I’ve just updated my Keeping Score page for November. …finally an up month!
During the course of trading on Tuesday of last week, the NASDAQ 100 touched the closing (though not the intraday) lows of February, before rebounding sharply. Simultaneously, the S&P 500 did a similar thing, only its stopping point was the higher lows of April.
It looks increasingly likely to me that this action is going to serve as the marker for a selling climax–the point where short-term speculators feel all hope of a rebound is lost and dump out their holdings in a final surge of selling with little regard for price–for the market downturn that began in October.
This positive sign for the market has been reinforced by the statements of influential Fed members that short-term interest rates are presently just below neutral, meaning that that body sees little need to continue to push them upward.
Barring any further damage to the economy from Mr. Trump’s bizarre tariff policies, it looks like we’ll enjoy enough market stability for us to return to the business of picking stocks.
It may be that the market downdrift we’ve been experiencing since early October started out as a bout of yearend mutual fund selling, as I’ve been writing for a while. Maybe not. In any event, the selling has continued for far longer than the mutual fund hypothesis can explain.
It may be that the market has been thinking that the prices of IT-related shares had gotten far too high, given their earnings prospects. Strike out the “far” and I’d have to agree; in my mind, the big issue preventing at least a temporary market rotation away from tech has been, and remains, what other group to rotate into.
It’s also possible that the operative comparison has been between stocks and bonds. The ongoing upward yield curve shift now has short-term Treasury notes yielding around 2.5% and the 10- and 30-year yielding above 3%. Arguably this is a level where income-hungry Baby Boomers could feel they should allocate somewhat away from stocks and into fixed income.
Whatever the market’s motivation, however, I’m sticking with my idea that the S&P bottomed on October 29th.
Many times, when the market has hit a low and has begun to rebound, it will reverse course to “test” the previous low. Also arguably, that’s what has been happening over the past week or so–formation of what technicians in their arcane lingo call a “double bottom.” The main worry with this idea is that two weeks after the initial low is an unusually short time for the double bottoming to be happening. Still, it’s my working hypothesis that this is, in fact, what’s going on.
The things to monitor are whether the market breaks below the late October low and, if so, whether it breaks below the April or February lows.
Another topic: oil. Crude oil and oil stock prices have been plunging recently. Most non-US producers added extra current output to offset the assumed negative impact of the US placing renewed sanctions on the purchase of oil from Iran. At the last minute, however, Washington granted exceptions to large purchasers of Iranian crude. Because of this, oil has continued to flow in addition to the extra oil from OPEC. Since demand for oil is relatively inflexible, even 1% – 2% changes in supply can cause huge changes in price. Whether or not the US deliberately set out to deceive OPEC and thereby cause the current oversupply, the price of oil is down sharply since the US acted.
Saudi Arabia and Russia have just announced supply cuts. Given that Feb – April is the weakest season of the year for oil demand, it’s not clear how long it will take for the reductions to lift the oil price. It seems to me, though, that the more important question is when rather than if. So I’ve begun to nibble at US shale oil producers that have been flattened since Washington’s action.
I’ve just updated my Keeping Score page for the ugliness of October. …some sector surprises.
My worst flaw as an investor–at least, the worst that I’m aware of–is that I’m too bullish. So I have to be careful at a time like this when the stock market has been on a downtrend, to ensure that I don’t call a tactical bottom too early.
I should also point out that mutual funds have most likely been out of the market for the past few days, so the wicked intraday spikes we’ve been seeing in recent trading are more likely the work of algorithms than humans. So the end of the mutual fund fiscal year is in itself no reason for these swings to stop.
Still, it looks to me as if the lows the market established early in 2018 are holding. Also, many tech stocks, having lost a third of their value, are beginning to move up on what seems to me to be the flimsiest of positive news–a so-so earnings report or an upgrade by a brokerage house analyst.
So my guess is that the worst is over and that stocks will go sideways to up from here.
Several things to note:
–intraday swings have been unusually large, based on past instances of correction. This may just be what machine-driven markets look like
–a change in market leadership often occurs after a correction. I’m not sure what that would be in this case. I’m still thinking that IT will lead, noting, though, that chip manufacturing businesses appear to be entering one of their periodic phases of oversupply (driven by the fact that capacity is added in huge chunks, and usually by everyone at the same time)
–the long-term economic negatives recently created by Washington–large-scale deficit spending; emphasis on reviving older, inefficient industries; policy directed at breaking down global supply chains–haven’t gone away. The considerable social/cultural damage being done by the administration hasn’t, either. At some point, these factors will begin to retard stock market progress, although they may be issues for 2019.
In an ideal world, portfolio investing is all about comparing the returns available among the three liquid asset classes–stocks, bonds and cash–and choosing the mix that best suits one’s needs and risk preferences.
In the real world, the markets are sometimes gripped instead by almost overwhelming waves of greed or fear that blot out rational thought about potential future returns. Once in a while, these strong emotions presage (where did that word come from?) a significant change in market direction. Most often, however, they’re more like white noise.
In the white noise case, which I think this is an instance of, my experience is that people can sustain a feeling of utter panic for only a short time. Three weeks? …a month? The best way I’ve found to gauge how far along we are in the process of exhausting this emotion is to look at charts (that is, sinking pretty low). What I want to see is previous levels where previously selloffs have ended, where significant new buying has emerged.
I typically use the S&P 500. Because this selloff has, to my mind, been mostly about the NASDAQ, I’ve looked at that, too. Two observations: as I’m writing this late Tuesday morning both indices are right at the level where selling stopped in June; both are about 5% above the February lows.
My conclusion: if this is a “normal” correction, it may have a little further to go, but it’s mostly over. Personally, I own a lot of what has suffered the most damage, so I’m not doing anything. Otherwise, I’d be selling stocks that have held up relatively well and buying interesting names that have been sold off a lot.
What’s the argument for this being a downturn of the second sort–a marker of a substantial change in market direction? As far as the stock market goes, there are two, as I see it:
–Wall Street loves to see accelerating earnings. A yearly pattern of +10%, +12%, +15% is better than +15%, +30%, +15%. That’s despite the fact that the earnings level in the second case will be much higher in year three than in the first.
Why is this? I really don’t know. Maybe it’s that in the first case I can dream that future years will be even better. In the second case, it looks like the stock in question has run into a brick wall that will stop/limit earnings advance.
What’s in question here is how Wall Street will react to the fact that 2018 earnings are receiving a large one-time boost from the reduction in the Federal corporate tax rate. So next year almost every stock’s pattern in will look like case #2.
A human being will presumably look at pre-tax earnings to remove the one-time distortion. But will an algorithm?
–Washington is going deeply into debt to reduce taxes for wealthy individuals and corporations, thereby revving the economy up. It also sounds like it wants the Fed to maintain an emergency room-low level of interest rates, which will intensify the effect. At the same time, it is acting to raise the price of petroleum and industrial metals, as well as everything imported from China–which will slow the economy down (at least for ordinary people). It’s possible that Washington figures that the two impulses will cancel each other out. On the other hand, it’s at least as likely, in my view, that both impulses create inflation fears that trigger a substantial decline in the dollar. The resulting inflation could get 1970s-style ugly.
My sense is that the algorithm worry is too simple to be what’s behind the market decline, the economic worry too complicated. If this is the seasonal selling I believe it to be, time is a factor as well as stock market levels. To get the books to close in an orderly way, accountants would like portfolio managers not to trade next week.
why an October selloff?
the old days
Before the rise of the mutual fund industry in the 1980s, big investing institutions–banks and insurance companies–used to do annual tax planning in November-December–because their tax year ended in December. They’d reshape their investment portfolios and dump unsuccessful holdings so that realized losses could be used to offset otherwise taxable income. The key word here is “selling,” made more intense by the end-of-year timing. The exact starting day of the resulting market downturn was the subject of intense jockeying by the major players. Once someone started selling, though, everyone else jumped in.
For mutual funds, which today dwarf the activities of those former giants, the crucial months are September-October (more detail on why). In most years since the late 1980s there has been a several-week, tax-related selloff during this time, triggered by mutual fund tax planning. It’s typically been followed by a significant bounceback as selling pressure abates.
I think this is what has been going on in domestic markets for the past week or so. If I’m correct, selling will abate at worst in about two weeks–if for no other reason than that firms will try not to do trading during the final week of their fiscal year (to avoid having unsettled transactions hanging over into the new fiscal year). At best, I think, selling pressure will begin to ease up by the end of this week.
the role of IT
As I see it, the selling so far has been the most intense in the IT sector. Within tech, medium-sized companies that have been sharp outperformers so far in 2018 have been hurt the worst. Again, if my diagnosis of what’s going on now is correct, this last group is where the best buying opportunities will lie.
An unusual twist: a main goal of the selling this year seems to be for funds to reduce their exposure to IT and to the new Communication Services sector. Typical selling is more across the board. Two factors are likely at work: managers think their IT overweights have grown too large and are trimming them back; and they perceive greater relative value in other sectors. My guess is that the first is the larger influence.
Long-term Treasury bond yields have risen by about 70 basis points so far this year (10bp of that during the past week). The 10-year yield now stands at 3.19%; the 30-year is at 3.35%. At some point such yields will provide competition for stocks, particularly in the minds of Baby Boomers seeking steady income. This is a very important issue, especially since the US market hasn’t been in a position where this might matter since the mid-1980s. Nevertheless, I don’t see this as the main force behind current selling.
what to do
My experience is that most people, including many (most?) professional money managers, either turn off their quote machines or hide under their desks during market declines. Financially, a better strategy is to try to upgrade portfolio holdings. Clunkers that have never gone up will likely be temporary pillars of strength. On the other hand, stocks with much stronger fundamentals will be sold off mostly for tax or internal portfolio structure reasons. Trend-following short-term traders will magnify this difference. Anyone with a longer investment horizon should sell inhabitants of the portfolio dustbin and buy stocks they’ve wanted to own but which always seemed too expensive or to have had too much short-term upward momentum.
In my case, I’m mostly rearranging my holdings within tech …but that’s just me.