What otherwise could have been a bad week for the market actually ended with modest losses. For the week, both the Dow and S&P were lower by 0.4% while the Nasdaq lost 0.6%. Bond prices rose as their yields moved lower. Gold had a nice week, rising 2.2%. Oil prices also moved higher, climbing 5.5% to end at $50.53 per barrel. The international Brent oil, used for much of our gas here in the East, rose to $53.80.
Source: Google Finance
Stocks had four decent days this week. Unfortunately it was that fifth day that did them in. But before getting into Wednesday’s losses, let’s look at the conditions leading up to it.
The market has been fairly calm since March and extremely quiet over the last two weeks. Fear of a decline in the market has also been very low.
Recently we’ve discussed the VIX index, which has been at historically low levels. The VIX index is a gauge of volatility and is also seen as indicator of fear in the market, since it rises when investors are more anxious and falls on the opposite. Last week this index hit its lowest level since 1993, so there has been a historically low level of fear in the market. The market often reverses at such extreme levels.
We also saw fewer and fewer stocks leading the market higher. Much of the gains in the market came from big tech names like Facebook, Apple, Amazon, Netflix, and Google (the so-called “FANG” stocks, because of the acronym). These companies are up between 11-14% since the beginning of March (through Monday), while the S&P is only up 1.1%.
A market lead by only a few companies is like a house built on sand. You want to see many companies doing well; otherwise the market is prone to sharp reversals. A similar story played out in 2007 before the market declines.
Below is a Reuters article from 2007 (LINK), which sounds very similar to today.
The market has been fairly calm since March and extremely quiet over the last two weeks. Fear of a decline in the market has also been very low.
Recently we’ve discussed the VIX index, which has been at historically low levels. The VIX index is a gauge of volatility and is also seen as indicator of fear in the market, since it rises when investors are more anxious and falls on the opposite. Last week this index hit its lowest level since 1993, so there has been a historically low level of fear in the market. The market often reverses at such extreme levels.
We also saw fewer and fewer stocks leading the market higher. Much of the gains in the market came from big tech names like Facebook, Apple, Amazon, Netflix, and Google (the so-called “FANG” stocks, because of the acronym). These companies are up between 11-14% since the beginning of March (through Monday), while the S&P is only up 1.1%.
A market lead by only a few companies is like a house built on sand. You want to see many companies doing well; otherwise the market is prone to sharp reversals. A similar story played out in 2007 before the market declines.
Below is a Reuters article from 2007 (LINK), which sounds very similar to today.
The quiet conditions and lack of fear in the market perversely made many investors nervous that a reversal was likely. The headlines Wednesday gave them that opportunity to sell.
By now you’ve heard the news out of Washington, so we will avoid the rehash. Much of the recent rally has been predicated on new pro-growth, pro-business policies from the Trump administration. The slightest possibility of them not being implemented creates a worry for investors.
By now you’ve heard the news out of Washington, so we will avoid the rehash. Much of the recent rally has been predicated on new pro-growth, pro-business policies from the Trump administration. The slightest possibility of them not being implemented creates a worry for investors.
Investors sold stocks as a result and the markets had their worst day since September.
Stocks that would benefit the most from Trump policies fared the worst. We can see this in the nearby chart, which shows the performance of a basket of stocks with high tax rates.
With the loss limited to just one day, it shows cooler heads are prevailing and Wednesday’s news was probably the result of a media-driven hysteria. It is important to note, though, that the press has shown its eagerness to create distractions for an easily-distracted administration, so these political shocks may not be that uncommon.
Switching gears to economic data, the week was light on important reports. Several housing reports were released, with existing home sales ticking higher and new home sales ticking lower. Industrial production, which measures the output of sectors like mining, manufacturing, and utilities, had its best month in three years.
When looking more broadly at the economic reports of the last few weeks, the results have been disappointing. We’ve talked recently about the Citi Economic Surprise Index, which tracks how economic data is faring relative to expectations. The index rises when economic data is better than economist expectations and falls on the opposite.
As you can see in the chart below, the index has fallen sharply (the white line), which means economic data has been well below expectations. Notice how closely the stock market (the orange line) had been following this index. If this trend holds, the large drop in the Economic Index suggests a downturn in stocks is possible.
Stocks that would benefit the most from Trump policies fared the worst. We can see this in the nearby chart, which shows the performance of a basket of stocks with high tax rates.
With the loss limited to just one day, it shows cooler heads are prevailing and Wednesday’s news was probably the result of a media-driven hysteria. It is important to note, though, that the press has shown its eagerness to create distractions for an easily-distracted administration, so these political shocks may not be that uncommon.
Switching gears to economic data, the week was light on important reports. Several housing reports were released, with existing home sales ticking higher and new home sales ticking lower. Industrial production, which measures the output of sectors like mining, manufacturing, and utilities, had its best month in three years.
When looking more broadly at the economic reports of the last few weeks, the results have been disappointing. We’ve talked recently about the Citi Economic Surprise Index, which tracks how economic data is faring relative to expectations. The index rises when economic data is better than economist expectations and falls on the opposite.
As you can see in the chart below, the index has fallen sharply (the white line), which means economic data has been well below expectations. Notice how closely the stock market (the orange line) had been following this index. If this trend holds, the large drop in the Economic Index suggests a downturn in stocks is possible.
Next Week
The Fed will be a big focus next week as several regional presidents will be making speeches. The odds of an interest rate increase have fallen, so it will be interesting to see if they provide any insight on this. The minutes from their latest meeting will also be released this week.
Next week looks fairly quiet for economic data. The most important report will come on Friday with the durable goods report. We’ll also get more info on housing and a report on retail inventories.
Investment Strategy
The Fed will be a big focus next week as several regional presidents will be making speeches. The odds of an interest rate increase have fallen, so it will be interesting to see if they provide any insight on this. The minutes from their latest meeting will also be released this week.
Next week looks fairly quiet for economic data. The most important report will come on Friday with the durable goods report. We’ll also get more info on housing and a report on retail inventories.
Investment Strategy
While Wednesday’s loss was the biggest of the year, a longer term chart puts the decline in perspective. It may have hurt to see your account value fall that day, but a longer-term perspective is important.
The decline actually put several of our shorter-term indicators at or near oversold levels, which means stocks may have moved down too far and could be due for a rise. This doesn’t mean stocks can’t keep going lower, but that the odds of a rise in the markets have increased.
Looking out a little longer, our outlook remains unchanged. Stock prices are historically on the high side and we still have some caution on the market over possible bubbles formed over the years due to the central banks and the trillions they have printed as stimulus. However, we believe new pro-business policies will be implemented that will negate or at least reduce the distortions caused by the stimulus. We are unsure how this will eventually play out, but think the pro-growth policies will be a net positive for the economy.
Bond prices had looked attractive in the short run, but the moves over the last couple weeks have put them on the expensive side.
As for the rest of the portfolio, 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. 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 as a flight to safety.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets, though they are looking cheap.
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.
The decline actually put several of our shorter-term indicators at or near oversold levels, which means stocks may have moved down too far and could be due for a rise. This doesn’t mean stocks can’t keep going lower, but that the odds of a rise in the markets have increased.
Looking out a little longer, our outlook remains unchanged. Stock prices are historically on the high side and we still have some caution on the market over possible bubbles formed over the years due to the central banks and the trillions they have printed as stimulus. However, we believe new pro-business policies will be implemented that will negate or at least reduce the distortions caused by the stimulus. We are unsure how this will eventually play out, but think the pro-growth policies will be a net positive for the economy.
Bond prices had looked attractive in the short run, but the moves over the last couple weeks have put them on the expensive side.
As for the rest of the portfolio, 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. 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 as a flight to safety.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets, though they are looking cheap.
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.
