It was an awful week on Wall Street. Through Friday’s close, the Dow and S&P 500 both fell 5.2% and the Nasdaq was off 5.1%. Bond prices continue to fall as their yields move higher. Commodities were again lower across the board with gold off 1.4%. Oil prices had their worst week in two years, plunging 9.8% to close at $59.05 per barrel. The international Brent oil moved down to $62.71.
First, the good news: stocks are looking cheaper. The bad news is it took the worst week in two years to get there.
News reports on the drop in stocks were hard to miss this week, so you’re probably aware of the sharp decline in the markets. In just two weeks, they’ve fallen more than 10% from their highs.
This week also had both the first and second-largest point decline in the Dow ever. Of course, the decline sounds ominous, but this is more because the market levels are so high and a point worth less than it used to be. On a percentage basis, the declines this week don’t even rank in the top-100 of all market declines.
News reports on the drop in stocks were hard to miss this week, so you’re probably aware of the sharp decline in the markets. In just two weeks, they’ve fallen more than 10% from their highs.
This week also had both the first and second-largest point decline in the Dow ever. Of course, the decline sounds ominous, but this is more because the market levels are so high and a point worth less than it used to be. On a percentage basis, the declines this week don’t even rank in the top-100 of all market declines.
The decline in stocks has been strong and swift, but some perspective is needed. Stocks are trading back to December levels and we’re still up 12% over the past year.
Just like last week, there was no specific news or events responsible for market decline this week. The upward momentum in stocks has broken down – and that alone can spook investors and cause markets to fall.
The most likely culprit for the volatility has been the rising interest rates. The bond market has seen a sharp rise in yields (and, therefore, a drop in prices) and this raises concerns among investors.
The most likely culprit for the volatility has been the rising interest rates. The bond market has seen a sharp rise in yields (and, therefore, a drop in prices) and this raises concerns among investors.
Eyes often glaze over at the mention of the word “bonds,” but stick with us for a minute…
Investors are concerned that the improving economic data will cause the Fed to pull back further on their stimulus. For years they’ve printed money to buy bonds and lower interest rates as a way to boost the economy. This has acted like a pain killer for the markets, allowing stock and bond prices to rise even in the face of disappointing fundamentals.
Now the stimulus is being removed as the economy improves and the party is ending. Interest rates are moving higher, which is like a kryptonite for stocks. This contributed to the volatility.
Additional spending from Washington announced this week also added to the problem. The increase in spending will result in deficits (only in the short term, we believe) that need to be financed by debt. That means the government needs to sell bonds, only the Fed will not be there to buy them like they did in the past. This, too, is a concern for investors.
Outgoing Fed chairwoman Janet Yellen probably didn’t help the market much this week, either. Her term officially ended this Monday and the reigns were handed over to new chief Jerome Powell.
In her last interview as Fed chief, Yellen indicated stock prices were on the high end and that this was a concern.
It’s never good to hear the Fed chief say this, especially when one of their “unofficial” objectives was to raise stock prices. This comment, along with significant last-minute restrictions she placed on Wells Fargo bank, added to investors’ concerns. It also seemed cowardly to do on her last day in office and gave her predecessor another problem to worry about.
Turning to economic data this week, a report on the strength of the service sector came in at its highest level in ten years. This was yet another report showing the strong economy, causing investors to worry that an additional pullback in stimulus was likely.
Investors are concerned that the improving economic data will cause the Fed to pull back further on their stimulus. For years they’ve printed money to buy bonds and lower interest rates as a way to boost the economy. This has acted like a pain killer for the markets, allowing stock and bond prices to rise even in the face of disappointing fundamentals.
Now the stimulus is being removed as the economy improves and the party is ending. Interest rates are moving higher, which is like a kryptonite for stocks. This contributed to the volatility.
Additional spending from Washington announced this week also added to the problem. The increase in spending will result in deficits (only in the short term, we believe) that need to be financed by debt. That means the government needs to sell bonds, only the Fed will not be there to buy them like they did in the past. This, too, is a concern for investors.
Outgoing Fed chairwoman Janet Yellen probably didn’t help the market much this week, either. Her term officially ended this Monday and the reigns were handed over to new chief Jerome Powell.
In her last interview as Fed chief, Yellen indicated stock prices were on the high end and that this was a concern.
It’s never good to hear the Fed chief say this, especially when one of their “unofficial” objectives was to raise stock prices. This comment, along with significant last-minute restrictions she placed on Wells Fargo bank, added to investors’ concerns. It also seemed cowardly to do on her last day in office and gave her predecessor another problem to worry about.
Turning to economic data this week, a report on the strength of the service sector came in at its highest level in ten years. This was yet another report showing the strong economy, causing investors to worry that an additional pullback in stimulus was likely.
On the negative side, the trade deficit continued to grow. Out exports rose – which is a positive – but imports grew even more. This is a very important metric for GDP. A large level of imports took two points off GDP last quarter and is likely to weigh on GDP again this quarter.
Lastly, corporate earnings remain strong. According to Factset, earnings are on pace to rise 13% over the past year while sales have increased 7.5%. The level of sales is noteworthy as they have now risen the past six quarters. Much of the rise in earnings over the last several years has come from companies cutting costs – not from increasing sales, so this is a positive development.
Next Week
Volatility will likely persist next week regardless of any economic reports or corporate earnings, but there will be a few things to keep an eye on. For economic data, we’ll get info on inflation, retail sales, industrial production, and housing. There will still be many earnings reports released, which can always have an impact on the individual stocks.
Investment Strategy
The selloff we’ve seen over the last two weeks has put markets into oversold (cheap) territory in the short run. We did a little nibbling this week when we wrongly thought markets were turning higher and we’re likely to commit more when we see some positive traction take hold.
The best time to buy is when you see other investors selling in a panic. A great contrary indicator is when CNBC talks about turmoil in the markets. As you can see in the chart below, they often display these graphics at market bottoms (the red circles).
Volatility will likely persist next week regardless of any economic reports or corporate earnings, but there will be a few things to keep an eye on. For economic data, we’ll get info on inflation, retail sales, industrial production, and housing. There will still be many earnings reports released, which can always have an impact on the individual stocks.
Investment Strategy
The selloff we’ve seen over the last two weeks has put markets into oversold (cheap) territory in the short run. We did a little nibbling this week when we wrongly thought markets were turning higher and we’re likely to commit more when we see some positive traction take hold.
The best time to buy is when you see other investors selling in a panic. A great contrary indicator is when CNBC talks about turmoil in the markets. As you can see in the chart below, they often display these graphics at market bottoms (the red circles).
Another interesting real-time metric comes from CNN. They put out a sentiment gauge (LINK) that looks at several pieces of market data to determine if investors are “fearful” or “greedy.” This week we hit the highest “fear” level since 2015. As a wise investor once said, “be fearful when others are greedy and greedy when others are fearful.”
While the market decline over the last two weeks has been significant, it may be presenting a good buying opportunity for stocks.
Bond prices have trended lower (and yields higher) the last few months and are now around their lowest level in four years. Buyers have yet to step in here, signaling this may be a shift in the bond market where yields continue to rise. This is good for investors needing more income, but the overall value of the bonds are lower.
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 prefer developed markets to emerging ones at this time.
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.
Bond prices have trended lower (and yields higher) the last few months and are now around their lowest level in four years. Buyers have yet to step in here, signaling this may be a shift in the bond market where yields continue to rise. This is good for investors needing more income, but the overall value of the bonds are lower.
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 prefer developed markets to emerging ones at this time.
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.
