Posts tagged Stock Market
Everyone is afraid of something. It’s true. The visceral reaction to threats, real and imagined, has driven human behavior for millions of years. As time has passed, our species has evolved from fearing simple threats from predators and harsh climates to fearing more sophisticated threats. We have mostly conquered our ‘lizard brain.’ The lizard brain (so called because it is believed that reptiles survive almost solely on its impulses) is the amygdala, which controls emotions such as fear, our survival instincts, and memory. Controlling fear is how our ancestors emerged from the cave and conquered predators and darkness. Now, millennia later, what are we most afraid of? According to Chapman University’s 2016 ‘Survey of American Fears,’ Americans are most afraid of government corruption than any other of the additional 79 topics in the survey. That’s right: we are more afraid of our own government than we are of death, disease, loneliness, war, climate change, going bankrupt, snakes and public speaking. This year, it appears, we are also afraid of our future.
Some of our recent discussions with clients have surfaced their biggest fear: the outcome of our national elections on November 8. As we might expect, investors are worried about the future because of heightened dislike for many of the candidates and an uncertain future for the economy, the markets, and their portfolios. Their collective lizard brain says sell stocks and hide, much like our primitive ancestors, and emerge when the perceived threat has passed. As we often say, we understand this reaction. We know that the markets, like people, hate uncertainty. We also know that managing our emotions – especially conquering fear – in trying times is the key to success in any endeavor. So it is today.
Remember that the market has weathered many crises since 1900: two world wars, the Roaring ‘20s, the Great Depression, the first big market crash in 1929, oil shocks, wars in Korea, Vietnam and the Middle East, the 1987 flash crash, the Tech Bubble, high inflation, low inflation, terrorist attacks on U.S. soil, the Financial Crisis, a government debt downgrade, landing a man on the moon, the Ebola and Zika scares, ISIS, the beginnings of climate change, banking crises, the rise of the internet, the rise—and fall—of communism, and so on. Through all these events, capitalism has survived and adapted and moved forward. We believe it will again regardless of Tuesday’s election results.
Here’s our brief summary of the main issues to consider when thinking about the election and the post-election markets:
The U.S. economy is chugging along in a low-growth/low-inflation environment. A recession is not on the IMMEDIATE horizon, interest-rate hikes are expected to be modest and drawn out, and the job and housing markets are stable. Preliminary Q3 GDP came in at +2.9%. As we write this, October’s payrolls number was good and included prior-month positive revisions, unemployment dropped to 4.9% and wages showed their highest year-over-year increase since 2009 (ending at +2.8%). Even market news is good: S&P 500 earnings results thus far for the third quarter of 2016 are showing improvement over the past six quarters. These data show expected improvement for the current quarter and into 2017.
The Fed is expected to use the calm after the election storm to raise short-term rates by 0.25% in December, with two additional +0.25% hikes expected next year.
The markets, and a narrow majority of the electorate, appear to favor the Democrat candidate. Mrs. Clinton has proffered a platform of change, but nothing that we see as too radical. We expect that, should she win and the U.S. Senate change control, that modest incremental legislation will be enacted to (among other things) change the tax code, work on regulatory and immigration reform and review U.S. trade pacts. The markets have, and should continue to, respond modestly.
Many of our clients have stocks and bonds in their portfolios. The stocks are expected to provide long-term growth to keep ahead of inflation; the bonds provide income and act as ballast when markets are especially volatile and investors seek safety. Adjusting this mix by using rebalancing opportunities is our best tool to keep our strategic focus and avoid costly tactical mistakes. This is what we do.
Investors need to battle their lizard brains and keep their focus on the future, not the short term. The initial fear trade is to sell and go to cash; a tried and true short-term palliative, selling stocks and sitting in cash is good for short-term peace of mind but not a long-term planning strategy. Our clients know that we believe in globally diversified portfolios, that we focus on the long-term, and consider strategy over tactics to ensure that portfolios are built to stand the weather of time rather than simply avoid today’s storm.
As always, we appreciate your confidence and would be happy to discuss any of the issues raised here or answer any questions you may have.
Have you ever been out to a great dinner, or on a great vacation, or perhaps at a great show, really enjoying yourself, yet knowing in the back of your mind that the bill for this great experience would come due, and it might be a doozy? Think about that experience and feeling, apply it to today’s markets, and ask yourself: how will investors feel when it’s time to pay the bill?
We’re not writing this to imply that a market crash akin to the Financial Crisis is just around the corner; far from it. We see ourselves in a slow-growth world that is a result of the experimental monetary policy by governments and central banks (CBs). They are manipulating interest rates without providing comparable fiscal stimulus to recover from a financial downturn, and as a result, these easy rate policies around the globe have lulled investors into a false sense of complacency.
Just looking at this small sampling of market returns gives us some idea about the effects of the CB’s policy of low rates:
During the period when the U.S. Fed embarked upon its Quantitative Easing programs (QE) and Operation Twist, the stock and bond markets earned much of the total returns since the low of the Financial Crisis. Other central banks, particularly in Europe, chose different paths that focused initially on austerity and had less robust results (e.g. a ‘double-dip’ recession in the U.K.). Across the globe, however, it appears that the ability for continued monetary policy stimulus to drive growth is limited. We are left with stagnant growth levels, negative interest rates in many countries, market uncertainty and growing populist movements that promote nationalism over growth.
Central banks are not united in policy goals, governments and corporations are not engaging in enough (if any) fiscal stimulus, and the world’s growth engine for many years—China—is retrenching and transforming. All of this leads to a suspicion that stocks and bonds are overpriced, particularly on the part of income-seekers driving money into utilities and other high-dividend stocks. This is clearly an important inflection point. We must accept that issues that have become political ‘hot button’ talking points—global trade, immigration policy, tax reform and populism—are perhaps now more important drivers of future growth than furthering the low interest rate policies that have dominated the past seven years.
Investors have asked us, are we worried about a bear market? A combination of several indicators turning bearish would cause us concern, such as much higher interest rates and inflation, an inverted yield curve and stock overvaluation. Recent market gyrations seem to be overreactions at this point; U.S. economic data do not currently predict a recession or an inflationary environment that would require the Fed to quickly raise rates. This does NOT mean valuations are at relative discounts—low rates are pushing some investors to equities, and areas such as utilities will be the first to sell off as rates move.
We’re seeing a lot of investment suggestions for private equity, private or second-market debt funds, real assets and options-hedged equity products. All are expected to provide better risk-adjusted returns than conventional stocks and bond portfolios. Our evidence doesn’t support many of these ideas. As we learned eight years ago, and can see in the table above, the traditional relationships between stocks and bonds provides the insurance and low correlation we need. In times of crisis, U.S. Treasurys and public-market liquidity (such as U.S. large-cap equities) are the prized investments.
Our clients know, too, that we preach diversification, patience and a focus on the far horizon, not the next step. The market data we review indicate that the U.S. economy is still healthy (but not robust), and few signs of the high rates, high inflation, excessive stock valuations or a recession are present. We expect some volatility in the period ahead, but our long-term growth outlook remains positive.
In an expectedly close but surprising vote, the U.K. has completed a referendum to endorse a withdrawal from the European Union (EU). Today’s market reactions are the usual result from market uncertainty around economic issues—sell-offs in “risk assets" such as stocks and currencies and a flight to quality in “safe-haven” currencies and bonds (e.g. the U.S. dollar and Treasuries). Early analysis of the results indicates, however, that the LONG-term results may not be as severe as feared.
HERE’S WHAT HAPPENED
U.K. and Commonwealth voters, by a slim margin, voted to leave the EU. Prime Minister David Cameron immediately resigned, and a new government will be installed in the fall.
WHAT HAPPENED IN TODAY’S MARKETS?
Stocks and other assets such as currencies, have sold off around the globe. The U.K. and other EU countries have been hard hit, while the U.S. decline has been muted. Leading up to this, the global markets were rebounding over the last couple weeks.
The U.S. dollar and Japanese yen have strengthened; the Euro has declined a bit, and the sterling has substantially declined against the dollar.
There has been a flight to quality in bonds, particularly U.S. Treasury Bonds.
Gold has been priced up, while oil has declined.
WHY WERE MARKETS VOLATILE?
Many believed that Britain would remain in the EU and short-term traders made heavy bets in currencies and other “risk assets.” In fact, markets rallied into the vote as the DJIA was up over 250 points yesterday. Interest rates were moving higher.
The markets were surprised once the votes were tallied and markets reversed their trend, giving back most of these gains. The behavior was violent as Britain leaving the EU is a significant event.
The U.S. markets declined as the thought process that European companies are trading partners of the U.S. This could be negative for some businesses.
WHAT ARE THE LONGER-TERM EFFECTS?
Britain represents 4%-5% of global GDP. Net results may not be that significant.
The U.K. will need to implement policies to provide liquidity and ease interest rates.
The sterling will fall, U.K. inflation will increase due to increased import prices, and U.K. GDP will likely decline in the near-term. A recession is possible in Britain.
The U.S. will be relatively insulated. The Fed will likely delay interest-rate hikes.
Global growth may be affected to some degree. This event is not a ‘Lehman moment’ that accelerated the global Financial Crisis. As one pundit noted, “…markets adapt. Policymakers adjust. Businesses will change course while they continue to seek profits. Prices will reset. Opportunities will emerge.”
WHAT SHOULD BE DONE IN MY PORTFOLIO?
Our principles of portfolio construction are based on each of our client's unique personal goals. Their plan is well thought out and balanced by diversified asset allocation.
Changing your portfolio based on a reaction to market events rarely leads to productive long-term results.
All of our plans are built upon the certainty that we will go through negative events and market fluctuations.
All of our portfolios contain an anchor of high quality bonds and bond funds, which help to limit declines in significant market events, and did so during the Brexit vote today. Our bonds are doing exactly what we want in uncertain times.
We expect short-term stock volatility and will be partially offset by bond and commodities gains. Today’s market moves are short-term reactions, and most currency and bond markets have moved in orderly fashion (i.e. no extreme drops). And, as our pundit notes, “The long-term political, economic and financial repercussions of the ‘Leave’ vote are incalculable at this point.”
While the Brexit vote has been surprising and unsettling, most of the effects will be felt in the U.K. and Europe. We don’t see any required portfolio moves at this point; most of the trading is just that—trading. Long-term investors should stay focused, and we’ll update you as events progress.
As always, if you have any questions or wish to speak to us directly please feel free to call us.
World stock prices have been volatile lately, and China’s crashing stock market has been in the front seat of the roller coaster. Many investors are worried that China’s economy is slowing down significantly faster than reported, and that a hard landing in the world’s second-largest economy will pull the global economy into recession with it.
For years, China has been the main economic-growth engine for many developed and emerging markets around the world. Latin America, most of Asia, parts of Africa and beyond have supplied the raw materials needed to fuel the economic boom in China. Mega-cap multi-national companies from developed economies have also prospered by tapping into China’s industrial revolution. Despite China’s impressive economic growth over the years and its impact on countries around the world, investing in China has been unconventional and guarded.
With the support of the central government, local investors swiftly bid the market up this year. The Shanghai market was up nearly 60% during the first six months of 2015 alone. Yet, the explosive growth had almost no impact on U.S. stocks. The S&P 500 traded sideways during the period. Moreover, when the Shanghai market tanked in July, U.S. stocks continued to be flat. The chart below is a terrific pictorial on what a classic bubble looks like; happily, it didn’t involve U.S. stocks.
Source: CNNMoney, For Informational Purposes Only
U.S. stocks didn’t react to China’s news and markets until recently. We believe the recent correlation to China’s stock market is temporary, and that U.S. investors have become more sensitive to other risks as we approach a key Federal Reserve meeting on interest rates. The Fed has indicated that it plans to raise rates at some point this year, and the September meeting has been targeted by many analysts as the date of the first increase in over a decade.
The potential of raising interest rates in the U.S., while China is retrenching and pulling many emerging markets down with it, has become a reason to take profits for many investors. However, the recent volatility has also spurred a wave of new money entering the markets. U.S. stocks have avoided a correction (a drop of at least 10%) since 2011. A four-year run without a correction is unusual for the U.S., and there seems to be pent up demand on the sidelines that has been waiting for entry points.
The Chinese Transition Redux
The points below are a few basic elements to summarize the ongoing dialogue we will see about China over the coming year. The media will likely focus on these issues:
Chinese economy moving from export based economy to a balanced economy – “a consumer driven economy.”
The transitional changes will be challenging and investments in China will be volatile.
China’s attempts to stabilize markets have not been as effective as hoped.
Reduced appetite for commodities and thus lower worldwide inflation is likely.
The U.S. Federal Reserve may be on hold for a while longer. Low inflation is good, but deflation is not. If the Fed raises rates in September, it could be taking a big risk of tipping prices into a deflationary zone and strengthening the U.S. dollar. If the Fed leaves interest rates unchanged, Fed members will have more time to analyze data and let the economy further develop some employment and price trends.
We know volatility can be unsettling; regardless, our long-term outlook is still positive. We believe investors who have sufficient diversification and flexibility in their portfolios should be able to successfully navigate these choppy waters. To see if your portfolio is properly balanced based on your long-term goals, contact our team to assess your needs. Now is the time to review your situation and make adjustments accordingly to help mitigate your downside risks.
JJ Burns was interviewed by Richard Rose from WLNY in New York during the Labor Day weekend. JJ discussed the history of market corrections, including the current one, and how economic turbulence in China is causing volatility around the world. More importantly, JJ tells viewers how proper financial planning can help to navigate uncertain environments.
Watch the full interview here
Backstage with JJ
As I prepared backstage for the CBS interview, a few things really struck me:
We live in a much more connected world—in the sense of technology and how events are related.
The old adage about the butterfly effect came to mind—a butterfly in the southern hemisphere flaps its wings and triggers a hurricane in the northern hemisphere. Lately, the butterfly effect is starting in China. Next week’s location? Who knows? Uncertainty can begin anywhere, anytime.
Investors need portfolio diversification to better withstand uncertain environments. Unexpected problems that occur in one asset class, continent, region or country can affect many investments. Exposure to U.S. Treasuries and the S&P 500 isn’t enough diversification for a global dynamic.
Investors need a plan—one that is structured on long-term thinking and preparation for rough patches. A good plan is the sum of the parts, and it equals a greater whole.
At JJ Burns & Company, we believe that proper financial planning can provide a calming experience during challenging times in the market. It’s comforting for an investor to know that their plan has been designed to withstand short-term market disruptions. We’re here to help you stay focused on reaching your big-picture destination.