What's Going on in the Markets September 9 2016

On Friday September 9 2016, the S&P 500 index fell 2.4%, while the Dow Jones Industrial Average fell 2.1%.  This was the first "greater than 1%" sell-off since June, its worst single-session loss in more than two months. The drop ended a relatively quiet summer for U.S. stocks, which had touched new highs in mid-August. But despite Friday's jarring downdraft, market internals remain solid and equity markets are within stones throw of their recent peaks. Of course, the press reports are describing it as a full-blown market panic.

Even if the short-term pullback in stocks persists, we do not believe the longer-term bull market—which has been underway since 2009—is dead. U.S. economic data has generally shown signs of strength, and an improving economy should support the stock market over the long term.

So what’s going on?  Efforts to trace the reason why quick-twitch traders scattered for the hills on Friday turned up two suspects.  The first was Boston Federal Reserve President Eric Rosengren, who sits at the table of Fed policy makers who decide when (and how much) to raise the Federal Funds rate.  On Friday, he announced that there was a “reasonable case” for raising interest rates in the U.S. economy.  According to a number of observers, traders had previously believed there was a 12% chance of a September rate hike by the Fed; now, they think there’s a 24% chance that the rates will go up after the Fed’s September 21-22 meeting. Oh the horror of a less than 1 in 4 chance of a quarter-point (0.25%) rise in short-term interest rates--sell everything!

If the Fed decides the economy is healthy enough to sustain another rise in interest rates—from rates that are still at historic lows—why would that be bad for stocks?  Any rise in bond rates would make bond investments more attractive compared with stocks, and therefore might entice some investors to sell stocks and buy bonds.  However, with dividends from the S&P 500 stocks averaging 2.09%, compared with a 1.67% yield from 10-year Treasury bonds, this might not be a money-making trade.

If the possibility of a 0.25% rise in short-term interest rates doesn’t send you into a panic, maybe a pronouncement by bond guru Jeffrey Gundlach, of DoubleLine Capital Management, will make you quiver.  Gundlach’s exact words, which are said to have helped send Friday’s markets into a tailspin, were: “Interest rates have bottomed.  They may not rise in the near term as I’ve talked about for years.  But I think it’s the beginning of something, and you’re supposed to be defensive.” My thoughts on this: pundits have been declaring the end of the bull market in bonds for many years and have been proven wrong time and time again. Statements like this are pretty worthless in my opinion. Could he be right? Sure, there's a 50/50 chance.

Short-term traders appear to have decided that Gundlach was telling them to retreat to the sidelines, and some have speculated that a small exodus caused automatic program trading—that is, money management algorithms that are programmed to sell stocks whenever they sense that there are others selling.  After the computers had taken the market down by 1%, human investors noticed and began selling as well.

Uncertainty about central bank policy outside the U.S. was another potential cause for Friday’s volatility. On Thursday, the European Central Bank opted for no new easing moves and Japanese bond yields have continued to rise. The two events have sent a message to markets that quantitative easing (bond buying and other monetary stimulus) may have lost some of its efficacy and will not continue indefinitely.

For seasoned investors, a 2% drop after a very long market calm simply means a return to normal volatility.  This is generally good news for investors, because volatility has historically provided more upside than downside, and because these occasional downdrafts provide a chance to add to your stock holdings at bargain prices. I've been telling clients all summer long to expect a volatile and rocky September and October. Does that make me smart? Nope, historically, periods of calm like we've seen are always followed by volatility. September and October tend to be more volatile than other months of the year.  Markets have been unusually calm this summer, and prolonged periods of low volatility can make markets susceptible to news and rumors. Given the emphasis the market is now placing on Fed policy—and the uncertainty surrounding it—we wouldn’t be surprised to see markets continue to experience volatile swings when news or economic data suggest the Fed may, or may not, raise interest rates.

That doesn’t, of course, mean that we know what will happen when the exchanges open back up on Monday, or whether the trend will be up or down next week or for the remainder of the month.  Nor do we know whether the Fed will raise rates in late September, or how THAT will affect the market.

As for bonds, while rising interest rates can translate into falling bond prices—bond yields typically move inversely to bond prices—it’s important to remember that yields generally don’t move in tandem all along the yield curve. The Fed influences short-term interest rates, but long-term interest rates are generally affected by other factors, such as economic growth and inflation expectations. And even if the Fed does raise short-term interest rates again this year, I would anticipate that future rate hikes would be gradual, as inflation remains low and the U.S. economy is only growing moderately.

That said, periods of market volatility are a good time to review your risk tolerance and make sure your portfolio is aligned with your time horizon and investing goals. A well-diversified portfolio, with a mix of stocks, bonds and cash allocated appropriately based on your goals and risk tolerance, can help you weather periods of market turbulence.

All we can say with certainty is that there have been quite a number of temporary panics during the bull market that started in March 2009, and selling out at any of them would have been a mistake.  You must resist overreacting to swings in the market. Stock market fluctuations are a normal part of investing; panicking and pulling money out of the market may mean missing out on a potential rebound.

The U.S. economy is showing no sign of collapse, job creation is stable and a rise in interest rates from near-negative levels would probably be good for long-term economic growth.  The Institute for Supply Management survey for the manufacturing sector recently showed an unexpected decline, and the service sector moved down by more than economists had expected, so I will be monitoring upcoming survey results closely to see if this develops into a trend. The employment situation remains firm; new job openings hit a record high in July and new claims for unemployment remain near recent lows.

While it may be prudent to trim some profits, panic is seldom a good recipe for making money in the markets, and our best guess is that Friday will prove to have been no exception. Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.bloomberg.com/news/articles/2016-09-08/gundlach-says-it-s-time-to-get-defensive-as-rates-may-rise

http://www.forbes.com/sites/laurengensler/2016/09/09/stocks-fall-worst-day-since-brexit/#3a9ed7252961

http://www.bloomberg.com/news/articles/2016-09-09/split-among-fed-officials-leaves-september-rate-outlook-murky?utm_content=markets&utm

http://thereformedbroker.com/2016/09/09/dow-decline-signals-end-of-western-civilization/?utm

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Learn to Embrace New Highs

It's been an interesting start of the week for those of us watching the stock markets. In case you hadn’t noticed, the S&P 500 index reached record territory on Monday, and the NASDAQ briefly crossed over the 5,000 level before settling back with a more modest gain.  At 2,137.6, the S&P 500 finished above the previous high of 2,130.82, set on May 21, 2015.

We’ve waited more than a year for the markets to get back to where they were before the downturn this January, before Brexit, and before a lot of uncertainties in the last 12 months.  The market top itself is an uncertainty; after all, many investors regard market tops warily.  When stocks are more expensive than they've ever been (or so goes the thinking) it may be time to sell and take your profits.  However, if you followed this logic and sold every time the market hit a new high, you’d probably have been sitting on the sidelines during most of the long ride from the S&P at 13.55 in June 1949, which was the bull market high after the index started at 10.  New highs are a normal part of the market, and it is just as likely that tomorrow will set a new one as not.  In fact, overall, the market spends roughly 12% of its life at all-time highs.

We all know that the next bear market will start with an all-time high, but we can never know which one in advance.  That's why in this business we say that there's nothing better than a new high, except the one that marks "the top".  But new market highs do not necessarily become market tops.  Let’s see if we can all celebrate this milestone without the usual dose of fear that often comes with new records.

Sources:

http://www.forbes.com/sites/shreyaagarwal/2016/07/11/sp-500-closes-at-record-high/?utm_source=yahoo&utm_medium=partner&utm_campaign=yahootix&partner=yahootix#7f74bf29721d

http://www.marketwatch.com/story/us-stock-futures-climb-with-sp-near-record-high-2016-07-11?siteid=yhoof2

http://www.usatoday.com/story/money/columnist/waggoner/2014/06/19/new-highs-dont-mean-you-have-to-sell/10921973/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

You Only Brexit Once (YOBO)

Not even a month ago, I wrote to you and shared my thoughts on Britain leaving the European Union (EU).  I guess I was wrong.

Thursday’s 52%-48% vote by the British electorate to end its 43-year membership in the European Union seems to have taken just about everybody by surprise, but the aftermath could not have been more predictable.  The uncertainty of how, exactly, Europe and Britain will manage a complex divorce over the coming decade, sent global markets reeling.   London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany’s DAX market lost more than 7%.  The British pound sterling is getting crushed (down 14% against the yen, 10% against the dollar).

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3%, though nobody knows if that’s the extent of the fall or just the beginning. I think after a bit of a hangover on Monday, Wall Street will move on to the next brick in the Wall of Worry that builds bull markets.

The important thing to understand is that the current market disruptions represent an emotional roller coaster, an immediate panic reaction to what is likely to be a very long-term, drawn out, ultimately graceful accommodation between the UK and Europe.  German companies are certainly not 7% less valuable today than they were before the vote, and the pound sterling is certainly not suddenly a second-rate currency.  When the dust settles, people will see that this panicky Brexit aftermath was a buying opportunity, rather than a time to sell.  People who sell will realize they were suckered once again by panic masquerading as an assessment of real damage to the companies they’ve invested in.

What happens next for Britain and its former partners on the continent?  Let’s start with what will NOT happen.  Unlike other European nations, Britain will not have to start printing a new currency.  When the UK entered the EU, it chose to retain the British pound—that, of course, will remain.  Stores and businesses will continue accepting euros.

On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing about in the breathless coverage in the press, is that the British electorate’s vote is actually not legally binding.  It will not be until and unless the British government formally notifies the European Union of its intention to leave under Article 50 of the Lisbon Treaty—known as the “exit clause.”  If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the remaining union.  Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably won’t start ticking until the British people decide on their next leader.

After notification, attorneys in Whitehall and Brussels would begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues.  Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will stay in place until new ones are agreed upon.

The exit agreement also requires obtaining the consent of the EU Parliament.  When was the last time the EU parliament got anything done quickly? The answer is never. Heck, even Prime Minister David Cameron’s splashy Friday morning resignation is not effective until October. For the foreseeable future, despite what you read and hear, the UK is still part of the Eurozone.

An alternative that is being widely discussed is a temporary acceptance of an established model—similar to Norway’s. Norway is not an EU member, but it pays EU dues, and has full access to the single market as if it was a member.  However, that would require the British to continue paying EU budget dues and accept free movement of workers—which were exactly the provisions that voters rejected in the referendum.

Meanwhile, since the Brexit vote is not legally binding, it’s possible that the new government might decide to delay invoking Article 50.  Or Parliament could instruct the prime minister not to invoke Article 50 until the government has had a chance to further study the implications.  There could even be a second referendum to undo the first.

The important thing for everybody to remember is that the quick-twitch traders and speculators on Wall Street are chasing sentiment, not underlying value, and the markets right now are being driven by emotion to what is perceived as an event, but is really a long process that will be managed by reasonable people who aren’t interested in damaging their nation’s economic fortunes.  Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.

When I want to gauge the intermediate-term economic outlook, I often look at how the large commercial traders are positioned in copper. Being the most basic component of the home/commercial building engine, how they're positioned in copper tells me how optimistic they are on the economy. As of this week, they're positioned more bullishly in copper than they have been in the past few years. I would say that offers us some degree of hope about the future of the global economy, even if one country amounting to less than 1% of the global population decides that it doesn't want to be in an economic union anymore with the rest of Europe.

But you can bet that, long-term, everybody will find a way to move past this interesting, unexpected event without suffering—or imposing—too much damage.  My guess is that the market will get back to its normal course of business by Tuesday or Wednesday and will have moved past this event. Meanwhile, hang on, because the market roller coaster seems to have entered one of those wild rides that we all experience periodically.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post.

Recovery—For How Long?

On Tuesday of this week, the U.S. stock markets (S&P 500 index) went up 2.39%, the highest one-day return in a month. Analysts attributed the rise to a variety of economic news that suggested that the American economy is not, after all, plunging into recession. The buoyant mood among investors may not last, but for many, it’s a welcome sign that things may not be as gloomy as they seemed just a month ago.

In fact, the S&P 500 only dropped about 12%, from 2078.36 at the end of December 2015 to the bottom of 1829.08 on February 11—despite widespread predictions of a 20% bear market. Since then, it has risen on shaky legs back to more than 1999, just 79 points from breaking even on the year. One more day like Tuesday would erase nearly all of the damage in 2016.

The good economic news involved construction spending, which reached its highest level since 2007. Oil prices were also gaining ground, although it’s hard to see why the average American would find reason to cheer about that. In addition, new orders and inventories stabilized in the manufacturing sector, after experiencing downturns in the last quarter of 2015.  On Friday, The February jobs report showed that the economy created 242,000 jobs and unemployment remains at a low 4.9%.  Other factors include the possibility that U.S. stock investors may finally have decided that declines in the Chinese markets are not going to directly affect the value of American-based businesses.

None of this means that we know what will happen next. Neither we nor any of the pundits you see on the financial news have any idea whether that long-awaited 20% decline will materialize, or the markets will continue to recover and we’ll all look back on February 11 prices as a great time to buy. But it’s worth reflecting on how unexpected this latest rally has been at a time when it seemed that all the news pointed to more pain and decline. Anybody who believed the pundits and fully retreated to the sidelines after the January selloff is now sitting on losses and wondering whether to jump in now and hope the gains continue, or wait and hope for another downturn, and risk losing even more ground if this turns out to be a long-term rally. This is not to say that hedging or taking some bull market profits off the table is still not a good idea. All-or-nothing investing is almost never a good idea.

We can never see the next turn in the market roller coaster, but long-term, the markets seem to operate under the opposite of the pull of gravity. You and I know with some degree of certainty in which direction the next 100% market move will be, even if we can’t pinpoint when or where.

Sources:

http://www.businessinsider.com/the-stock-market-is-over-china-2016-2

http://www.bloomberg.com/news/articles/2016-02-29/japan-futures-down-on-strong-yen-as-china-stimulus-buoys-aussie

http://finance.yahoo.com/news/wall-st-open-higher-oil-143344528.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post