FYI | Feb 14 2018
By Peter Switzer, Switzer Super Report
How does last week's drama change my strategy?
After the financial fallout of last week, the big question everyone should be asking (and I’ve asked it myself) is: how do I change my investment strategy as a consequence?
Before I answer this question, let’s recap on the big revelations of the week. I think we should look at it all via the following questions: What happened? Why did it happen? What will happen?
Here are the facts of what happened
- The S&P 500 Index lost about 5.2% last week but is down around 11% since January 26.
- The [Dow] actually travelled about 22,000 points across the week. This is volatility like I’ve never seen before!
- Both indexes have erased 2018 gains even after clocking their best starts to a year in January in some time. It was the Dow’s best January since 2013 and the S&P 500’s best since 1997.
- The sell-off began Friday week, February 2, when the Dow fell 666 points after a better-than-expected jobs report and a solid wage rise number ignited inflation fears. That fall was exacerbated last Monday after the yield on the benchmark 10-year Treasury note hit a 4-year high, sending the Dow tumbling another 1,175 points, as investors grew more nervous about an overheating economy
- The Dow might have lost 5.2% over the five days of last week but January 2016 was worse. So, we have been in similar situations and the market was able to march higher. However, since January 26, it’s down 9% but, before Saturday’s close, it had been in correction mode down over 10%.
- The Dow’s loss last Monday was the biggest point-drop in history, losing 1175 points on Monday, wiping out all the 2018 gains!
- On Friday, the Dow surged on a 300-point rebound into the close, which is a positive sign.
- The CBOE Volatility index (VIX) — the market’s best fear gauge — shot above 40 again Friday after jumping as high as 50 earlier in the week. At the end of January, the VIX was below 14, which says fear has retreated.
And why it happened
- The S&P 500 index in January hit its 10th consecutive monthly gain, the longest streak in 59 years but a correction was way overdue
- The trigger for the sell-off was rising interest rates in bond markets because of better-than-expected employment and wage data that sounds the warning bell on US inflation.
- Hedge fund managers and short sellers thrive on these unstable, volatile times and it’s when they make their money. So, they buy and sell stocks, bonds, currencies for all their worth to take advantage of market instability. And remember, they’ve had some rough years lately, with stocks in most markets trending higher most of the time.
- Exotic ETFs linked to the VIX or ‘fear index’, along with algorithmic trading, increased the volatility and accentuated the falls. During the week, Fidelity banned its retail investors putting their money into their VIX-related products. One crazy product fell about 85% in after-hours trading Monday, prompting the issuer, Credit Suisse, to say it would end trading in it after February 20!
- Goldman Sachs’ Peter Oppenheimer warned clients on January 29 that correction signals were “flashing” and advised clients to prepare for a correction. “Our Goldman Sachs Bull/Bear Market Indicator is at elevated levels, although the continuation of low core inflation and easy monetary policy suggests that a correction is more likely than a bear market,” Oppenheimer wrote.
Of course, he wasn’t alone, and regular readers would know I’ve said many times that we should expect a pullback in 2018 because the gains on the US stock market since the election of Donald Trump have been extraordinary.
Now for what will happen…
I wouldn’t be surprised if the hedge funds guys will give a sell-off another nudge but my investment strategy is never predicated on what happens over a couple of weeks.
The best piece of research that tells me that this is a buying opportunity comes from Citi.
This week, Citi’s research team looked at 18 indicators that can flash buy or sell stock signals. This is what they concluded: “.Good news is our checklist shows that only 3.5/18 factors are flashing SELL compared to 17.5/18 in 2000 [the dotcom crash] and 13/18 in 2007 [the GFC crash]” Citi strategists said. “So, our bear market checklist says it is too early to call the end of this bull market.”
If they’re right, we are in buying opportunity territory.
That said, I do respect this observation of Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, who said to CNBC: “I think this bull market is basically in the process of forming a top. This is the first crack of it.”
Undoubtedly, the Yanks are in the euphoric zone, which Sir John Templeton warns can’t be ignored if you’re on the lookout for the coming of the next bear market.
Sir John told us that “Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria.”
But he also said the following: “The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.”
He also said: “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
The euphoric zone and the top-forming period is never the same for any bull market but I have always told you I was comfortable about stocks in 2017 and 2018, but would be more cautious in 2019. That is because it was obvious the Yanks would be raising interest rates which has been the trigger for the recent Wall Street wobbles.
To me, this is the right take on what’s going on now and should be important when you work out how you want to play stocks going forward.
“The market is focused on higher interest rates right now,” said Kate Warne, investment strategist at Edward Jones on CNBC. “The underlying fundamentals are going to drive stocks higher, but I think the path higher will be more volatile than it’s been in the past few years.”
It wasn’t long ago when market-driving investors were worried that inflation and wage rises weren’t going to happen in the USA. The almighty bond market was taking bond yields down, despite the expectations from many economists that the then US economy, plus the Trump agenda, had to mean more growth, inflation and higher interest rates.
We are in different and, potentially better, times for stocks as the observations of Jim Bianco, head of the Chicago-based advisory firm Bianco Research noted this week: “Since the financial crisis, this is the first 10 percent correction in stocks that has not been accompanied by a significant fall in rates.”
The one important thing about this correction, is that it demonstrates that the US economy is getting back to pre-GFC normalcy. Rising economic growth bringing inflation, better wages and higher interest rates, along with stock market volatility as we climb the wall of worry, is all very normal stuff.
Remember, this correction started because of great economic news in an economy where company profits are exceptional.
Of the 294 companies in the S&P 500 that have reported earnings to date for Q4 2017, 77.9% have reported earnings above analyst expectations. This is above the long-term average of 64% and in-line with the prior four-quarter average of 72%.
But the good news doesn’t stop there, with 80.1% of companies having reported Q4 2017 revenue above analyst expectations. This is above the long-term average of 60% and above the prior four quarter average of 63%.
Back to the economic story and this was a big deal, as Reuters summed up the surprise numbers: “Average pay rose by more than 3 percent in at least half of U.S. states last year, up sharply from previous years.
“The data also shows a jump in 2017 in the number of states where the jobless rate zeroed in on record lows, 10 years after the financial crisis knocked the economy into a historic recession.”
For this week, the courageous investor who can cop losses, knowing that in the longer term going in early often pays off, will buy today, boosted by the positive finish on Wall Street on Friday.
Bruce McCain, chief investment strategist at Key Private Bank in the US, puts the ‘investment now or later’ question into the right perspective, in my opinion.
“A lot of people want to let it settle out a bit and really make sure the worst has past … [but] for our standpoint on where we’ll be over the next year — we see no signs of recession.”
I also liked the fact that the panic in the stock market didn’t send investors rushing into bonds, as would normally happen. Why? Because smarties know they can make more out of stocks.
Gina Sanchez, CEO of Chantinco Global, who used to work with that great bear Nouriel Roubini, who got the GFC crash call right, remains bullish on equities and recommends that nervous investors focus on the source of the sell-off. “Those are all bond problems and ultimately those problems are going to cause a sell-off in the bond market,” said Sanchez. “That money will ultimately find its way back into the stock market.”
One last positive sign to help offset the pile of negatives that last week brought was Friday’s trading on the local stock market – we dropped just 0.89% on the S&P/ASX 200 index, while the Dow Jones lost over 4%.
I’ve been arguing that 2018 should be a year where our stock market can rise faster than the Yanks because there has been so much positivity there, which had found its way into stocks.
I still believe in the RBA’s 3% plus economic growth forecast and that 2018 will be better for not only growth, but company profits, business investment, employment and wages.
We follow Wall Street’s sell-offs more slavishly than we follow its rises, which shows how important the US story will be for our stocks story.
I have always argued that I was confident about stocks in 2017 and 2018, albeit with volatility, and would be wary by 2019 but I could be convinced to be positive on that year as well. What happens in the USA with inflation and interest rates will be critical.
One major fear is around those VIX-risk products that allowed traders to go long stocks, while shorting the VIX. It was these kamikaze stock pilots who were bailing out of US stocks, especially last Monday, that made a correction look like a crash!
Regulators need to do what Fidelity and Credit Suisse have done and ban these crazy products.
My strategy this week will be to give the market a few days to see if the craziness has subsided and then look for stocks that are even better value than they were before all this madness was rained down upon us.
Starting points would be the big four banks, the S&P/ASX 200 index via ETFs. And I still want overseas exposure, either through an ETF or via a smart fund manager.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
Content included in this article is not by association the view of FNArena (see our disclaimer).
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
