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.
I’ve just updated my Keeping Score page for September, 3Q19 and year-to-date. Newly-created Communication Services is the monthly leader.
The Trump administration has just triggered the latest round of tit-for-tat tariffs with China, declaring 10% duties on $200 billion of imports (the rate to be raised to 25% after the holiday shopping season). China has responded with tariffs on $60 billion of its imports from the US. Domestic firms affected by the Trump tariffs are already announcing price increases intended to pass on to consumers all of the new government levy.
It isn’t necessarily that simple, though. The open question is about market power. Theory–and practical experience–show that if a manufacturer/supplier has all the market power, then it can pass along the entire cost increase. To the degree that the customer has muscles to flex, however, the manufacturer will find it hard to increase prices without a significant loss of sales. If so (and this is the usual case), the company will be forced to absorb some of the tariff cost, lowering profits.
From an analyst’s point of view, the worst case is the one where a company’s customers are especially price-sensitive and where substitutes are readily available–or where postponing a purchase is a realistic option.
Looking at the US stock market in general, as I see it, investors factored into stock prices in a substantial way last year the corporate tax cut that came into effect in January. They seem to me to be discounting this development again (very unusual) as strong, tax reduction-fueled earnings are reported this year. However, the tax cut is going to be “anniversaried” in short order–meaning that reported earnings gains in 2019 are likely going to be far smaller than this year’s. The Fed will also presumably be continuing to raise short-term interest rates. Tariffs will be at least another tap on the brakes, perhaps more than that.
Because of this, I find it hard to imagine big gains for the S&P 500 next year. In fact, I’m imagining the market as kind of flattish. Globally-oriented firms that deal in services rather than goods will be the most insulated from potential harm. There will also be beneficiaries of Washington’s tariff actions, although the overall effect of the levies will doubtless be negative. For suppliers to China or users of imported Chinese components, the key issues will be the extent of Chinese exposure and the market power they wield.
PS Hong Kong-based China stocks have sold off very sharply over the past few months. I’m beginning to make small buys.
I’ve just updated my Keeping Score page for the end of the stock market “summer.” …continuing S&P 500 strength.
On August 16th, WMT reported very strong 2Q18 earnings (Chrome keeps warning me the Walmart investor web pages aren’t safe to access, so I’m not adding details). Wall Street seems to have taken this result as evidence that the company makeover to become a more effective competitor to Amazon is bearing enough fruit that we should be thinking of a “new,” secular growth WMT.
Maybe that’s right. But I think there’s a simpler, and likely more correct, interpretation.
WMT’s original aim was to provide affordable one-stop shopping to communities with a population of fewer than 250,000. It has since expanded into supermarkets, warehouse stores and, most recently, online sales. Its store footprint is very faint in the affluent Northeast and in southern California, however. And its core audience is not wealthy, standing somewhere below Target and above the dollar stores in terms of customer income.
This demographic has been hurt the worst by the one-two punch of recession and rapid technological change since 2000. My read of the stellar WMT figures is that they show less WMT’s change in structure than that the company’s customers are just now–nine years after the worst of the financial collapse–feeling secure enough to begin spending less cautiously.
This interpretation has three consequences: although Walmart is an extraordinary company, WMT may not be the growth vehicle that 2Q18 might suggest. Other formats, like the dollar stores or even TGT, that cater to a similar demographic may be more interesting. Finally, the idea that recovery is just now reaching the common man both justifies the Fed’s decade-long loose money policy–and suggests that at this point there’s little reason for it not to continue to raise short-term interest rates.