Dear Mr. Market:
You’ve certainly kicked 2016 off with a bang! Even investors that rarely, if ever, look at their portfolio are aware of the rough start to the New Year. Over $8 trillion in market valuations has seemingly disappeared in the blink of an eye. Many are pounding the table with a bear market narrative capturing your attention and emotions but is there anything truly different this time?
There are many different factors at play in this volatile market environment but in our opinion none of them are really all that new nor are they indicative of a bear market, a recession, or impending crash. We’ll briefly touch on each of them but at the end of this article you may be surprised to learn why we believe this market could bounce strongly when least expected.
Currently there are three factors that are dramatically impacting the markets: China, Oil and the Fed. It appears that when these are combined it creates a combustible combination that not even the most seasoned analysts know how to handle! The reality is that the stock market and all the ‘experts’, who analyze and report on it, seem to have short-term memories. For lack of a better description people have also been put to sleep and forget what it’s like to see a normal market correction. Let’s quickly break them down and attempt to put them in perspective:
China – Yep, it is the 2nd largest economy in the world. There is no doubt that China is a huge player in the global economy but what many don’t realize is that in a sense they are still learning to ‘play with the big boys in the sandbox’. As we wrote about earlier this month they attempted to put ‘circuit breakers’ in place to manage volatility but after two devastating days in the first week of 2016 they were quickly dismissed, as they simply did not work. Another factor that drives the Chinese market both up and down is that a high percentage of purchases have been done with margin (that’s a nice way of saying “gambling”). Is the Chinese economic slow down a real and “new” story? Nope! It’s been talked about for a while now but in combination with everything else it serves as platform for a global market sell-off (at least in the short-term). Just last week China’s GDP for 2015 came in at 6.9%, which is a 25-year low. Don’t let that last thought lead you to think that China is going to repeat what Japan did in the late 1980s (also the 2nd largest economy in the world at the time) essentially disappearing and struggling to fight deflation for the last 20 years. Chinese officials announced several times over the last few years that they would like to intentionally slow down their growth and transition from a manufacturing economy to a service-based model.
Oil – The energy sector continues to have a dramatic impact on economies around the world (both positive and negative). With oil now under $30 everyone is attempting to predict where the bottom will be. One thing can be certain…we are closer to a bottom then we are to a top! As Amory B. Lovins, Chief Scientist with Rocky Mountain Institute stated in a recent Forbes article, “oil prices go down because they went up before, and they go up because they went down before. Get used to it. Commodities do that; it’s their job. If you don’t like it, don’t buy them.” While the oil story led most headlines last summer…is it really all that new now? The bottom line is that if you have exposure to energy, consider adding to your position to bring your average price down…and then be patient; it will come back but it could take some time.
The Fed –Our cover story in the summer issue of our investment newsletter, “the Guide”, was that we thought rates would NOT rise for at least a few more Fed meetings. It finally happened in December but not even close to when those who were pounding the table called for it. All the talking heads on the various media outlets that were pushing and calling for a rate hike are now nowhere to be seen! This too was a not a “new” story but rather one of the most telegraphed announcements ever.
In our opinion the Fed raised rates because they had essentially painted themselves into a corner. What our economy has clearly demonstrated over the last month is that it was not ready for a rate hike…it is now time for the Fed to change their verbiage that it plans to continue moving rates up no matter what. Inflation is more than in check and the market simply cannot handle another hike just to appease the Fed.
Before we wrap up this article let’s consider one simple question…what do the three factors we’ve discussed have in common (aside from not being new)? Need a hint?
The answer is nothing! And investors have no control over any of them! The only thing that investors can do at this time is adjust their allocations. It is in markets like this that emotional decisions are often made; those are the ones that haunt investors for years.
We’ll also leave you with this to chew on: Aside from the fact that none of the above factors are all that new to the market, we’re now getting very close to an oversold condition. Yes, the market could (and most likely will) have another leg down to rattle some more nerves and “shake out weak hands”. Was a near-term bottom put in last week? Perhaps…but the dips we’ve seen aren’t quite the same as over the past several years. Investors would almost automatically “buy the dip” whereas this most recent correction has created more fear. As a seasoned investor, you actually want this. Go against the herd and it’s not for the sake of being a contrarian. The average person will swallow almost whatever is fed to them…but you don’t have to follow the herd.
Having some “dry powder” in your portfolio allocation is critical right now. Nobody will (nor should) ring a bell and tell you when it’s time to raise cash or deploy it; the sad fact is, however, that the average portfolio is married to the market. That reality creates angst, amplified fears when things go south, and unrealistic expectations of gains when stocks buoy up. Last week we sold a considerable position in TIP (iShares TIPS Bond ETF)…That’s our dry powder and what comes next is why stock market corrections are actually a good thing…
The bounce we saw last Wednesday signaled something potentially very different than what we’ve all been so accustomed to over the past seven years. Even if full capitulation has not been reached this could be a turning point. That Wednesday rally was not solely driven by oil. Oversold stocks (biotechs and many small caps that are deep in bear market territory) led the charge. If this market learns to diverge itself of oil driven rally attempts a more sustained bounce could be coming. Over the next few months the stock market will also have other topics to take its attention off of some of these “not-new” stories! We actually cover several of these in our most recent newsletter.
The Q1 edition of the ‘the Guide’ is currently being printed – If you would like an electronic copy we encourage you to send an email to: firstname.lastname@example.org with the Guide in the subject line.