.
By far the most important thing investors can do is stick to a smart, long-term investing strategy that was developed before stocks start dropping. This strategy needs to factor in your risk profile, time horizon, goals, and thus develop an asset allocation that works best for you. It's that asset allocation and portfolio construction, not market timing (which history shows is essentially impossible to do), that will ensure your wealth is protected during corrections and bear markets. So, avoid market timing like the plague, no matter how tempting it may seem or how confident some analyst or economist is in his/her short-term predictions. If someone had a system for perfectly identifying market tops and bottoms, they would be a fool to share it. It would be like giving away a treasure map.
Finally, remember that market volatility has a major silver lining. That would be the opportunity to buy great companies at bargain prices. Even deeply undervalued stocks can fall further.
It is important to remember that a prudent investment plan is like the navigation system in your car. It provides a route to get you to your destination with as few detours as possible. However, you may find the first route it suggests isn’t necessarily optimal for you. If you’re a right-lane-of-the-highway, cruise-control-set-to-60 type of driver, then a route that has you zipping through city streets may not be the best route for you, even if it would get you to your destination five minutes sooner. The point is, the best navigation system or investment plan is the one that gets you to your destination and does so by providing a route that you will follow. After all, you’ll arrive at your destination much later if you abandon your aggressive through-the-city route halfway through than if you had just taken the slightly longer highway path in the first place.
As you are probably very well aware, there has been a notable pickup in market volatility recently. This increased volatility feels even more pronounced following 2017, which was one of the least volatile markets in history. But is the volatility that we are experiencing right now in 2018 outside of historical norms?
I did some investigation into past market numbers to see what I could find. Interestingly enough, when I looked at the historical numbers, I found that 2018 is definitely not outside of the historical norm. I know. It certainly doesn't feel that way. But in the moment, things always seem tougher than they actually are.
So far in 2018, there have been 57 days in which the Standard & Poors 500 Index (S&P 500) moved at least 1% up or down. For comparative purposes, this is actually seven times the amount of such moves that we saw during the relatively calm period that was 2017. However, we need only look back to 2015 to find a year in which we had more days of market moves up or down of 1% or more. In that year the market recorded 72 such days. With only 15 trading days remaining in the year, the S&P 500 would have to move at least 1% every day until the end of the year to equal that mark.
That being said, just looking at the number of days in which the market moved more than 1%, doesn’t necessarily give us a complete picture of overall volatility. For example, on Tuesday this week (12/4), we had a day where the S&P 500 was down 3.24%. So, I wondered if we could be experiencing a market that is having an abnormally high number of larger daily moves. As it turns out, not really. So far in 2018, there have been 15 days when the market changed by at least +/- 2% and there have been five days when it moved at least 3%. Again, comparing this year to 2015, we see that there were ten days of +/- 2% moves and three days of +/- 3% moves. We don't need to go far to find a year that exceeded these numbers. It happened only seven years ago. In 2011, the S&P 500 had 96 days of +/- 1% moves, 35 days of +/- 2% moves, and 12 days of +/- 3% moves. Another interesting tidbit? Each of the three years preceding 2011 also recorded more 1%, 2%, and 3% days, than we have seen so far in 2018.
Zooming out a little farther, we can see that since 1928 the S&P 500 on average has moved more than 1% on 60.26 days each year, more than 2% on 16.76 days each year, and more than 3% on 6.58 days each year. Therefore, while the recent volatility has been painful, from a historical perspective, what we have been experiencing in 2018 has been in-line with historical averages.
Here are a few more interesting historical data points:
* 1932 had more 1% days, 2% days, and 3% days than any other year with counts of 181, 132, and 94 respectively.
* 1964 was certainly a far cry from 2018. It was the calmest year on record, with just three 1% days and no 2% or 3% days.
* Since 1928, there have been 11 years, including 2017, that did not have a day when the S&P moved 2% or more.
* There have 35 years in which the S&P 500 did not have a single one-day move of 3% or more.
It is also worth noting that there have been zero days in 2018 that fall into the largest one day changes in the closing price of the S&P 500. The index's largest one-day gain in 2018 was 2.72%, on March 26th. Since 1928, there have been 1,040 bigger one-day gains. Conversely, the S&P 500's largest single-day decline of 2018 was -4.10% on February 5th. This ranked as the 414th largest one-day drop in the index's history.
So what's the point of all this? It is a fact that stock market volatility often drives investors to make rash and untimely decisions. I hope that this bit of historical context can help to keep you on track as 2018 comes to a close.
With Friday's close, the S&P 500 Index is 9.3% off of its closing high that was set on September 20, 2018. We are almost at a 10% correction in the S&P 500. What is interesting is that the index has fallen almost 10%, but the average S&P 500 stock has fallen over 16% and the average Top 1000 largest stock has fallen over 18%. If we do see the S&P 500 fall further, it will be the second time in 2018 that the market has fallen more than 10%. While this most recent pullback has been relatively swift, it is not an uncommon occurrence, especially in bull markets.
The following graphic is one of my favorites, as it sums up our expectations and experiences pretty well. We envision our investment plan to resemble the smooth uphill journey in the upper panel. While in reality, the lower panel resembles our actual journey. We will reach our destination, but there will certainly be "bumps" along the way. October 2018 is clearly represented below. While things seem "scary" right now, the prudent thing to do is stay the course.
As strong as the stock market was in the 1990's, there were numerous pullbacks along the way. As a matter of fact, the S&P 500 experienced a 5% pullback on 24 different occasions in the 90’s. Seven of those pullbacks resulted in a correction of 10% or more. So, for the 10-year period of the 1990's, there were seven times the S&P 500 corrected at least 10%.
2018 is displaying strong parallels to 1994. The year 1994 was labeled as a stealth bear market, because the major stock market indexes were basically flat for the year. Unlike the averages though, the average stock experienced a lot of pain (not unlike what we’re seeing this year). Looking back at 1994, the S&P 500 had two corrections (one for -8.93% and another for -6.44%). Far greater was the decline of the average economic sector; over 18% that year. In 2018, the S&P 500 has had two corrections (one of -10.2% and the current one of -9.3%), but the average sector has declined over 15%.
Another parallel to 1994 is that the Federal Reserve sharply raised interest rates, through six rate increases. The Federal Funds rate actually doubled in 12 months. The past couple of years have seen a steady rise in interest rates as well, with three increases taking place in 2018. That being said, the interest rate headwinds made it difficult for bond investors in 1994, as well as 2018. The Aggregate Bond Index ETF's (AGG) total return was down 2.92% in 1994 and currently it's down 2.07% in 2018.
As Mark Twain famously once said, "History doesn't repeat itself, but it often rhymes." So while every year is different, there are some parallels between today and previous years. Of course, things could turn out differently this time and instead of a 1995 style rally, things could look a lot like the early 2000's or 2011. For now, I will continue to pay attention to my indicators and follow the discipline that has served me well in the past.
Typically, pullbacks during bull markets tend to be viewed as buying opportunities as opposed to wholesale shifts towards defensive asset classes. Some pullbacks were steeper than others, but the bull market remained intact until the end of 1999. The structural bear or fair market of the 2000's looked much different in terms of the number of pullbacks and the magnitude of those pullbacks. For example, while the S&P 500 pulled back 5% or more 24 times in the 90's, in the decade of the 2000's, the market pulled back 5% or more 47 times and 20 of those times resulted in double-digit declines.
Prudent investment portfolios are constructed with the knowledge that there will be corrections or "scary" times in the market. Market history, as well as our own experiences tell us that. A diversified portfolio expects to experience "scary" markets. We don't know when or why these corrections will happen. Just that they will. Since weeks like these last few are to be expected, your portfolio should not be changed because of short-term market fluctuations. Investment portfolios are not designed to avoid all volatility and drawdowns. If they were, the portfolio would experience very minimal upside. Short-term volatility is the admission price for higher expected returns. As an example, your savings account at the local bank avoids all volatility. It also avoids providing you with a high return. It is important to remember that while short term volatility is uncomfortable and cannot be eliminated, the long term probabilities are skewed heavily in your favor. (see the chart above) Keep a long-term perspective, because months like October will try to knock you off of your game.
Halloween has arrived early! You would think this if the recent stock market action was any indication of such.
It is entirely normal to have a reaction to yesterday's stock market drop - probably a very, very strong reaction. It is human nature. We are wired to do so. There really is nothing you can do about preventing that reaction. I can tell you though, what you are experiencing has everything to do with feelings and nothing to do with thinking.
If you have ever taken a course in Psychology, you probably learned about the Fight-or-Flight Response. The term "fight-or-flight" represents the choices that our ancient ancestors had when faced with an imminent danger in their environment. They could either stay and fight or run away. In either case, the physiological and psychological response to this stress prepares the body to react to the danger. So why does a bad day in the stock market trigger a stone-aged response in our bodies. As I said before, it is just the way that we are wired. It is an automatic response and there is nothing that we can do to prevent it from happening.
Enough about feelings. Let's do some thinking. If we zoom out a little and take a look at what is really going on we note the following two facts: U.S. corporate earnings are surging, and the U.S. economy as a whole is also surging.
There is also much noise out there to trying to throw you off of your game. For example, this Fortune Magazine cover from a couple of months ago:
The article makes for a catchy cover story, and certainly entices people to buy the magazine. But it has the potential to seriously scare and mislead investors. Why? Because, as the author himself says, nobody, including most notably economists, has been able to accurately predict economic and market downturns. So, time and time again, market “timers” have gotten burned.
My view is that the strength in U.S. stocks can continue until the Federal Reserve makes a deliberate move to slow the economy. From every indication we have from the Fed, that is still a ways off. As you know, I do not care for predictions. I am a strong believer in "What is, is." And what is right now, is the fact that despite recent volatility, U.S. stocks continue to remain the strongest asset class of the six that I follow on a daily basis. Not cash. Not bonds. Not commodities. It is U.S. stocks. I remain vigilant every day for changes that are truly long-term in nature and will adjust our portfolios accordingly.
Investment success comes from ignoring the short-term noise and following a plan. Emotions can and will wreak havoc on your portfolio. I know that it is tough to do, but try to ignore the short-term market fluctuations that will severely tempt you to abandon your plan. There will be bad days for sure. Fight the urge to react to your feelings. Think instead. The prudent and best way to maximize long-term wealth-building is to stay fully-invested in a broadly diversified portfolio.
Do you have an HSA? And if you don't, should you have one? Let's take a look and see.
First of all, HSA stands for Health Savings Account. As the name suggests, it is a way to save and pay for health related expenses. What the name doesn't imply though, is that it is also a way to reduce your taxable income. Who wouldn't want those two things?
Before you can set-up an HSA, you need to qualify to do so. To qualify you need to be enrolled in a high-deductible health insurance plan (HDHP). The U.S. Government has established that for 2018, an HDHP for an individual is a health insurance plan that has a minimum annual deductible amount of $1,350 and a maximum annual out-of-pocket expense of $6,650. If you have a family insurance plan, then the minimum annual deductible must be $2,700 with a maximum annual out-of-pocket expense of $13,300. Just to clarify; out-of-pocket expenses are things such as deductibles, co-pays, and other fees. They do not include health insurance premiums.
So how does this all work and what about reducing your taxable income? Every year you can contribute to your HSA any amount up to the government mandated maximum. Just as IRAs and 401Ks have maximum contribution amounts, so do HSAs. For 2018, the maximum contribution to an HSA for an individual is $3,450. For a family, the maximum contribution is $6,900. Here's an added bonus. If you are 55 years of age or older, you can contribute an additional $1,000 to your individual or family account. On top of this, these contributions are 100% tax deductible!
Another attractive benefit of an HSA is the fact that unlike a Flexible Spending Account (FSA), your HSA balance rolls over from year to year. You do not have to spend it or lose it each year like you do with a FSA. Once you turn 65 and enroll in Medicare, you are no longer eligible to contribute to your HSA, but you can still use the funds in your HSA to pay for out-of-pocket medical expenses. If you decide to use HSA funds on non-eligible expenses, you will have to pay income tax on the amount that you withdraw (plus a 20% penalty if you are under the age of 65).
In total, HSAs have three tax advantages.
Your HSA contributions are tax deductible.
Your money within your HSA grows tax-free.
Withdrawals that are used to pay qualified medical expenses are also free from income tax.
Sounds pretty good. But there are still more benefits to mention. First, money within your HSA can also be invested in mutual funds for the potential for higher growth than if the funds were left in cash. Second, unlike IRAs and other retirement accounts, there are no Required Minimum Distributions (RMDs) once you reach the age of 70 1/2. And finally, if you make your HSA contributions through payroll deductions with your employer, these contributions will not be subject to Social Security and Medicare (FICA) taxes. So in addition to escaping Federal and state income taxes, you will also avoid the 7.65% FICA tax hit. While your 401K contributions escape Federal and state income taxes, they do not escape the FICA tax.
While not the optimal solution for everyone, an HSA is a very attractive way to reduce your health insurance costs while at the same time saving for future medical expenses in a triple tax-advantaged way.
October is right around the corner. It's a time for World Series baseball, pumpkins, brilliant foliage, and stock market crashes. Wait? Stock market crashes? That's right. Some of the most notable stock market meltdowns have occurred, or escalated, in the month of October. These include 1978 (-9%), 1987 (-22%), and most recently, 2008 (-17%). October has also produced several of the largest one-day market declines. Black Monday (1987) and Black Tuesday (1929) both occurred in October.
Now I am not pointing this fact out to alarm you. Quite the contrary. I just want to put the current market environment into context for you, because I am sure that we will be inundated with a myriad of media reports about the coming stock market correction. You know, the one that is coming just because this bull market has been going on for so long now. Do not pay attention to those kind of stories!
Here's today's fun fact: Did you know that since 1950 the S&P 500 has had more double-digit gains in October than it has had double-digit losses? It's a fact. The month of October is also known as the "bear killer" because it marks the end of the seasonally weak period in the market. Historically speaking, October has been a positive month more often than it has not. The S&P 500 has actually finished higher in 60% of the Octobers between 1950 and 2017.
So while October may have a notoriously bad reputation, the histogram below shows us that maybe it is not well deserved. Each of the previous sixty-eight Octobers' returns have been placed into a performance bracket, allowing us not only to see that there have been more up Octobers than down Octobers, but also the degree to which they have been up or down. When you look at the far left of the histogram, you will notice that only four Octobers since 1950 have experienced a decline in excess of -5%. The most common experience in October has been a gain in the range of 2.5% - 5%.
(source: Dorsey, Wright and Associates, LLC)
While this is an interesting exercise to demonstrate what has happened in the past, it really does not tell us much about October 2018. What I do know is that currently my U.S. stock market indicators remain positive. U.S. Equities remain the top ranked asset class out of the six that I follow on a daily basis. There certainly could be some short-term market volatility as corporate earnings season will begin again in the next month or so. Also, increasing trade tensions and rising interest rates could impact market volatility. I remain vigilant and if US Equities begin to deteriorate relative to the other asset classes, portfolio allocations will be adjusted accordingly.
In the meantime, don't be spooked by dire warnings about the month of October and what it might mean for your investments. If the past is any indicator, then things will be OK.
I have often said that it is important to ignore the short-term "noise" so often heard in the markets. This noise emanates from the financial media as well as from some very highly paid professionals. (Please note: the size of one's paycheck does not signify brilliance.) While catching up on some reading over the weekend, I came across an article on MarketWatch titled, Chart of Shame: The S&P 500 vs Everyone Who Said the Market Was About to Crash. This article contained the following graphic compiled by Jon Boorman of Broadsword Capital.
Wow! This chart says it all. There are over 25 quotes from some highly paid and well respected stock market pundits from 2012-2018. All of them warning about an upcoming market crash that never materialized. Total and complete wrongness. I especially love the two "Sell everything!" directives in 2016. Since 2016, the S&P 500 has climbed an impressive 40%! If you had heeded their warnings and moved your money to cash, your investment portfolio and possibly your long-term financial goals would have taken a serious hit as you sat on the sidelines during this strong market rally.
The financial media's main mission is not to help you succeed as an investor, but instead to generate digital clicks or old-fashioned magazine sales. It's about them, not you. Sensational headlines like "The Big Crash is Coming!" sells many more magazines than a more useful headline such as "Everything is Fine. Stay the Course". Yes, I know that these headlines are usually backed up by some very credible sounding and well-researched rationale. However, the track record of these stock market pundits' predictions is horrendous.
Economist John Maynard Keynes famously said, "The only function of economic forecasting is to make astrology look respectable." Let's take a look at the accuracy of some of these so-called forecasting experts. The website Econlife.com provides a very telling report card on their past performance. When they looked at 12 month market predictions (i.e. what the "expert" thought the market would do over the next 12 months) made between 1998 and 2016, they found that 92% of the time the "market expert" predicted that the market would rise. The stock market has historically gone up more than it has gone down, so this was a pretty safe prediction from a probability standpoint. Not surprisingly, they were right 92% of the time. Most investors are more concerned about knowing ahead of time when the market is going to drop. So how did the "experts" do when it came to accurately predicting market downturns in the coming 12 months? Only 9% of the predictions accurately predicted the market downturn. Utterly worthless! Why would anyone ever listen to these people?
My portfolio methodology does not rely on forecasts. I think that we can clearly see that there is little benefit to listening to the well-paid "experts". Instead, I rely on a methodology that is based on the laws of supply and demand. We all understand why there are lemonade stands in the summer and hot chocolate stands in the winter. When there are more buyers than sellers willing to sell, prices must rise. When there are more sellers than buyers willing to buy, prices must fall. It's easy to follow the rules of a methodology when things are going well, but it's when the going gets rough that we need the rules the most. I don't listen to the "experts" who are telling us what the market should do. And either should you. I listen instead to what the market is saying. When U.S. stocks are no longer in demand, that is when I will know that it's time to alter our allocation or raise cash in our portfolios.
On Monday (February 5, 2018), the S&P 500 fell 4.1%. This was the steepest decline since August 2011. Should we be worried? Right now, I don't think so. Let's take a rational look at what's going on with this market.
While Monday's decline was steepest since August 2011. The decline back then took place after Standard & Poor's cut the United States' credit rating from AAA to AA+. By the look of it, the current sell-off was fueled by the prospects of economic growth, inflation, and the possibility of continued interest rate hikes. Hmmm. The same reaction to two, very different outlooks. Is that rational?
Throughout much of 2017, investors seemed to be concerned about the flattening of the U.S. Treasury yield curve. A flat yield curve happens when there is very little difference between short-term and long-term rates for U.S. Treasury bonds. Typically, the yield curve curve slopes upward. Meaning that short-term interest are lower than long-term interest rates. In 2017, there was a concern that continued flattening of the yield curve could lead to an inverted yield curve. Historically, inverted yield curves, specifically when the two-year Treasury yield is higher than the ten-year yield, have preceded recessions. Each of the four recessionary periods since 1980 have occurred either while the yield curve was inverted or within one year of when an inversion occurred.
On the other hand, a steep yield curve (ie. short-term interest rates are much lower than long-term interest rates) often indicates a period of inflation. Increased inflation is often associated with strong economic activity. Since the beginning of this year, the yield curve has steepened. This is most likely due to the forecasts of strong economic growth ahead.
According to FactSet Research, earnings reports are indicating that there has been strong economic activity. They recently stated in their Earnings Insight report, "For Q4 2017 (with 50% of the companies in the S&P 500 reporting actual results for the quarter), 75% of S&P 500 companies have reported positive EPS surprises and 80% have reported positive sales surprises. If 80% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008." Strong economic activity is certainly preferable to a recession.
Rising interest rates, a stronger than expected jobs report, and increased wages have all been given as potential causes for the recent sell off in U.S. Equities. The speculation is that investors fear that a strong employment market will lead to inflation and cause the Federal Reserve to accelerate the pace of interest rate increases. However, these concerns are in many ways the opposite of the concerns of last year when investors feared that a flattening yield curve would lead to inversion and ultimately a recession. Now, because the yield curve has been steepening so far in 2018, this is the cause for the sell-off in U.S. Equities?! This a great example of why I say that the markets can be irrational at times!
For now, the move in the S&P 500 has functioned much like a "reversion to the mean." Since September, the S&P 500 had been in what felt like a perpetual state of being overbought. It just kept going up and up. With Monday's sell-off, that state is now over. The S&P 500 is now in oversold territory.
To wrap things up, we are in the midst of a 5% pullback in the S&P 500. U.S. Equities still are the top ranked asset out of the six major asset classes that I look at every day. International Equities are currently number two. So this is still a positive in favor of U.S. and International Equities exposure right now. Even with the two days of volatility and the market pullback, U.S. and International Equities remain firmly entrenched in the top two spots, so I continue to suggest a tactical overweight to those two areas of the market.
So what's next? We cannot know for certain, but you can rest assured that I am constantly monitoring my indicators and if anything changes, I will react appropriately. As I have said before, it is important to tune out the short-term market noise and listen to what the indicators are saying instead. My indicators have guided me safely in the past; and they will guide me safely in the future. Positioning investments toward current trends, rather than past or future presumptions, serves as the driving force behind my portfolio management methodology. If you would like to discuss anything that you read here in greater detail, please do not hesitate to contact me. Thank you.
The more things change, the more things stay the same. Another week has passed and there were no major changes in the stock market. U.S. Equities continue to lead; with International Equities close behind. The strongest stock market sectors also continue to be Technology, Financials, and Industrials. Not much has changed in 2017.
So far this year, we have witnessed historically low levels of volatility. Perhaps the biggest story of 2017 is the complete and utter disregard that the U.S. stock market has shown for the myriad of major headline events that we have witnessed so far. There have been numerous natural disasters; even more saber rattlings from North Korea; and still more social media balloons floated by the White House. In the face of all this, the stock market has been given plenty of opportunities to implode, or at least display some sort of pronounced reaction. Instead......(insert the sound of crickets here) nothing! This extended period of low volatility is not often observed in the U.S. stock market and certainly has the pundits perplexed.
The S&P 500 Index has gained more than 13% this year. As I noted above, it has done so with an extremely quiet set of "ups and downs" that hasn't been experienced in over 40 years. Earlier this year, the S&P 500 index went 58 days without a single price change that was greater than +/- 1% of its previous day's closing price. We've now gone 232 trading days (almost a year) without a daily price move of more than +/- 2%. So, are we due for a 2% rise or fall? Not so fast. The longest period on record without a 2% change in daily price occurred from October 2003 through June 2006. This equated to 680 trading days. Through the first three quarters of 2017, only 8 days have experienced a price change of 1% or more. That means 96% of all trading days so far this year have finished with less than a 1% change from the day before. The historic average is 76%. Where is the volatility? While 2017 is not yet over, there has not been a year this "quiet" since 1972!
So why does this market feel so jittery when in fact it is not? I read recently an explanation as to why we may feel that this market is volatile even though in reality it has been uncharacteristically calm. When headlines remain vitriolic, it is far too easy for the typical investor to feel volatility that doesn't exist. This occurs in much the same way that a young NFL quarterback might feel a rush from the opposing defense that simply isn't there. A savvy defensive coordinator will often send just three rushers in an obvious blitz situation (3rd and long, for instance), begging an inexperienced passer to panic and throw the ball in the direction of any one of the eight defenders now waiting for their opportunity to run the other way with it. That's right! We are just imagining it! Our minds are being tricked by the constant headlines that are touting the next big scary thing. So turn off that TV and put down that newspaper. They are just making you feel market volatility that isn't there. This in turn, makes you loose faith in your investments.
In spite of all of the daily shocks that should be derailing this market, the 2017 stock market continues to calmly march forward. When my indicators tell me that this is no longer the case, our portfolios will adapt. Until then, we will stay the course and remain confident in the methodology.
Last Thursday, Equifax announced that they had been the victim of a serious cybersecurity breach. Approximately 143 million U.S. consumers' personal information may have been accessed. This hack has affected nearly one half of the U.S. population! It's huge. The information that was accessed included: names, Social Security numbers, dates of birth, addresses, and driver's license numbers. Equifax has also stated that the credit card numbers for almost 209,000 Americans and certain dispute documents with personal information for approximately 182,000 Americans were accessed. This breach occurred from mid-May through July 2017.
Who is Equifax? They are one of the three largest consumer credit reporting agencies in the United States. If you have ever applied for credit or taken out a loan, chances are that the creditor or lender accessed your credit report from Equifax in order to determine your credit worthiness.
So what should you do now? Equifax has set up a website for you to determine if your information was exposed (mine was!). The easiest way to get there is to go to: www.equifax.com. Right there, front and center on their website, is a link to check to see if your information was impacted by this breach. Click on the orange block and you will taken to a page with more information on this data breach. Click on the “Potential Impact” tab near the top of the page and then enter your last name and the last six digits of your Social Security number. Make sure that you are on secure computer when you enter this information. The site will tell you if you’ve been affected by this breach. Regardless if your information was exposed or not, Equifax will provide you with a free year of credit monitoring and other services. You will have to return at a future date to enroll. So, write down the date that you are provided and come back to the website and click “Enroll” on that date. You will have until November 21, 2017 to enroll.
According to the Federal Trade Commission's website, here are some additional steps that you can take to protect yourself after a data breach:
Check your credit reports from Equifax, Experian, and TransUnion - for free - by visiting annualcreditreport.com. Accounts or activity that you don’t recognize could indicate identity theft. Visit IdentityTheft.gov to find out what to do.
Consider placing a credit freeze on your files. A credit freeze makes it harder for someone to open a new account in your name. Keep in mind that a credit freeze won’t prevent a thief from making charges to your existing accounts.
Monitor your existing credit card and bank accounts closely for charges you don’t recognize.
If you decide against a credit freeze, consider placing a fraud alert on your files. A fraud alert warns creditors that you may be an identity theft victim and that they should verify that anyone seeking credit in your name really is you.
File your taxes early - as soon as you have the tax information you need, before a scammer can. Tax identity theft happens when someone uses your Social Security number to get a tax refund or a job. Respond right away to letters from the IRS.
I hope that you had a chance to catch a glimpse of Eclipse 2017 - either through a pair of NASA approved "eclipse glasses" or via an Internet stream. Boy, what did we ever do before the Internet? Just as the moon eclipsed the sun, the performance of Domestic Equities have eclipsed International Equities (and every other asset class). The main difference between these two events? The solar eclipse lasted a few minutes, while Domestic Equities have been favored over International Equities for more than seven years now!
Each day I evaluate the relationship between the six major investment assets classes; Domestic Equities, International Equities, Fixed Income, Commodities, Currencies, and Cash. Through this daily evaluation I see where the strength in the markets lie. It is a fools errand to try and predict what the markets will do, rather I watch and identify market trends. In other words, I prefer to listen to what the markets are telling me rather than try and tell the markets what I think they should do.
Since the beginning of 2017, International Equities have closed the gap considerably on Domestic Equities. Does this mean that it is inevitable that International Equities will become the top ranked asset class. Not necessarily. But it does make it far more plausible. Over the last seven years, we have witnessed the U.S. stock markets sustain a sizable performance advantage over the International markets. The following chart clearly shows this fact.
source: Dorsey Wright & Associates
This invariably brings up the question, "Why don't we just invest all of our money in U.S. stocks?" Not so fast! Unfortunately, things are not quite that stable. No too long ago, we witnessed the polar opposite in this performance relationship. The following chart shows that in August 2003, International Equities became the higher ranked asset class and for the next five years they outperformed Domestic Equities handily. Much like we have seen with the U.S. markets in more recent memory, the performance advantage for International Equities was both dramatic and sustainable over a long period of time.
source: Dorsey Wright & Associates
I share this historical perspective for two reasons. First, it seems as if the financial news is full of stories about the coming U.S. stock market collapse. No one knows for sure how long this Domestic Equity outperformance will last. And to predict its demise with certainty is harmful to investors who heed such advice. As demonstrated, outperformance can persist for extended periods of time. And second, putting all of your eggs in one basket (like Domestic Equities) can lead to subopitmal results for extended periods of time. This is why I don't believe in trying to predict the market's next move. Instead, I believe in positioning investment assets to take advantage of prevailing trends. When these trends change, so does the portfolio. In order to manage portfolio risks, you must adapt.
Well, the so-called "experts" got it wrong again. Voters in the United Kingdom didn't do what they were expected to do. Instead, they voted decisively on Thursday to leave the European Union. They favored Brexit over remaining in the EU by an unexpectedly high margin of almost 4%. As expected, markets around the world are reacting negatively. As of this writing, the major U.S. indexes are down between two and three percent. Please do not panic. And here's why.
Polls showed that there were three main issues that drove the vote to exit.
1) concerns about the micro-managing and over-regulation of UK businesses by European Union bureaucrats which leads to slowing business growth and job destruction
2) passage of laws and regulations which many Britons considered unnecessary and contributed to the slow erosion of their national sovereignty
3) the fear that EU bureaucrats are unable, and in some cases unwilling, to control immigration and screen out terrorists - especially in light of the recent terror attacks in Paris and Brussels
It appears that the UK's decision to leave the EU will have little long-term effects on the UK or EU economies. Today's market volatility is the immediate reaction to the current uncertainty that the world's market must absorb. This volatility often causes short-term mispricings that should be viewed as an opportunity to find some bargains amongst the stronger companies.
In reality, the UK represents approximately 25% of all business trade within the EU and runs consistent trade deficits with the rest of Europe. The rest of the EU needs the UK and will beat a path to its door to sign new trade agreements with them. If they don't? They will lose a major trade partner. There really is no way that any EU country will allow one of its biggest export markets to go away.
Nothing is going to fundamentally change by tomorrow, by next month, or even by next year. There is even some good economic news in yesterday's vote. The US and the UK have been trying to sign a major free trade agreement, but the EU has been blocking this effort. It now looks like that impediment has been removed. We may see more of this from other non-EU countries.
To sum this all up, Brexit really is a political issue and not a fundamental business or economic issue - despite what the press may be telling you. Yes, stock markets hate uncertainty and this uncertainty will cause days like today in the short-term. But like most political events, the long-term impact to the markets should be minimal. A prudent, diversified portfolio is your best long-term weapon against days like today. Stay focused on your goals and not on the news. In the long run it is just noise which is trying to distract you. Ignore it. Instead, think of this famous British poster from the World War II era.
I am continually amazed by the number of purported experts on TV and in print that are predicting a coming market crash. I guess if you keep making this prediction long enough, you are bound to be right at some point. But, will these prognostications help you to reach your goals? Hardly. They are more likely to derail you.
The recent volatility in the markets has many investors feeling a sense of unease. Despite this increased volatility, bonds and U.S. equities remain the strongest asset classes of the six that I follow on a daily basis. Until stocks fall from their number 2 position, I will stay the course. Will stocks fall from here? That remains to be seen. Earlier this week, one of the market indicators that I follow did flash a cautionary signal. Even though this signal comes at a time of the year when the market always seems to throw a few "curveballs" as we are now in the seasonally weak period, it does not mean that I will be shifting away from stocks. What it does mean is that the defensive team is on the field and my focus has moved from wealth accumulation to wealth preservation.
This indicator's shift is akin to that of a red light. Like the literal traffic light, a "red light" is not caused by a catastrophic accident, but is rather there to greatly reduce the probability of such an event. I am sure that you know someone who has at one point or another, disregarded a red light for one reason or another. They may have escaped unnoticed. Or in some states, they may have simply received something in the mail from the Department of Motor Vehicles suggesting a contribution of some kind. Or, they may have experienced a far worse outcome. The point is that a red light suggests elevated risk to you and those around you. I will remain vigilant.
The S&P 500 had rallied about 12% (through 5/18) from it’s February bottom. Prior to this recent rally, the S&P 500 experienced a 10% correction. So what's next? Well we cannot know for certain, but if U.S. stocks begin to deteriorate relative to the other asset classes, I will react appropriately. As I have said before, it is important to tune out the short-term market noise and listen to what the indicators are saying instead. My indicators have guided me safely in the past; and they will guide me safely in the future. Positioning investments toward current trends, rather than past or future presumptions, serves as the driving force behind my portfolio management methodology.
It’s hard to believe that it’s already the end of February 2016, and in many ways it is good to have the month of January and most of February behind us. With that said, there is an old market adage that warns, "As January goes, so goes the year". This adage would imply that if the first month of the year was positive, then the remainder of the year would be positive, and if the first month of the year was negative then the remainder of the year would be negative. However, it is not that cut and dry. Going back to 1950 there were 40 January’s that saw positive returns in the S&P 500 Index. Out of those 40 years, only three ended up having negative returns at the end of the year. In other words, 92.5% of the time a positive January is followed by a positive year. So, what happens when the market is down in the month of January? There have been 26 years in which January started off with negative returns for the S&P 500, and 14 of those years saw negative returns. In other words, 53.8% of the time a negative January is followed by a negative year, or just slightly better than a flip of a coin.
So, a positive January is typically a positive sign for the market, but a negative January is far less conclusive. In 2016, the market, as defined by the S&P 500, closed the month of January down -5.07%, the 7th worst January since 1950 (there is a three way tie for 7th place). It also marked the third consecutive year that the S&P 500 ended the first month of the year in the red, as 2014 and 2015 saw the market decline -3.6% and -3.1%, respectively, and 2014 turned out to be positive year for the market while 2015 was down just slightly by the end of the year.
The point of this discussion is for you to not get caught up in the media hype. The volatility in the markets has picked up over the past few months, and with the volatility will come opportunity. There is another saying that we often talk about, and that is the fact that a rising tide lifts all boats. Well, the other side of that is a receding tide reveals trash on the beach. Pullbacks in the market often reveal weakness otherwise masked by a rising tide.
Over the past few years US Equities have held the number one ranking when compared to the five other asset classes that I follow. However, on February 8, 2016 Fixed Income moved into the number one ranking and was followed on February 11th with Cash moving to the number two ranking, thus leaving US Equities trailing in third. This is a very important relationship that I will continue to monitor.
Within the US Equity market there is evidence of sectors beginning to rotate out of favor for the first time in many years, and others emerging as leaders. For example, the Healthcare Sector has been a leader for many years from a relative strength perspective, but has fallen in rankings recently while sectors like Technology, Consumer Discretionary, and Consumer Staples stocks have ascended to the top of the ranks. One of the consistent trends in the market has been the weakness in the Energy Sectors and there is no evidence of a change there as Energy is the lowest ranked sector out of the 10 broad economic sectors.
I hope 2016 is off to a great start for you, and your New Year’s resolutions are still alive and well.
Volatile. When asked to describe Monday's market action with one word, that is the only word that you need. The Merriam-Webster dictionary defines volatile three ways.
volatile, adjective | vol - a - tile | 1) likely to change in a very sudden or extreme way, 2) having or showing extreme or sudden changes of emotion, 3) likely to become dangerous or out of control
All three of those definitions fit the Dow Jones Industrial Average's (DJIA) behavior on Monday to a "T". Likely to change in a very sudden or extreme way - Within the first five minutes of trading on Monday morning the DJIA was down over 1,050 points. From there it rallied over 950 points and then turned south again to close down 588.40 or -3.57% for the day. The changes were definitely sudden and extreme! Having or showing extreme or sudden changes of emotion - While the stock market is not a person and therefore cannot exhibit emotions, it is pretty safe to assume that Monday's wild price swings caused many investors to experience extreme and sudden change of emotions. The talking heads on TV and on Twitter were constantly asking questions like: Will the market close down 1,200 points? Will the market only close down 100 points? Will the market make it all the way back and close up for the day? These so called experts on television love to see wild swings in the stock market because more people will tune in and their networks will collect more advertising dollars. Remember, the financial news channels are not there to primarily help you with your investments. They are there to make you want to stay tuned for the next salacious story. Likely to become dangerous or out of control - Is this the start of a bear market? I know that many of you were probably asking yourself that very question. While we can't know the answer to that question for sure, the indicators that I look at on a daily basis are not telling me that this is the start of the next structural bear market.
U.S. Stocks are still the number one ranked asset class of the six macro asset classes that I evaluate. As a comparison, I took a look back at what my indicators were saying in August 2008; prior to the Financial Crisis and Meltdown at the end of September 2008. The major difference that I see between the indicators now and then is the ranking of cash or money market relative to the other asset classes. Back in 2008, defensive asset classes like Cash and Currencies were ranked one and two. Conversely, U.S. Equities were then ranked near the bottom at number five. Fast forward to today. While bonds are a defensive asset class and are currently ranked number two, the number one ranked asset class as I stated previously is U.S. Stocks. Until U.S. Stocks relinquish their hold on the top spot, I recommend not doing anything in spite of the recent market volatility. At the beginning of August, International Stocks deteriorated enough relative to Bonds to facilitate the adjustment of our portfolios. Bond allocations were increased and International Stock allocations were decreased well in advance of this latest market turmoil.
At this point I am sure you know what I am about to say - Please do not panic. Please resist the urge to sell your stocks. Take a step back and tune out all of the noise that is trying to convince you to do otherwise. The end of summer is rapidly approaching. Wouldn't you rather focus on enjoying the beautiful weather with family and friends? Go out and enjoy it! Rest assured that I am here and remain ever vigilant for changes that will warrant our attention.
A strong punch to the gut. With the stock market's behavior this week, I can certainly understand it if you are feeling as if the market has delivered a strong punch to your gut. This past week has been one of the toughest weeks for U.S. stocks so far this year. Through Thursday, the S&P 500 Index has lost a little over 3% this week. Thursday's decline was the S&P 500's worst one day drop since February 3, 2014. Not to be left out, the Dow Jones Industrial Average (DJIA) fell 358 points on Thursday. So far this year, there have only been two days (prior to Thursday) that the DJIA has closed down more than 300 points. Days like Thursday have certainly not been a common occurrence in 2015! As a matter of fact, it wasn't a common occurrence last year either. In 2014, there were only five days where the DJIA closed down more than 300 points.
So what's behind the increased stock market volatility of late? There is no shortage of opinions when it comes to assigning the blame for what has caused this latest market drop. Some would have you believe that it is the slowing down of China's huge economy, along with their decision to devalue their currency - the yuan. Still others say that it is the uncertainty about whether or not the Federal Reserve will raise its benchmark interest rate next month. The Fed has not raised interest rates from their current historically low levels in almost ten years. Continued uncertainty surrounding Greece also bears some blame. Who knows? The markets are complex entities that react to many variables - and usually react to things that we are not even aware of yet. As human beings, we constantly feel the need to understand the world around us. We are eager to learn what is causing things to happen. While the answers that are proffered may make us feel better, they may or may not be the true cause. Only time will tell....maybe.
To put things in a little better perspective, let's back up and take a longer look. So far in 2015, the S&P 500 is down only 1.13%. From it's May peak, the S&P 500 is down a little more than 4%. Historically, a 4% pullback in the market is not uncommon. Another important observation is that the S&P 500 has not had a 5% pullback yet this year, let alone a 10% draw down. Going back to 1928 and looking at daily closing prices for the S&P 500, the stock market has pulled back 10% 93 times over that 86 year span. In other words, on average the market has pulled back by 10% once per year. The last time the S&P 500 had a 10% pullback was back in 2011 when it fell a little more than 19% from April 29th to October 3rd. We have not seen a 10% stock market decline in almost four years! Maybe this is why this recent market pullback has felt a bit worse than the numbers might suggest.
By historical averages, the market is certainly "due" for a 10% correction. However, that is not a guarantee. There is a precedent for the stock market to go for prolonged periods of time without a 10% correction. For example, from the stock market bottom in March 2003, it took until November 2007 for another 10% correction. That was 4 1/2 years. And that was during a structural bear market. Since we are currently in a structural bull market, let's take a look back to the last structural bull market from the early 1980 through the end of 1999. During that period, the S&P 500 went over seven years between 10% pull backs; from August 1990 to October 1997.
While we have not had a 5% correction yet this year, I wanted to provide you with some statistics on recent 5% stock market pullbacks in order to give this latest market action some added perspective.
Since the stock market bottom in 2009 there have been 20 pullbacks of at least 5%.
On average, there is an additional pullback of 2.12% after achieving the loss of 5%.
On average, during the 2009-present rally, it has taken 7 days after reaching 5% down before the actual low point was reached.
While the average is 7 days from hitting the 5% pullback mark to finding a stock market bottom, the longest stretch was 24 days (November 2011) and the shortest was zero days on multiple occasions.
While looking at the past data is a nice way to help us understand what we are currently experiencing, it is not a prudent way to manage your portfolio. You know that I am fond of saying, "What is, is." And currently "what is" is that US Stocks continue to be ranked as the number one asset class out of the six asset classes that I evaluate on a daily basis. As a matter of fact, U.S. stocks have been ranked number one for almost four years straight! Bonds are currently ranked second. If U.S. stocks begin to deteriorate relative to the other asset classes, I will react appropriately. It is important to tune out the short-term market noise and listen to what the indicators are saying instead. I know that it is hard to do. But my indicators have guided us safely in the past; and they will guide us safely in the future. You can rest assured that these indicators will tell me when it is no longer prudent to be bullish on the U.S. stock market. Please remember that positioning your investments toward current trends, rather than past or future presumptions, serves as the driving force behind the methodology for managing client portfolios at Tapparo Capital Management.
I have had many conversations over the course of the past couple weeks and they all have had pretty much the same common theme - "this market has felt tough". There certainly has been many news events to keep things stirred up. Namely among them, Greece, China, and the fear of rising interest rates. While these things could definitely be pointed to as reasons for this market turmoil, I want to provide you with a bit of perspective on the "tough feeling" of the stock market this year.
Through July 30th, the S&P 500 stock index is showing a positive return of about 2.4%. However, that does not tell the whole story. So far in 2015, the S&P 500 has experienced 14 moves of 2% or more. Nine of those movements have been greater than 3%. The largest rally this year was a 6.55% move off the February correction low up to a peak of 2115.48. What is really fascinating and hard to believe is that we have yet to see a 5% correction this year!
There often is a lot going on underneath the surface of the market. One way to get some perspective on the market movements this year is to look at the performance of the various sectors that make up the stock market. There are 40 sectors that I track. So far this year, the difference in performance between the best performing sector and the worst performing sector is almost 54 percentage points. The best performing sector is the Biotech Sector, which is up 22.7%. Six other sectors have managed double digit returns so far this year. On the other end of the spectrum though, 25 out of the 40 sectors are actually underperforming the S&P 500 so far this year, and 7 sectors are down double digits with Steel, Precious Metals, and Non Ferrous Metals leading the way down with losses of more than 20%. There have been plenty of positive developments within the US Equity markets so far this year. However, there have been some land mines out there as well for those not paying attention.
US Stocks continue to be ranked as the number one asset class out of the six asset classes that I evaluate on a daily basis. As a matter of fact, US stocks have been ranked number one for almost four years straight! While the financial media has proclaimed for awhile now that the stock market is due for a correction, it continues to do what it wants to do - go up! It is a lesson that is hard to learn, but it is an important one. The market will continue to do what it wants to do and not what the so-called experts think it should do. Please ignore the financial media. I do. In the meantime, I remain bullish because the indicators that I follow are based on the irrefutable law of supply and demand and not on the prognostications from the financial media. These indicators will tell me when it is no longer prudent to be bullish on the US stock market.
Did you know that on Tuesday, the Dow Jones Industrial Average (DJIA) celebrated it's 119th Birthday? That's right - the DJIA was formed on May 26, 1896. What once started as a minuscule batch of twelve industrial stocks has now grown to a mature thirty. Interestingly, two of the original twelve, Chicago Gas Light & Coke and North American Company, both ended up being part of the current Wisconsin Energy Company (not in the DJIA). The United States Leather Company was the only preferred stock among the original twelve, but it dissolved in 1911. Only one company from the original twelve is still a member of the DJIA to this day. Like a fine bottle of wine, General Electric has improved with age and remained in the DJIA for all 119 years.
On October 4, 1916, the original twelve names expanded to twenty. Twelve years later, on October 1, 1928, this market index grew to its current size of thirty companies. The number of companies has remained constant for the last 87 years, while the composition has seen a fair number of changes. One of the more recent additions to the current thirty (March 2015) is Apple. They were responsible for replacing American Telephone & Telegraph Company - or more simply, AT&T. AT&T had been a member of the DJIA since its expansion to twenty companies in 1916. The fact that companies like Westinghouse Electric, Studebaker, Western Union, and Woolworth have been replaced by the likes of Cisco Systems, Intel, Nike, and Wal-Mart is a reflection of our society and how it has evolved over the years. Just as the Dow has continued to change, we too live in an ever changing world. One thing is for sure - change is here to stay.
Earlier this week I was reading an article about the January Barometer. Did you know that there was such a thing? Well, in a nutshell the January Barometer states that as January goes, so goes the year. In other words, if the first month of the year records a gain, then the entire year will also post a positive return. Conversely, if the first month of the year records a negative return, the market will post a loss for the year. Pretty simple.
Unfortunately, January 2015 was a down month. The S&P 500 lost 3.1% in January. As a matter of fact, this was the 15th worst January performance since 1950. And it was the worst January since last January when the S&P 500 lost 3.6%! So this must mean that 2015 is going to be a losing year right? Not so fast. While there is research that supports the January Barometer, it is not infallible. Utilizing data going back to 1950 (as published by Stock Trader's Almanac), this barometer is "right" about 75% of the time and "totally wrong" just 12% of the time. By "totally wrong" I mean that the S&P 500 moves five percent or more in the opposite direction as January. In years in which January is up, the S&P 500 manages an average return of +16.8% for the year, versus -3.4% in years starting with a down January.
Since 1950, there have been 8 of those "totally wrong" years for the S&P 500. Interestingly, 3 of those 8 years have occurred within the past decade and the latest one happened just last year. In January 2009, the stock market started the year much like 2008 ended - with a loss of 8.6%. But after a March bottom, the market got back on solid footing and ended the year with a substantial gain of 23.5%. In 2010 the year started with a -3.7% return in the S&P 500, but the rest of the year was quite strong and finished with a 12.78% gain. Last year, the market stumbled out of the gate, falling more than 3% in January, only to turn around and finish the year with double-digit gains. So there have been three "totally wrong" years for the January Barometer recently, but over time the January Barometer has been right more often than it has been wrong.
Here are some of the relevant January Barometer statistics:
* Since 1950, when the S&P 500 records a gain in January, it has recorded a gain for the full year 90% of the time (36 out of 40).
* When January is a positive month, the S&P 500 has average annual returns of 16.8% for the full calendar year.
* When the S&P 500 is down in the month of January, it has finished down for the full calendar year 52% of the time (13 out of 25).
* When January is a negative month, the S&P 500 has average annual returns of -3.4% for the full calendar year.
One final point: as you can see from the above data, the January Barometer has been far better at predicting strong years than it has been predicting losing years. Of the 25 down Januaries since 1950 (not including 2015) the market has followed up with down years 52% of the time. There have been 5 double-digit rallies following a bad month of January (2014, 2010 and 2009 being the most recent examples). These historical tendencies are just that - tendencies. While they may be interesting as discussion items, it is important to remember that they can be wrong and should not serve as a primary indicator for anyone looking to tactically manage market risk. Rest assured, I do not utilize the January Barometer as a tool to manage the risk in your portfolios.
Happy Hanukkah and Merry Christmas! Whichever holiday you choose to celebrate, I hope that it is a wonderful time spent with family and friends. Enjoy the season!
Keeping with the holiday theme, I was reading PNC Financial Services Group's latest report on the Christmas Price Index. Did you know that there was such an index? In the spirit of the holidays and the "Twelve Days of Christmas" song, PNC Bank decided 31 years ago to figure out how much it would cost to buy each of the twelve gifts in that famous Christmas song. As your recall from the song, during the twelve days of Christmas, one's true love purchases a whole bunch of gifts, ranging from 12 Drummers Drumming, 5 Gold Rings, all the way down to a Partridge in a Pear Tree. But how much would buying all those gifts really cost today? According to the this year's update of PNC's index, the total cost of all the gifts would equate to $27,673.22. This is a 1.02% increase over last year's total cost. In terms of the price inflation, this is a much smaller increase than 2013, when the cost of the goods increased by almost 8% from 2012. At least it's not 2003. That year the cost of buying these twelve Christmas gifts rose a whopping 16%!
On the investment front, I wanted to alert you to change in the rankings of the asset classes that I evaluate on a daily basis. International Equities is no longer one of the top two asset classes. It has fallen to number three, while Fixed Income (ie bonds) has risen to number two. U.S. Equities remain in the number one position. The decline in the International Equity asset class ends a nearly two year reign of being in the top two ranked asset classes. International Equities have been a story of the "haves" and the "have nots". Those who "have" enough Crude Oil to export to the rest of the world, have been hit hard in the market, while those that "have not" a drop of oil to export have held up far better. China, India and the US are 3 of the top 4 importers of Crude Oil globally, and all have produced gains over the past 3 months. Countries such as Russia, have not faired so well.
With that being said, you will begin to notice a shift in your portfolios that I manage. International Equity allocations will be reduced while Fixed Income allocations will be increased. U.S Equities continue to look unstoppable, as they have a strong grip on the number one position. Rest assured that I will continue to monitor these asset classes so that your portfolios are positioned to take advantage of the current trends in the markets. This concept of positioning your investments toward current trends, rather than past or future presumptions, serves as the driving force behind the methodology that I employ to manage risk in your portfolios.
The stock market was up again in November. But few people were even aware of that fact because the headlines have been all about oil and how cheap it has gotten. The price of oil is down to where it was back in 2009! So while the price of oil is falling, the S&P 500 continues to solidly hold on to it's year-to-date gains. What does this mean to the U.S. economy and to us? Well, at the risk of sounding non-committal, it depends....
A week ago, the price of oil fell 10% in one day when OPEC declined to cut oil production in the face of falling prices! Can you imagine the "end of the world" prognostications if the stock market dropped 10% in one day? The panic would be incredible! The only people panicking about the drop in the price of oil are the speculators and investors in oil and oil related companies. People like you and me, who fill our cars up at the gas station, are rejoicing at the fact we are paying gasoline prices that we haven't seen in years! No panic here. We are happy to have that extra spending money in our pockets.
In order to assess the impact of lower oil prices on the U.S. and world economies, we must look for clues concerning the reason for this drop in the price of oil. For this we need to think back to our Economics 101 class and what we learned about supply and demand. Are lower oil prices being caused by increasing supply? Remember, increased supply causes prices to drop. This would be a good thing for the economy - mainly because it would give consumers more disposable income. On the other hand, if lower oil prices are being caused by weakening demand, then this could be a harbinger of bad things ahead for the economy. Commodity prices, such as oil, are usually the most sensitive asset class with regards to a weakening economy and to an impending recession. Obviously, this would be a bad thing for economic growth. See? Just like I said earlier, it depends.
In my opinion, I believe that lower oil prices are not foreshadowing an economic slowdown. And I do not appear to be alone in this thinking. The fact that the S&P 500 has continued to rise while oil prices have fallen, shows that most investors continue to have a bullish outlook on the U.S. economy. Couple this with the fact that U.S. stocks and international stocks are currently the strongest asset classes out of the six that I evaluate daily, and you will see why I remain bullish. It is not because my gut tells me to be bullish. It is because the indicators that I follow are based on the irrefutable law of supply and demand and not on the predictions for our economic growth by the so-called experts. As I have said many times before, my indicators will tell me when it is no longer prudent to be bullish on U.S. and international stocks. In the mean time, enjoy the lower prices at the pump.
Winter is here....especially if you live in Buffalo, New York. Didn't fall just start a few weeks ago? As the snow in Buffalo continued to pile up, the stock market looked like it was stuck in a snowbank. Each day that the market went up, it did so minimally. While that fact may frustrate us, the stock market has also not had a large down day in almost a month. In spite of this market "sleepiness", the S&P 500 closed at another all-time high on Thursday. Slow or not, the S&P 500 at an all-time high is usually something that makes investors want to move more of their money into stocks. So I was more than a little surprised when I read in a recent research report from Wells Fargo's chief economist that U.S. households are putting their money into investment grade bond mutual funds. As a matter of fact, the amount of money flowing into these funds has risen dramatically - in spite of expectations that interest rates will begin to rise soon. Is it just me, or have the "experts" been expecting interest rates to rise for more than a year now?
Many predictions are made throughout the course of the year, and they are made by people both very smart and very well versed in their particular fields of study. Sometimes this expertise works against them. Experts can get it wrong too. The best of them adapt quickly upon realizing it though. As we are all far too familiar with, even the best of meteorologists get it wrong from time to time, and so when we open our front door to an unsuspected snowfall, we adapt to the scenario, generally by going back inside and putting on our boots. In our day-to-day lives we regularly adapt, but in our investments it is all too easy to buy into a story or a concept that is simply rejected by the reality of the market. When managing client portfolios, I continually adapt, as I know I will be wrong in any number of investment decisions over the course of my career. It is okay to be wrong, in fact its inevitable. But it isn't okay to stay wrong. While U.S. households are piling into bonds because their "gut" tells them that the stock market has gone up for a long time now, I continue to follow my indicators. These indicators are based on the irrefutable law of supply and demand and not on the predictions of so-called experts. Currently, bonds are not an asset class that should be overweighted in your portfolio. My indicators continue to say that U.S. stocks and international stocks are currently the strongest asset classes. Rest assured that these indicators, not "market experts", will tell me when that is no longer the case.
The trick-or-treaters are gone. The World Series Champion has been crowned. That means that it must be November. It also means that the seasonally weak period in the stock market is over and we are heading into the seasonally strong period for stocks. You have probably heard of the old adage, "Sell in May and go away." It was born from the broad observation, that historically the U.S. stock market performs far better during the November through April time period than it does from May through October. 2014 turned out to be one of those years where this adage did not hold true. At times (especially from late September until mid-October), it certainly felt as if it was the weak period in the stock market. But in actuality, the Dow Jones Industrial Average was up 4.88% from May through October. Good thing that we didn't "go away"!
With that being said, we are now entering the strong six month period in the stock market. There is no question that the November to April period has historically provided substantially better stock market returns than the May to October period. Here is something fascinating about this stock market seasonality: the strong six months of the year have actually equaled the pace of the average annual compounding return of the Dow Jones Industrial Average overall since 1950. The Dow began 1950 at 200 and closed October 2014 at 17,390.52. This is an average annual compounded return of about 7.11%. The seasonally strong six months have produced an average annual compounded return of about 7.03%, while only being invested 50% of the time! Along the way there have been down periods in the seasonally strong months, and up periods in the seasonally weak months, but one cannot miss the historical bias evident here. While this strategy does have a very strong historical bias to it, it is no way to manage your investment portfolio. So as we enter this seasonally strong period, my indicators continue to say that U.S. stocks and international stocks are currently the strongest asset classes. Rest assured that these indicators, not market seasonality, will tell me when that is no longer the case.
Well, I am finally doing it. I am jumping into the "Blogging World"! No, it's not because everyone is doing it. I think that blogging will allow me to more easily stay in touch with clients, associates, and anyone else who is looking for timely and useful information about financial topics, as well as other items that I feel would add value to your world.
So, stay tuned! I welcome your feedback (good and bad) as well as your ideas about topics that should be discussed in this forum. Main my goal is to keep this blog fresh and chock full of valuable stuff. I know that you are busy and have many sources of information that vie for your attention on a daily basis. To that end, I will endeavor to post here regularly, but not daily.
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The calendar has turned to May. The April showers that were supposed to bring May flowers, have only brought more rain here instead. I am confident that the flowers will be here soon enough.
There is an old adage in the stock market - "S...