a bear market in time? sort of…

In the middle of a garden-variety bear market–i.e., one orchestrated by the Fed to stop the economy from running too hot–I remember a prominent strategist saying she thought the market had fallen far enough to be already discounting the slowdown in profits but that the signs of recovery were yet to be seen.  So, she said, we were in a bear market in time.

We’re in a different situation today, though:

–most importantly, we don’t know for sure how much damage the coronavirus will do, only that it’s bad and we unfortunately have someone of frightening incompetence at the helm  (think:  the Knicks on steroids) who continues to make the situation worse (while claiming we’re in the playoffs)

–with most of the seasoned investment professionals fired in the aftermath of the financial crisis, and replaced by AI and talking heads, it’s hard to gauge what’s driving day-to-day market moves

–if we assume that the US economy is 70% consumption and that this drops by 20% in the June quarter, then COVID-19 will reduce GDP by 14% for those three months.  This is a far steeper and deeper drop than most of us have ever seen before

–on the other hand, I think it’s reasonable to guess that the worst of the pandemic will be behind us by mid-year and that people released from quarantine will go back to living the same lives they did before they locked themselves up.

 

It seems to me, the key question for  us as investors is how to navigate the next three months.  In a pre-2008 market what would happen would be that in, say, six or eight weeks, companies would be seeing the first signs that the worst was past.  That might come with more foot traffic in stores or the hectic pace of online orders for basic necessities beginning to slow.

Astute analysts would detect these little signs, write reports and savvy portfolio managers reading them would begin to become more aggressive in their portfolio composition and in the prices they were willing to pay for stocks.

 

How the market will play out in today’s world is an open question.  AI seem to act much more dramatically and erratically than humans, but to wait for newsfeeds for stop/go signals.  (My guess is that the bottom for the market ends up lower than history would predict and comes closer to June.  At the same time as the market starts to rise again, it will rotate toward the sectors that have been hurt the worst.  Am I willing to act on this?   –on the first part, no; on the second part, looking at hotels, restaurants…when the time comes, yes)

A wild card:  Mr. Trump now seems to be indicating he will end quarantine earlier than medical experts say is safe.  At the very least, this will likely bring him into conflict with the governors of states, like NY, NJ and CA, who have been leading efforts to fight the pandemic.  At the worst, it will prolong and intensify the virus effects in areas that follow his direction.  Scary.

 

 

 

dealing with market volatility

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today

 

more on Monday

 

what if this is a bear market…and not just a wicked correction?

standard definitions

Commentators often use sound-bite definitions for economic and stock market phenomena.  For example,

–a recession is two successive quarters of year-on-year GDP decline.

–a correction is a short, counter-trend, fall in stocks of 5%-10%.

–a bear market is a fall in stock prices of 20% or more.

The virtues of these definitions are that they’re brief and unambiguous.  On the other side of the coin, brief and unambiguous doesn’t represent real life that well.

adding complexity, but also relevance

There’s a time aspect to corrections and bear markets.

A correction typically lasts a few weeks.  That’s because it’s normally a valuation issue–that “animal spirits” have pushed stock prices higher than near-term earnings can comfortably support.  Short-term traders sell, but intend to repurchase in short order, hopefully at somewhat lower prices.

Bear markets, on the other hand, come in two types.  Both anticipate–and ultimately reflect–widespread economic weakness that will last for a year or so.  The garden variety is a consequence of governments’ countercyclical fiscal and money actions when economies are about to overheat (too bad Mr. Greenspan forgot about this part of his job).

The really deep ones come from one-time shocks to the system.  In the past, these have been “external shocks,” like huge oil price rises.  The most recent is the self-inflicted wound of the financial meltdown.  As we experienced in 2007-2009, these ones are deeper and longer.

for the record…

…I don’t think we’re in a bear market–at least not in the world outside the EU (where stocks have already lost over a third of their value since May).

I think we’re in an unusual situation of correction in world markets, complicated by the EU situation.  In brief, the EU hoped to get away with not rebuilding its banks’ strength after the losses they took in the financial crisis, but hiding them instead.  They figured they could free-ride on the economic coattails of China and the US instead and use worldwide growth to mend.

Then the Greek crisis came.  And, instead of addressing the fact their gamble had failed, EU governments have spent the last year with their heads in the sand, letting the problem get worse.

why bring this up now?

EU stocks have lost over a third of their value since May.  US stocks are down by almost 20% (the “magic” bear market line).  Metals prices are crashing.  Stocks have been extremely volatile.

Monday morning I saw a lot of crazy stuff when I turned my computer Monday morning.

–European markets were down 5% intraday.

–Hong Kong-traded Ping An Insurance (I own it–ouch!) had lost another 8%+.  It was down by 25% in three days on rumors that HSBC was about to sell a portion of its holding (so what, I say).

–AAPL lost $10 in early trading in a rising US market on a report out of Taiwan that orders for iPad components from Hon Hai for the December quarter were lower than expected.  It turns out the orders, if they are indeed being lost at Hon Hai, are most likely going to a new iPad factory that’s opening in Brazil in December. It could equally be that AAPL is preparing for iPad3, which would be a bullish sign, I think.  But, noooo. Traders took the most bearish interpretation.

The world isn’t 5% better one week, 6% worse the next, and 7% better the week after that.  Economic processes don’t change that fast.  Human emotions do, however.  And the extremes of emotion we’re seeing now typically signal significant turning points in market behavior.  Hence the title of this post.

what to do

My best guess is that we continue to move sideways in markets ex the EU until European governments address their banking crisis.  They markets probably rally.  But that may not be for a while, so don’t bank on that.

I think the best strategy is to use days of crazy selling as a chance to buy stocks that are being irrationally sold down.  Be very picky, though.  Look for high quality names where you’re very confident about the fundamentals.  And don’t bet the farm on a single stock.

On September 6-9, for example, I bought INTC, because I saw it was trading at under $20 a share, or less than 9x earnings, and with a dividend yield of 4.3%.  As/when it reaches $24, I have to decide whether I keep it.

if it’s a bear market, then what?

Then markets are not turning up again until maybe next summer.  And, if past form holds true, we’ll see at least one more downdraft in stock prices–maybe another 10% from here, more in economically sensitive stocks and in emerging markets securities (even though the emerging economies themselves may be fine).  That will come as government statistics and company reports show economic activity dipping into negative territory.  Yes, world stock markets may have begun discounting this possibility.  But, ex the EU, they’re barely begun to, in my view.

As much as it cuts against the grain of my growth stock temperament, it seems to me it’s worthwhile thinking about asset allocation and how you’d act if a more ursine mood begins to make itself evident on Wall Street.  My portfolio is betting against this, but it never hurts to think about what happens if you’re wrong.