Thoughts {08.12.15}
Breaking in from the "East Coast Office" to try and put some perspective on the recent volatility in the markets.
Yesterday and today's market declines {futures indicate a down open as of this writing} are related to a surprise devaluation by the Chinese of their currency. China is doing this to boost exports. Investors fear that the Chinese economy is doing much worse than previously thought and also worry about a budding trade war and its effect on U.S. exports. The effect was stock losses all around the globe in the past 24 hours. Markets don't like surprises and this one gobsmacked investors yesterday. This of course is a short generalization of what occurred. You can read more about this here and here if you want more detail.
I don't know why market moving events like this always seem to happen in August. Maybe it's coincidence, bad luck or bad timing but I'm going to guess that literally half of the years I've spent summer time in Rhode Island has seen a market moving event wash over the transom. I'd also guess the majority of these are negative. At some point I'm actually going to figure out how many years this has occurred. I do know that events like this are magnified because Wall Street is on vacation right now and markets trade thin.
The initial read from yesterday is that this is a negative event. China's devaluation of their currency allows cover for investors that were on the fence as to stock's short term direction to turn bearish if they want. That suggests a higher probability of more volatility and potential market weakness in the near term. As such we have the defensive pages of the playbook right next to the computer. On average we've carried higher levels of cash depending on our investment strategies and client risk/reward mandates. We also have reviewed portfolios in terms of asset allocation and will make changes where and if necessary.
We use a probabilistic form of analysis based on the weight of the evidence we find from doing fundamental and money flow analysis along with valuation. That analysis has caused us to have a more neutral short term view {a view we still maintain} for months now. That neutral view has come from stock valuations being slightly higher on a historical basis. This has left less potential room for price appreciation than we've seen in the past few years. Meanwhile the underlying U.S. economic fundamentals have so far acted as a floor for equities, stopping every decline so far from turning into something more significant. Stocks as represented by the S&P 500 have therefore traded in a much tighter range this year than we typically see. Nothing so far leads us to think that this dynamic has changed but it may be subject to certain seasonal issues as well as affected by current news that in the short term has negatives outweighing the positives.
Money flows, by our work, do not show our ETF universe to be oversold to the point where we have typically seen the potential for a sustainable longer term advance. However, we are starting to see this potential in certain sectors of the market. Probability also suggests now stocks could see a continued period of higher volatility as markets are trading so thin due to summer. Also the potential for a deeper price correction cannot be discounted as on a seasonal basis the period between now and early autumn has historically been more prone to this sort of thing. Having said that, US economic data continues to show a growing economy {albeit at lower growth rates than most would care to see} and we would need to see a fundamental change in that for us to turn longer term more negative. Stocks have corrected by time since last November and markets as represented by major indices have mostly traded flat in 2015.
There are those that would counter that market leadership has narrowed with few large companies holding up the indices. They would be correct. However, for those of us that invest in ETFs which are based on an underlying index, that fact matters less than to those investing in individual stocks or actively managed mutual funds. For the most part major U.S. market capitalized index ETFs have held their own this year being roughly flat or showing small losses in 2015. Also while ETFs are subject to the fundamental traits, directional bias and money flows into and out of their underlying indices, you do not have the single stock risk that comes with owning a portfolio of individual equity names.
We'll stick by what we said in our most recent investment letter about the longer term and will repeat what we sent to clients in late July and published here on August 5, 2015:
Our longer-term view of the markets remains positive and is roughly the same as it has been for the past few years. We believe that there is still compelling evidence that the US economy continues to expand. Employment is increasing on average by nearly 200,000 persons per month. Americans are voting with their wallets. Car sales for example are still showing solid gains and there are no empty seats on airplanes. We are still of the opinion which we have reiterated in the past that positive demographic trends, revolutionary developments in energy, continued advances in productivity as rooted in the efficiencies of the knowledge based economy and the continuing age of innovation that we have dubbed the “era of miniaturization” are all longer term positives for the economy.
While we may face more headwinds right now. There is no law that says stocks have to decline. While a larger price correction is possible, stocks could also continue to correct by time. There is also an old Wall Street adage that says that "stocks will do what they have to do to prove the most amount of investors wrong". In that vein, it is also possible that irregardless of what our indicators suggest, stocks will move higher, confounding all the experts. That is not our short term expectation but at the end of the day, the market's vote counts more than our analysis.
We may be a bit more defensive for the coming months when we've often experienced seasonal weakness. A more significant market price correction also cannot be ruled out at his time, especially since it has been a very long time since the S&P 500 has experienced a correction of 10% or more. However, we are still longer term positive on U.S. markets. Absent a change in the underlying fundamentals, we'll use any weakness to add to positions that we find compelling, particularly where we find dividend yields attractive on a total return basis. We will be governed by the game plan for our investment strategies and by individual client risk/reward mandates.
Oh and I also think that China's actions makes an expected interest rate hike by the Federal Reserve in September more open to debate.
*Long ETFs related to China in certain foreign and personal accounts. Chinese stocks are also held in various foreign related ETFs we hold in client and personal accounts. Long ETFs related to the S&P 500 in both client and personal accounts. Note that these positions can change at any time without notice to our readers.
I don't know why market moving events like this always seem to happen in August. Maybe it's coincidence, bad luck or bad timing but I'm going to guess that literally half of the years I've spent summer time in Rhode Island has seen a market moving event wash over the transom. I'd also guess the majority of these are negative. At some point I'm actually going to figure out how many years this has occurred. I do know that events like this are magnified because Wall Street is on vacation right now and markets trade thin.
The initial read from yesterday is that this is a negative event. China's devaluation of their currency allows cover for investors that were on the fence as to stock's short term direction to turn bearish if they want. That suggests a higher probability of more volatility and potential market weakness in the near term. As such we have the defensive pages of the playbook right next to the computer. On average we've carried higher levels of cash depending on our investment strategies and client risk/reward mandates. We also have reviewed portfolios in terms of asset allocation and will make changes where and if necessary.
We use a probabilistic form of analysis based on the weight of the evidence we find from doing fundamental and money flow analysis along with valuation. That analysis has caused us to have a more neutral short term view {a view we still maintain} for months now. That neutral view has come from stock valuations being slightly higher on a historical basis. This has left less potential room for price appreciation than we've seen in the past few years. Meanwhile the underlying U.S. economic fundamentals have so far acted as a floor for equities, stopping every decline so far from turning into something more significant. Stocks as represented by the S&P 500 have therefore traded in a much tighter range this year than we typically see. Nothing so far leads us to think that this dynamic has changed but it may be subject to certain seasonal issues as well as affected by current news that in the short term has negatives outweighing the positives.
Money flows, by our work, do not show our ETF universe to be oversold to the point where we have typically seen the potential for a sustainable longer term advance. However, we are starting to see this potential in certain sectors of the market. Probability also suggests now stocks could see a continued period of higher volatility as markets are trading so thin due to summer. Also the potential for a deeper price correction cannot be discounted as on a seasonal basis the period between now and early autumn has historically been more prone to this sort of thing. Having said that, US economic data continues to show a growing economy {albeit at lower growth rates than most would care to see} and we would need to see a fundamental change in that for us to turn longer term more negative. Stocks have corrected by time since last November and markets as represented by major indices have mostly traded flat in 2015.
There are those that would counter that market leadership has narrowed with few large companies holding up the indices. They would be correct. However, for those of us that invest in ETFs which are based on an underlying index, that fact matters less than to those investing in individual stocks or actively managed mutual funds. For the most part major U.S. market capitalized index ETFs have held their own this year being roughly flat or showing small losses in 2015. Also while ETFs are subject to the fundamental traits, directional bias and money flows into and out of their underlying indices, you do not have the single stock risk that comes with owning a portfolio of individual equity names.
We'll stick by what we said in our most recent investment letter about the longer term and will repeat what we sent to clients in late July and published here on August 5, 2015:
We still remain positive on the long-term prospects for the US economy. We believe stock valuations will become more compelling as earnings catch up to valuations. While stocks can at any time experience price declines, so far we’ve seen a correction by time instead of price. The reason for our optimism is that the weight of evidence continues to suggest that the US economy is still in expansion mode. Strength in the dollar, muted global demand and lower oil prices has put a crimp on growth. This has hurt the industrial and energy sectors as well as businesses that rely on exports. However, lower oil and a higher dollar have muted inflation and has been positive for consumers. That should sustain domestic demand.
While we may face more headwinds right now. There is no law that says stocks have to decline. While a larger price correction is possible, stocks could also continue to correct by time. There is also an old Wall Street adage that says that "stocks will do what they have to do to prove the most amount of investors wrong". In that vein, it is also possible that irregardless of what our indicators suggest, stocks will move higher, confounding all the experts. That is not our short term expectation but at the end of the day, the market's vote counts more than our analysis.
We may be a bit more defensive for the coming months when we've often experienced seasonal weakness. A more significant market price correction also cannot be ruled out at his time, especially since it has been a very long time since the S&P 500 has experienced a correction of 10% or more. However, we are still longer term positive on U.S. markets. Absent a change in the underlying fundamentals, we'll use any weakness to add to positions that we find compelling, particularly where we find dividend yields attractive on a total return basis. We will be governed by the game plan for our investment strategies and by individual client risk/reward mandates.
Oh and I also think that China's actions makes an expected interest rate hike by the Federal Reserve in September more open to debate.
*Long ETFs related to China in certain foreign and personal accounts. Chinese stocks are also held in various foreign related ETFs we hold in client and personal accounts. Long ETFs related to the S&P 500 in both client and personal accounts. Note that these positions can change at any time without notice to our readers.
posted by CR English at 8:27 AM
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