If during a two week summer vacation, you heard that there was an escalation of tensions between the US and Korea; two international terrorist attacks; a US domestic terrorist attack; a looming debt ceiling crisis; and political upheaval in the White House, you might think that US stock markets would be in free-fall. You would be mistaken. Although markets were down over the most recent fortnight, the damage was fairly limited—about two percent overall. Even with the recent declines, the S&P 500 remains 8.3 percent higher on the year and just 2.2 percent below its record high, while the NASDAQ is up 15.5 percent in 2017. Given these numbers, its not surprising that the most frequently asked question that I have fielded over the past month has been, “I can’t believe that market is doping so well, considering (fill in the blank)…SHOULD I SELL MY STOCKS?”
2016 started with a stock sell off and full-blown correction (down 10 percent from the recent peak), challenging investors to remain calm and stick to their game plans. Then Brexit came along and once again, rattled nerves. Today the Cassandra's are out again with an old worry: the Fed will kill the stock market rally. The reignited jitters have been attributed to a few central bank officials hinting that the improving economy may justify an interest rate increase as soon as next week’s Fed meeting. Previously, there seemed to be little doubt that the central bank would wait at least until the December meeting. While most believe that December is still more likely, the selling acknowledges that the most recent leg up in stock prices occurred NOT because the economy is humming and companies are making a lot of money; rather the buying has been a sign that big investors feel with interest rates so low, stocks are the only assets that can deliver any potential for gains. As Federal Reserve Governor Daniel Tarullo recently acknowledged “There's no question...when rates are low for a long time that there are opportunities for frothiness and perhaps over-leverage in particular asset markets.” (Emphasis added!)
In other words, when rates stay so low for so long, investors look past fundamentals, drive prices higher and can become complacent. One sign of that complacency can be seen in the VIX index, which is a measure of the expected swings in the S&P 500 over the next thirty days. Recently, the 30 day annualized volatility (of daily changes) in the S&P 500 fell to its lowest level since 1994. Friday’s selling may simply be proof that people periodically remember that the risks they previously accepted, may no longer feel so great, especially considering the age of the bull market. But as the analysts at Capital Economics note, “The fact that volatility was low in the mid-1990s did not preclude equity prices from rising for several years as a bubble inflated.”
Still, when you hear dire predictions, it’s hard not to feel butterflies. Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions: when to sell and then when to buy back in, something that is nearly impossible. After all, even if you sell and manage to steer clear of the bear by staying in cash, you will not be able to reinvest dividends and fixed-income payments at the bottom and you are likely to miss the eventual market recovery. The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you are a long-term investor and you do not have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon and do not be reactive to short-term market conditions, because over the long term, this strategy works. It’s not easy to do, but sometimes the best action is NO ACTION.
If you are really freaked out about the movement in your portfolio, perhaps you came into this period with too much risk. If that’s the case, you may need to trim readjust your allocation. If you do make changes, be careful NOT to jump back into those riskier holdings after markets stabilize.
Should you follow the old Wall Street adage to “Sell in May and Go Away”? You might be tempted to do so, especially with economic growth crawling at a measly 0.5 percent annualized pace in the first quarter, consumer spending decelerating for the past nine months and corporate earnings on track for a third consecutive quarter of declines—the longest streak since the financial crisis. 2016 has been a year of investor anxiety, starting with a swift Jan-Feb 10 percent stock market correction. Now that indexes have clawed their way higher, many are worried that something ominous is brewing for the summer. This week’s employment report could either fan the fear flames or tamp them down. Analysts expect that 200,000 jobs were created in April and the unemployment rate will remain at 5 percent.
If those estimates were to come in on target, they would add to the mostly upbeat data on jobs that we have seen over the past few years. According to Calculated Risk, through March, total employment was 5.3 million above the previous peak and up 14 million from the employment recession low. Last week, although the Federal Reserve did not raise interest rates, it acknowledged that since its previous meeting six weeks prior, “Labor market conditions have improved.”
But the broad numbers may not paint a true picture of the employment landscape. Steve Murphy of Capital Economics notes that there has been a surge of low paying jobs in sectors like retail and leisure, while “at the same time, employment in higher-paid sectors such as manufacturing and mining has fallen back sharply. More generally, there has been a sharp deterioration in the quality of jobs created.”
Career coach Connie Thanasoulis-Cerrachio, co-founder of SixFigureStart® says her on-the-ground-interaction with employers and candidates echoes that sentiment: “We see a tale of two [labor] markets – strong candidates have a great market. Mediocre ones are still have a hard time.” What makes a strong candidate? It helps if those seeking jobs are looking in the hot industries that are hiring, like technology, healthcare, accounting, marketing/data analytics as well as the non-profit world, which Thanasoulis-Cerrachio says is “booming”.
Even if many parts of the economy are growing and employees do eventually see an uptick in their paychecks (Capital Economics expects “to see a marked acceleration in hourly wage growth to around 3 percent by year-end”), the stock market may still stumble, due to valuations, exogenous events across the globe or plain old exhaustion, which brings us back to the original question of selling in May. According to Charles Schwab, “since 1950, nearly all of the S&P 500’s gains have occurred between October and April. The mean return during May through October was 1.3 percent; while for November through April it was 7.1 percent.”
Unfortunately, “Sell in May and Go Away” hasn’t been as reliable over the past dozen years. It didn’t work from 2012-2014, or from 2003-2007, so you may want to stick to the tried and true strategy of investing in a diversified portfolio, targeted to your specific goals. Not as catchy as “Sell in May and Go Away”, but probably a smarter way to manage your money.
- DJIA: 17,773 down 1.3% on week, up 2% YTD
- S&P 500: 2065 down 1.3% on week, up 1% YTD
- NASDAQ: 4775 down 2.7% on week, down 4.6% YTD
- Russell 2000: 1130, down 1.4% on week, down 0.4% YTD
- 10-Year Treasury yield: 1.83% (from 1.9% a week ago)
- June Crude: $45.92, up 20% on month, up 75% since bottoming out in February at a 13-year low
- June Gold: $1,294.90, highest level in 15 months
- AAA Nat'l avg. for gallon of reg. gas: $2.21 (from $2.13 wk ago, $2.58 a year ago)
THE WEEK AHEAD:
9:45 PMI Manufacturing Index
10:00 ISM Manufacturing Index
10:00 Construction Spending
Motor Vehicle Sales
Tesla, Lending Tree, Priceline
8:15 ADP Private Sector Employment Report
8:30 International Trade
8:30 Productivity and Costs
9:45 PMI Services Index
10:00 Factory Orders
10:00 ISM Non-Manufacturing Index
Alibaba, Merck, GoPro, Herbalife
Chain Store Sales
8:30 April Employment Report
3:00 Consumer Credit
Since the Great Recession, the Federal Reserve has worked hard to boost the economy. Part of the Fed’s mission was to keep core inflation (the price of goods and services excluding food and energy), at a pace of two percent annually. Although there have been instances over the past six years when either energy or food prices jumped, temporarily raising the specter of inflation, throughout the financial crisis and the recovery, the central bank has been much more focused on deflation, which is defined as a drop in the price of goods and services. For those who were around during the inflationary 1970s and 1980s, deflation is an alien concept. But according to data released by the government last week, the near-60 percent plunge in oil prices pushed down consumer prices by 0.4 percent in December from the previous month, leaving the CPI just 1.6 percent above where it stood a year ago, below the 1.9 percent annual rate over the past ten years.
Although the idea of falling prices seems like a good thing, when deflation is persistent, it can put into a motion a scary, downward spiral. It starts when the economy cools, which prompts companies to reduce prices in the hopes of luring customers and maintaining sales volume. But as companies make less money, they could then cut jobs and/or wages, which could then cause consumers to spend less in order to service their fixed costs, like taxes and mortgages/rents.
The longer that deflation goes on, the higher the risk that consumers’ and businesses’ become accustomed to the situation and delay spending, hoping they will eventually be able to buy goods more cheaply and to invest more efficiently. They also become less willing to borrow.
The vicious deflationary cycle can mire an economy in a deep recession or even worse, a depression. As an example, between 1929 and 1933, US consumer prices fell by a cumulative 25 percent. More recently, Japanese consumer prices have been stuck for the past 20 years and the Euro Zone and the United Kingdom are both currently battling falling prices.
Besides the obvious harm that deflation can cause, the other problem is that central bankers have limited tools to fight it. (In contrast, when there is inflation, hiking interest rates may hurt in the short-term, but it is effective in combating higher prices.) In a deflationary environment, policy makers would likely return to bond buying (Quantitative Easing), which depending on the magnitude of price declines, may not stop the downward spiral. (FYI, there will be an excellent test case in the efficacy of QE coming up. This week, the European Central Bank is expected to unveil its version of bond buying to boost prices in the euro zone.)
Back to the US, where the big question is whether the current drop in prices is temporary or whether there is something scary brewing. Analysts at Capital Economics believe that odds are that while negative readings on headline inflation could persist at least for the first half of the year, “it is hard to see why this renewed slump in oil prices, which is developing against a backdrop of a rapidly improving real US economy, will lead to anything more than a temporary drop in inflation.” They are quick to point out that even when crude oil collapsed from a 2008 peak of $140 per barrel to $40, amid a deep recession, prices recovered and the economy avoided a prolonged bout of deflation.
That said, they also add that “Deflation may be just one recession away,” which is probably why Fed officials continue to err on the side of adding more stimulus to the economy than less and are taking a “wait and see” attitude towards increasing short-term interest rates. Currently, the consensus is for the first rate hike to occur in the third quarter of this year. But any indication of an economic slowdown, accompanied by a more substantial drop in core prices, could put the Fed on hold longer, to avoid a dangerous deflationary downward spiral.
MARKETS: Last week, the Swiss Central Bank’s decision to discontinue its 3½ practice of pegging the Swiss Franc to the Euro sent ripple effects throughout global markets. (The policy was intended to halt the rise of the Swiss currency, which made it difficult for Swiss exporters to remain competitive in the global market.) Meanwhile, the punk US Retail Sales report unnerved investors, who continue to worry about a slowdown in global growth.
- DJIA: 17,511, down 1.3% on week, down 1.8% YTD
- S&P 500: 2019, down 1.2% on week, down 1.9% YTD (still within 4% of all-time highs)
- NASDAQ: 4634, down 1.5% on week, down 1.5% YTD
- Russell 2000: 1176, down 0.8% on week, down 2.3% YTD
- 10-Year Treasury yield: 1.84% (from 1.97% a week ago)
- February Crude Oil: $48.69, up 0.7% on week (oil CAN rise!)
- February Gold: 1,276.90 $1,216.10, up 5% on week
- AAA Nat'l average price for gallon of regular Gas: $2.08 (from $3.33 a year ago)
THE WEEK AHEAD:
Mon 1/19: Markets closed in honor of MLK Day
Baker Hughes, Coach, Haliburton, Morgan Stanley, Netflix
2014 Tax Season begins
10:00 NAHB Housing Market Index
State of the Union address
American Express, eBay
8:30 Housing Starts
Southwest Air, Starbux, Verizon
European Central Bank Policy meeting
8:30 Weekly Jobless Claims
General Electric, McDonald’s
8:30 Existing Home Sales