The markets kicked off the year in historic fashion – historically poor, that is. For the week, the Dow lost 6.2%, the S&P fell 6.0%, and the Nasdaq was down 7.3%. Gold rose on the turmoil, climbing 3.4% on the week. Both the U.S. and international oils hit their lowest levels since 2004. U.S. oil – WTI – fell 13.0% on the week to close at $32.88 per barrel. The international Brent closed down to $33.65 per barrel.
Source: Google Finance
What a rough way to start the year. This was the worst start to a year – ever – and the market now stands at a level we saw in mid-2014. Several issues are creating jitters for investors, including global economic weakness, poor corporate earnings, and a Fed pulling back from its stimulative measures.
A weak start to the year isn’t unusual. Last year also opened with similarly strong losses for stocks. The difference last year, though, is the Fed stepped in and pledged more stimulus to help the market, sending stocks higher. This year we have the Fed doing the opposite – pulling back on its stimulus. We think this will be good for the economy but not great for stocks.
It is no coincidence to see a lower market as the Fed removes stimulus. That stimulus acted like a painkiller for the market – stocks rose even in the face of bad news.
One part of the stimulus was trillions of dollars printed by the Fed that flooded into the market, pushing stocks higher. Stocks have been relatively flat since this program ended in late 2014. However, historically low interest rates have buoyed the market by keeping money cheap and in the system. Rates are now rising, resulting in more volatility for stocks.
The removal of this stimulus finally allows the market to stand on its own two feet, though that doesn’t always mean stocks will be positive, like we saw this week. Bad news actually means bad news.
One big issue is the strength of the global economy. Economies around the world are very weak and China in particular is a concern.
The country is a major manufacturer, but that manufacturing sector has been weak and slowing. The government has taken steps to help their economy, like weakening the currency to make items easier to export and adding more money to the stock market. This just seems to have made things worse and their market fell 10% on the week.
The other concern weighing on markets is corporate earnings. Earnings have been lower the last two quarters and are expected to be lower again once fourth quarter results are released. According to Factset, it will also mark the first annual decline in earnings since the start of the economic crisis.
Economic data released this week didn’t help much, either. The reports were mixed, but continue the trend we’ve seen over the past year of good employment numbers and poor economic data.
Employment in December came in much better than expected and has been decent all year. On the other hand, our manufacturing sector contracted at the strongest level since 2009 and the service sector hit its lowest level since March of 2014. Further, imports and exports both fell last month.
It’s hard to understand how employment has done so well while economic fundamentals continue to deteriorate. This likely adds a little volatility to the market, too.
Next Week
Next week we’ll see corporate earnings and economic data that wouldn’t normally have a large impact on the market, but after this week, anything is possible. For corporate earnings, fourth quarter results will start rolling in with a diverse group of names like Alcoa, JPMorgan, Intel, and CSX all releasing results.
We’ll also get economic reports on the strength of the retail sales, inflation at the producer level (PPI), and industrial production.
Investment Strategy
Above we listed several reasons why the market has been under pressure. With all that said, we are very near a point we normally find to be an attractive buying level – at least for the short/medium term (a few weeks to a couple months). We’d like to see the market stabilize first, though, and not try to catch a falling knife.
The longer term is where those concerns come in. Since much of this rally has been on the back of the Fed’s stimulus, those fundamentals we discussed above were ignored. They become more apparent now as stimulus is pulled back. It’s great that the market is now able to stand on its own, but it won’t always be pretty.
Bonds prices rose (so yields fell) on the weakness in stocks this week as investors sought safety. Prices have been in this range for months now and we continue to believe they will stay in this range for the foreseeable future. A weak economy and demand from overseas will keep bond demand high (which keeps prices high and yields low).
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, 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 issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
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.
A weak start to the year isn’t unusual. Last year also opened with similarly strong losses for stocks. The difference last year, though, is the Fed stepped in and pledged more stimulus to help the market, sending stocks higher. This year we have the Fed doing the opposite – pulling back on its stimulus. We think this will be good for the economy but not great for stocks.
It is no coincidence to see a lower market as the Fed removes stimulus. That stimulus acted like a painkiller for the market – stocks rose even in the face of bad news.
One part of the stimulus was trillions of dollars printed by the Fed that flooded into the market, pushing stocks higher. Stocks have been relatively flat since this program ended in late 2014. However, historically low interest rates have buoyed the market by keeping money cheap and in the system. Rates are now rising, resulting in more volatility for stocks.
The removal of this stimulus finally allows the market to stand on its own two feet, though that doesn’t always mean stocks will be positive, like we saw this week. Bad news actually means bad news.
One big issue is the strength of the global economy. Economies around the world are very weak and China in particular is a concern.
The country is a major manufacturer, but that manufacturing sector has been weak and slowing. The government has taken steps to help their economy, like weakening the currency to make items easier to export and adding more money to the stock market. This just seems to have made things worse and their market fell 10% on the week.
The other concern weighing on markets is corporate earnings. Earnings have been lower the last two quarters and are expected to be lower again once fourth quarter results are released. According to Factset, it will also mark the first annual decline in earnings since the start of the economic crisis.
Economic data released this week didn’t help much, either. The reports were mixed, but continue the trend we’ve seen over the past year of good employment numbers and poor economic data.
Employment in December came in much better than expected and has been decent all year. On the other hand, our manufacturing sector contracted at the strongest level since 2009 and the service sector hit its lowest level since March of 2014. Further, imports and exports both fell last month.
It’s hard to understand how employment has done so well while economic fundamentals continue to deteriorate. This likely adds a little volatility to the market, too.
Next Week
Next week we’ll see corporate earnings and economic data that wouldn’t normally have a large impact on the market, but after this week, anything is possible. For corporate earnings, fourth quarter results will start rolling in with a diverse group of names like Alcoa, JPMorgan, Intel, and CSX all releasing results.
We’ll also get economic reports on the strength of the retail sales, inflation at the producer level (PPI), and industrial production.
Investment Strategy
Above we listed several reasons why the market has been under pressure. With all that said, we are very near a point we normally find to be an attractive buying level – at least for the short/medium term (a few weeks to a couple months). We’d like to see the market stabilize first, though, and not try to catch a falling knife.
The longer term is where those concerns come in. Since much of this rally has been on the back of the Fed’s stimulus, those fundamentals we discussed above were ignored. They become more apparent now as stimulus is pulled back. It’s great that the market is now able to stand on its own, but it won’t always be pretty.
Bonds prices rose (so yields fell) on the weakness in stocks this week as investors sought safety. Prices have been in this range for months now and we continue to believe they will stay in this range for the foreseeable future. A weak economy and demand from overseas will keep bond demand high (which keeps prices high and yields low).
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, 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 issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
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.
