This was the third straight week of declines for the market and it was a very volatile week, at that. For the week, the Dow dropped 2.7%, the S&P fell 3.1%, and the Nasdaq plunged 4.5%. Gold ended its losing streak, actually moving higher by 2.4%. Oil remains a big story as it hit the lowest level in over two years, declining 4.4% to $85.82 per barrel. The international Brent, used in much of our gas here in the East, hit its lowest price in almost three years to close at $90.27 per barrel.
Source: Yahoo Finance
Volatility was the story this week. The moves in the market were so big that we saw both the best day and worst day of the year for stocks. This made it the most volatile week in three years.
With such volatility, everyone is looking for a reason for the big moves. Unfortunately, there really isn’t one thing we can point to as the cause. The news has not been any better or worse than it has recently.
However, one thing that is different now is we are nearing the end of the Fed’s bond buying program. Plus, we are inching closer to higher interest rates (low interest rates helped fuel the stock market rise). These programs had dampened volatility and sent stocks higher, so a market without stimulus may be more volatile.
As for the news of the week, poor economic growth around the globe remains a concern. Europe, in particular, grabbed headlines as Germany posted very poor numbers. Germany is the strongest economy in Europe, so a decline here indicates trouble for the continent.
Germany blamed the weakness on the fighting in Ukraine and the sanctions which have limited their exports. This may be part of the blame, but there is another factor involved here. Several weeks ago, the Wall Street Journal published an article (LINK) detailing the reason many manufacturing companies were leaving the country. The country has invested heavily in renewable energy, making their energy costs among the most expensive in the world. Companies are fleeing to lower cost nations, including the U.S., and German consumers are feeling the pinch in their wallets.
Examples like this help explain why stimulus from central banks are so ineffective. There are fundamental problems holding economic growth back, something that low interest rates and money printing cannot overcome. This is very important to recognize.
Indeed, this was cited by the European Central Bank (ECB) as a reason for not taking their stimulus program a step further. The head of the ECB said he wanted to see structural reforms implemented before additional stimulus was undertaken. Knowing the unlikeliness of this occurring, stocks sold off on the news.
The week was not all negative, as we also saw the best day of the year. The gain could be attributed entirely to news out of our central bank (see how much impact the central banks have on the market these days?).
The Fed released the minutes from its latest meeting, expressing concerns over slow growth and a strong dollar. That view signaled a reduction in stimulus and increase in interest rates was unlikely any time soon. Remember, the market wants to see more stimulus, so it soared on the news.
To us, the minutes showed how unlikely the Fed is to ever pull back from stimulus. We say this jokingly, but they really seem determined to keep the spigots open.
Regarding the weaker dollar, there is one legitimate concern of a weaker currency. It makes exports more expensive and less attractive to foreign buyers. This hurts companies that do a lot of exporting (nearly half the revenue of companies in the S&P 500 comes from outside this country). However, companies have been hedging currency fluctuations for centuries. This is not a new phenomenon, so we think the stronger currency will have little impact on companies’ bottom lines.
The Fed brought up another concern with the weaker dollar that was a bit infuriating. A goal of their stimulus program is to boost inflation, thinking this will lead to economic growth (which we disagree with, but that’s a different subject for a different day). The stronger dollar has reduced energy prices, and lower energy prices means less inflation. Because of this, they expressed their concerns over lower energy prices and would like to weaken the currency to get prices rising again.
It’s hard to see how lower gas prices or lower power bills are a bad thing, especially as people have been struggling with these higher costs for years. This view of the Fed shows us just how disconnected from common sense their policies can be.
Next Week
Next week will be fairly quiet for economic data, but still has the potential to be a volatile one. For economic data, we’ll get info on retail sales, industrial production, and housing.
Investors are more likely to focus on corporate earnings that really start to roll in next week. Many financial and tech companies will be reporting, so those sectors could be particularly active. The focus on earnings may take the attention off the global issues that have weighed on the market recently.
Investment Strategy
Well, it looks like last Thursday was not a good buying opportunity, at least in the short run. We don’t think this is the start of a bigger decline (though only time will tell) and we would look to do some buying if the market moves a little lower from here. We don’t want to try to catch a falling knife, though, and would wait for a little stability. There are many individual stocks that are at attractive buying levels, too.
Below is an update to a leading indicator chart we often mention, where high yield bonds (the black line) have tended to move before the broader stock market (the orange line). They moved mostly in tandem this week, but the longer term trend still looks to be lower. We’ll continue to watch this indicator, but keep in mind that no indicator is perfect. As we saw this week, big moves in the market have come on the words of central bankers, which are inherently unpredictable.
With such volatility, everyone is looking for a reason for the big moves. Unfortunately, there really isn’t one thing we can point to as the cause. The news has not been any better or worse than it has recently.
However, one thing that is different now is we are nearing the end of the Fed’s bond buying program. Plus, we are inching closer to higher interest rates (low interest rates helped fuel the stock market rise). These programs had dampened volatility and sent stocks higher, so a market without stimulus may be more volatile.
As for the news of the week, poor economic growth around the globe remains a concern. Europe, in particular, grabbed headlines as Germany posted very poor numbers. Germany is the strongest economy in Europe, so a decline here indicates trouble for the continent.
Germany blamed the weakness on the fighting in Ukraine and the sanctions which have limited their exports. This may be part of the blame, but there is another factor involved here. Several weeks ago, the Wall Street Journal published an article (LINK) detailing the reason many manufacturing companies were leaving the country. The country has invested heavily in renewable energy, making their energy costs among the most expensive in the world. Companies are fleeing to lower cost nations, including the U.S., and German consumers are feeling the pinch in their wallets.
Examples like this help explain why stimulus from central banks are so ineffective. There are fundamental problems holding economic growth back, something that low interest rates and money printing cannot overcome. This is very important to recognize.
Indeed, this was cited by the European Central Bank (ECB) as a reason for not taking their stimulus program a step further. The head of the ECB said he wanted to see structural reforms implemented before additional stimulus was undertaken. Knowing the unlikeliness of this occurring, stocks sold off on the news.
The week was not all negative, as we also saw the best day of the year. The gain could be attributed entirely to news out of our central bank (see how much impact the central banks have on the market these days?).
The Fed released the minutes from its latest meeting, expressing concerns over slow growth and a strong dollar. That view signaled a reduction in stimulus and increase in interest rates was unlikely any time soon. Remember, the market wants to see more stimulus, so it soared on the news.
To us, the minutes showed how unlikely the Fed is to ever pull back from stimulus. We say this jokingly, but they really seem determined to keep the spigots open.
Regarding the weaker dollar, there is one legitimate concern of a weaker currency. It makes exports more expensive and less attractive to foreign buyers. This hurts companies that do a lot of exporting (nearly half the revenue of companies in the S&P 500 comes from outside this country). However, companies have been hedging currency fluctuations for centuries. This is not a new phenomenon, so we think the stronger currency will have little impact on companies’ bottom lines.
The Fed brought up another concern with the weaker dollar that was a bit infuriating. A goal of their stimulus program is to boost inflation, thinking this will lead to economic growth (which we disagree with, but that’s a different subject for a different day). The stronger dollar has reduced energy prices, and lower energy prices means less inflation. Because of this, they expressed their concerns over lower energy prices and would like to weaken the currency to get prices rising again.
It’s hard to see how lower gas prices or lower power bills are a bad thing, especially as people have been struggling with these higher costs for years. This view of the Fed shows us just how disconnected from common sense their policies can be.
Next Week
Next week will be fairly quiet for economic data, but still has the potential to be a volatile one. For economic data, we’ll get info on retail sales, industrial production, and housing.
Investors are more likely to focus on corporate earnings that really start to roll in next week. Many financial and tech companies will be reporting, so those sectors could be particularly active. The focus on earnings may take the attention off the global issues that have weighed on the market recently.
Investment Strategy
Well, it looks like last Thursday was not a good buying opportunity, at least in the short run. We don’t think this is the start of a bigger decline (though only time will tell) and we would look to do some buying if the market moves a little lower from here. We don’t want to try to catch a falling knife, though, and would wait for a little stability. There are many individual stocks that are at attractive buying levels, too.
Below is an update to a leading indicator chart we often mention, where high yield bonds (the black line) have tended to move before the broader stock market (the orange line). They moved mostly in tandem this week, but the longer term trend still looks to be lower. We’ll continue to watch this indicator, but keep in mind that no indicator is perfect. As we saw this week, big moves in the market have come on the words of central bankers, which are inherently unpredictable.
The outlook for stocks in the short run is still cloudy, but on a longer term perspective we have serious concerns. Stocks and bonds appear overvalued from a longer term perspective, especially as our central bank cuts back on stimulus. Other central banks around the world are picking up the slack, but there is still reason for caution. Europe is a particular worry as they drift back into recession with record levels of overvalued debt. At some point we see this correcting in a painful way, but it is anyone’s guess as to when this will occur.
As for the bond market, bonds rose in price this week (so yields fell) as stocks sold off. A short position has not done well here (where your profit increases when prices fall) and may continue to do poorly if stocks fall further. However, a longer term perspective suggests bonds may fall as central banks increase rates. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. They have not done well recently, but are intended to be a longer term investment. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
As for the bond market, bonds rose in price this week (so yields fell) as stocks sold off. A short position has not done well here (where your profit increases when prices fall) and may continue to do poorly if stocks fall further. However, a longer term perspective suggests bonds may fall as central banks increase rates. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. They have not done well recently, but are intended to be a longer term investment. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
