The stock markets have been choppy the past 4 weeks. After hitting all-time highs in mid-September volatility has picked up and the market has been pulling back. What happened, don’t markets go up all the time? The answer is no. Long term returns in the stock market are close to 10% annually, but they certainly aren’t linear. Recent success in the markets has lulled investors into a false sense of security that stocks never go down. In reality we have consolidations and corrections all the time in the equity markets. Observe the chart below of the S&P 500:
Over the past 5 years the market has doubled, even though we’ve had multiple corrections (red circles) and consolidations (yellow arrows). This is the nature of the stock markets. If you want an asset class with no volatility CD’s are available, but remember they only pay about 0.50% a year.
Each market pullback has its own story and this pullback is no different. Below is what I think were the catalysts for the recent correction:
- The S&P 500 hit a new high pushing above 2,000 for the first time. It was only natural some profit taking might occur
- The Eurozone is slipping once again back into no-growth mode. Germany’s economy had been holding up some of the weaker countries (France, Spain, Italy), but they recently reported weak manufacturing data. Europe is the 2nd largest economy in the world
- Because Europe is deteriorating the Euro currency was weak. This in turn caused the dollar to get stronger. A strong dollar initially sounds good, but it hurts the revenue lines of US companies doing business in foreign markets
- The price of oil has collapsed due to global overproduction and the strong dollar. It’s the same thing for material and commodity prices. We’re in a bear market in the energy and material sectors of the market
- A bellwether semiconductor company (Microchip) preannounced poor earnings and warned of tough conditions in the semiconductor markets. This put a scare into the whole technology sector
- The Russell 2000 Index (a good proxy for small, mid and growth stocks) has been performing poorly all year approaching double digit losses for 2014
- Finally, we’re seeing a ton of headlines on Ebola creating further investor anxiety
Let’s look at some of the charts highlighting these issues:
German industrial production is about to go below zero, which correlates to negative growth:
The European markets have taken a hit. Below is the chart of the ETF tracking the Euro Stoxx 50 Index:
Look at the chart of oil (green line) collapsing and the dollar (blue line) surging:
Finally, the Russell 2000 chart representing small and mid-cap growth stocks:
There are certainly issues in the market right now, there always is. I think this quarter’s earnings season is critical to the future direction of the market. At the end of the day, its corporate earnings that drive stock prices. If this quarters earning look good, stocks just went on sale. It’s early in earnings season, but so far they look good.
In July Gradient Investments went incrementally more cautious on stocks when our price target of 9% was met. With the recent 5-10% correction (depending on the hour or day) we’re reviewing our call. We don’t want clients to panic, and encourage you to view this pullback as more of an opportunity, than a reason to sell. Our rationale is highlighted below:
- We believe stocks will be higher in 12-18 months
- The US economy continues to recover
- The growth of corporate earnings should persist
- Soon the market will start valuing stocks on 2016 S&P 500 forward earnings of $138
- Fixed income yields this low increase the relative attractiveness of stocks
If you feel your portfolio is underweight equities, I’d encourage you to get in the market now. If you’re properly allocated in equities and the market corrects more than 10%, I’d encourage you to increase your allocation. We still believe in the long term benefits of investing in stocks and the returns they provide to a properly allocated portfolio.
We understand that each time the market pulls back it’s not easy, it gets us anxious too. However, selling after corrections puts investors in a difficult spot, how and when do we get back in?
As of October 17th, 2014:
Dow Jones US Moderately Conservative Index is up 2.80% (TR) for the year
S&P 500 closed at 1,886.76 up 3.73% for the year
Russell 2000 closed at 1,082.33 down 6.04% for the year
U.S. 10 year Treasury Futures are yielding 2.20% down 0.77% for the year
WTI Crude Oil futures closed at $82.93 down $15.77 for the year
Gold closed at $1,238 per ounce up $34 for the year
To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to the Gradient Investment team.
