It was only a couple of days ago that I was writing in Current Market Tactics that I thought the correction we’re now in was just about over–and that the charts suggested to me that the S&P would likely hold around 1130.
Well, so much for that. As I’m writing this, S&P stock index futures are indicating the market, which closed yesterday around 1070, will open ten points or so lower. How should we think about this?
First of all, although I’ve been pretty good at calling the twists and turns of the stock market road over the past over the past 14 months, I’ve been seriously wrong this time. That’s not so surprising to me, since professional equity investors quickly get used to being wrong on a regular basis. And in the grand scheme of things, laying out a coherent investment strategy to meet your saving goals is much more important than doing the investment equivalent of predicting the weather–fun as that may be to try.
Second, the fact that the market has broken down below the floor of the channel it has been in since the bull market began means that something has changed in a negative way about investors’ perception of the market.
I’ve often thought of managing a portfolio as like being in a small sailboat out in the middle of the ocean (the closest I’ve come to this in reality is being in a runabout in the middle of a lake or being on a ferry on the way to school). You’re going along with lots of sail out when a storm comes up. What do you do? If you think it’s just a summer squall, you may take a little sail in but still proceed as you were before. On the other hand, if you think this is the leading edge of a hurricane–or, worse, the start of monsoon season–your actions may be a lot more defensive.
That’s the fundamental question–have we changed direction from bull market to bear market–we all have to decide about now. My answer is that we haven’t changed into the rainy season, we’re just in a particularly ugly squall.
Two things bother me about the current correction:
–I’m a growth stock investor, so I have a relentlessly bullish outlook. So if we have radically changed market direction (earnings are too good, valuations too reasonable, the recovery has barely started for me to believe this), I’ll find it harder to recognize than a value investor would.
–I usually get progressively more worried as the market goes down. I don’t mind this. In fact, I welcome a little angst. I figure that I have enough scars on my body from prior market downturns (being a global investor means having a chance to be beaten up three times a day, in Europe, the Americas, and in Asia). So when I get really worried, I figure most other investors are in worse shape and have probably already acted out their fears by selling. That means we’re close to the end of the downturn.
Today I’m more bewildered than anything else, not worried–which would suggest there’s more selling to come. As I’ve demonstrated this week, however, I’m not currently a good indicator.
Many market commentators are saying the downdraft is due to worries over the fraying at the edges of the euro. That may be aggravating what would otherwise be a “normal” correction, but I don’t think this is the key issue. For one thing, the fall in the euro will add 1.5%-2.0% to EU economic growth in the coming year (subtracting it from emerging markets–which won’t miss it much–and the US). For another, let’s say that earnings from Europe or ownership of European assets made up 25% of the value of the S&P a month ago. I don’t know the exact number, but I don’t think it can be much higher than that. If the 13% fall in the S&P since is due to a belief that European earnings/assets are permanently impaired, then the market would be saying that those earnings/assets are worth slightly less than half what they were in mid-April. A 20% impairment would mean a 5% fall in the market. That’s still too high, I think, but I can imagine people feeling this way.
what to do?
If this is a correction, then the best thing to do is to try to upgrade your portfolio by trading clunkers, which go down less, for market leaders, which get beaten up the worst in a time like this.
The second-best thing is to have faith in the structure you have built and do nothing.
If you believe the market has fundamentally changed direction, you should plan what a defensive portfolio should look like and begin to implement your new strategy.