As we discussed yesterday, it’s very dangerous to let political views influence your perspective on markets and investing.
And I suspect we are seeing plenty of people make that mistake.
That means many will be left behind on a stock market recovery, again. That probably means the bull market for stocks still has a ways to run. John Templeton, know to be one of the great value and contrarian investors of all time, said “bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
Incredibly, after a more than four-fold run from the financial crisis bottom, the stock market continues to have a LOT of skepticism. Does this mean we are only half way through this cycle? Maybe.
The arguments for the stock market bears and pessimists on the economy have many holes, but the biggest is the lack of context. That context: the global economic crisis, and the aftermath (up to present day).
You can’t evaluate anything about this economy without taking into account where we’ve been over the past decade, the role central banks have played throughout, the coordinated intervention that has taken place globally (along the way) to avoid a global depression, and the interconnectedness of global economies that continues.
Without this context, the skeptics like to call it “late in the cycle” for an economy that (on paper) is in the second-longest expansion in U.S. history. With context, we’re probably closer to “early cycle,” given that the decade of ultra-slow growth was manufactured by central banks.
This violent repricing of the tech giants came with clear warnings (i.e. the tightening of regulatory screws).
Now that we have it. And it is very healthy, and needed.
As we discussed yesterday, I would argue we are seeing regulation priced-in on the tech giants, which can create a more level playing field for businesses, more broad-based economic activity, and a more broad-based bull market for stocks. This is a theme we’ve been discussing in my daily note here for quite sometime.
And I suspect now, we can see the areas of the stock market that have been beaten down, from the loss of market share to the tech giants, make aggressive comebacks.
On that note, here’s another look at the big trendline we’ve been watching in the Dow …
Again, this line holds right at the 10% correction mark. And we’ve now bounced more than 700 dow points.
As I’ve said, it’s easy to get sucked into the daily narratives in the financial media, and it’s especially easy and dangerous (to your net worth) when stocks are declining. They tend to influence people to sell, when they should be buying.
And as someone that has been involved in markets more than 20 years, I can tell you that it’s also very dangerous to let political views influence your perspective on markets and investing. And I suspect we are seeing that mistake made in this environment (by pros and amateurs alike).
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Yesterday we looked at this big trendline support in stocks (the yellow line).
We had a good bounce today, but experience tells me that we will make a run at that trendline, and things will look a little messy before we bottom.
We still have seven trading days before the mid-term elections. A stock market in correction is not as easy to promote as one at record highs (as we had just earlier this month). With that, I suspect there are plenty of interests (China among them) to keep the pressure on stocks in hopes of dividing U.S. Congress come November 6th.
When the dust clears from the elections, market folks will realize that stocks are incredibly cheap at 15 times next year’s earnings estimates, in an economy growing better than 3%.
On that note, we have our first look at third quarter GDP tomorrow. The market is looking for 3.6% growth, which would give us 3.22% annualized growth averaged over the past four quarters. That would be the best growth since 2006.
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On Friday we talked about the opportunity presented by this recent dip in the broad stock market.
We’re beginning to see more clearly today the rotation out of tech and into value. That is translating into a continued slide in the Nasdaq, while the Dow is rising.
Now, even though this looks like a re-pricing of the high-flying tech stocks, as we often see the “baby gets thrown out with the bathwater.” In this case, because the big tech giants have been so widely held, when they crack, everything has cracked. That’s an opportunity to buy broader stocks on sale. And stocks are indeed cheap.
Take a look at historic valuations (P/E on the S&P 500) …
From a valuation perspective, Wall Street is estimating stocks on next year’s estimated earnings to be as cheap as we’ve seen only two times in the past 26 years.
You can see where stocks were valued on the S&P going into 2012. Stocks finished up 16% that year. The other year was 1995 (a P/E of 14.89). Stocks finished that year up 37.6%.
Still, many have continued to harp on valuation, always pointing to the long run average P/E on stocks, which is around 16. That’s a long history. If we look back at the past twenty years, the average valuation is MUCH, MUCH higher. It’s 23 times earnings!
If we take Wall Street’s estimate on S&P 500 earnings of $176 and multiply it by 23, we get and S&P at 4,048. That’s 47% higher than Friday’s close.
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The S&P 500 has declined more than 5% (from peak to trough) on four different occasions this year. That’s despite an economy that is heating up, finally escaping the slow growth rut of the past decade.
So, should you be fearful when these declines occur, or should you be greedy?
During market declines – with the constant barrage of market analysis and opinion on financial television, in newspapers, or through the Internet – it’s easy to get sucked into drama played out in the media.
And that tends to make many investors fearful.
But while the fearful start running out of the store when stocks go on sale, the best billionaire investors in the world, start running IN.
The fact is, the best investors in the world see declines in the U.S. stock market as an exciting opportunity. And so should you.
Most average investors in stocks are NOT leveraged. And with that, they should have no concern about U.S. stock market declines, other than saying to themselves, “what a gift,” and asking themselves these questions: “Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?”
Billionaire Ray Dalio, the founder of the biggest hedge fund in the world, has said what we think is the most simple yet important fact ever said about investing.
“There are few sure things in investing … that betas rise over time relative to cash is one of them.”
In plain English, he’s saying that major asset classes, over time, will rise (stocks, bonds, real estate). The value of these core assets will grow faster than the value of cash.
That comes with one simple assumption. The world, over time, will improve, will grow and will be a better and more efficient place to live than it was before. If that assumption turned out to be wrong, we have a lot more to worry about than the value of our stock portfolio.
With that said, as an average investor that is not leveraged, dips in stocks (particularly U.S. stocks – the largest economy in the world, with the deepest financial markets) should be bought, because in the simplest terms, over time, the broad stock market has an upward sloping trajectory.
This is the very simple philosophy Dalio follows, and is the core of how he makes money and how he has become one of the best, and richest, investors alive.
Billionaires Bill Ackman and Carl Icahn, two of the great activist investors, lick their chops when broad markets sell off on fear and uncertainty.
Ackman says he gets to buy stakes in high quality businesses at a discount when broad markets decline for non-fundamental reasons. Icahn says he hopes a stock he owns goes lower so he can buy more.
What about the great Warren Buffett? What does he think about market declines? He has famously attributed his long-term investing success to “being greedy when others are fearful.”
Bottom line: Declines in the broad market are times to take out your shopping list.
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Yesterday we talked about the repricing of the tech giants as the catalyst for the slide in global stocks. That slide continued today.
But the brunt of the punishment is back on the Dow, which was down another 2%. At the lows today, that takes us back to flat on the year for the DJIA … up 1% for the S&P 500. And the Nasdaq, at the lows today, was up just 4.8% on the year.
As they say, stocks go up in an escalator and down in an elevator.
Interestingly, in this slippery slide for stocks, money has NOT been piling into bonds. This is the flight to safety trade we’ve seen throughout the post-financial crisis era. It doesn’t seem to be happening this time. The 10-year yield remains in sniffing distance of 3.25% (closing today at 3.14%).
So, where is the money going? Gold.
Gold is on the move — the top performer in global markets today. And it looks like it’s just getting started. As I said last week, “the set up for a bounce in gold here looks ripe. The level to watch will be 1,214.”
You can see in the chart, the 1214 level gave way today, and we had a break of the downtrend of the past six months.
Now, when we discussed gold last week, we were talking about the potential for China to perhaps try a few shenanigans over the next month, in order to influence the outcome of the November elections.
Here’s an excerpt from that October 3rd note: “China remains the holdout on making a deal with Trump on trade. And it looks likely that they are holding out to see what the Novemberelections look like.
Will Trump retain a Republican led Congress? I suspect we may see China do what it can to influence that outcome. As we know, the Republicans will be promoting the economy as we get closer to voting day.
What can China do to rock that boat?
They can sell Treasuries, in an attempt to ignite a sharper climb in rates. And a fast move in rates (at these levels) has a way of shaking confidence in equity markets–which has a way of shaking confidence in the economy.“
I suspect we may be seeing precisely this above scenario play out.
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China remains the hold-out on making a deal with Trump on trade. And itlooks likely that they are holding out to see what the November elections look like.
Will Trump retain a Republican led Congress? I suspect we may see China do what they can to influence that outcome.
As we know, the Republicans will be promoting the economy as we get closer to voting day.
What can China do to rock that boat?
They can sell Treasuries, in an attempt to ignite a sharper climb in rates. And a fast move in rates (at these levels) has a way of shaking confidence in equity markets – which has a way of shaking confidence in the economy.
As we’ve discussed, the economy can withstand a 10-year yield in the low 3s. But what has spooked market this year (namely stocks) is the fear that a 3% 10-year could quickly turn into a 4% 10-year.
We may have seen a taste of it today. We had a run from 3.08% to 3.18%. That’s the highest level since 2011. And stocks came off of the highs.
If China was the culprit, or if China chooses to dump some Treasuries over the next month, in attempt to stir up some instability in markets, we should see them move that money elsewhere. The likely recipient of that capital would be gold.
It wasn’t evident with the behavior gold today. Gold had a big dayyesterday, but backed off today, even as rates ran. But as you can see in the chart below, the set up for a bounce in gold here looks ripe. The level to watch will be 1214.
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Back in May, the populist movement that gave us Grexit, Brexit and then the Trump election, gave us a new government in Italy with an “Italy first” agenda.
Italy first, means EU second. And that puts the future of the European Union and the European Monetary Union in jeopardy. Today, the new government made that clear by rejecting EU fiscal constraints, in favor of running a bigger deficit spending.
This puts the game of poker the European Union has been playing since the financial crisis erupted, front and center (again).
As we discussed back in May, this story is looking a lot like Greece, which used the threat of leaving the euro as leverage to negotiate some relief from austerity and reforms. It was messy, but it gave them a stick, in a world where the creditors (the ECB, Eurogroup and IMF) had been burying the weak economies in Europe in harsh austerity since the financial crisis.
As the third largest euro zone constituent, Italy brings a lot more leverage in negotiating, in this case, the EU rulebook. We may see this all result, finally, in a relaxing of the fiscal constraints that have suppressed the economic recovery in the euro zone in the post-Great Recession era. And Italy’s pushback may lead the way for a euro-wide fiscal stimulus campaign — following the lead of Trumponomics.
A better economy has a way of solving a lot of problems. And Europe has a lot of problems.
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The Fed moved again today on rates, as the market expected. This is the eighth quarter point hike in this post-QE normalization on rates. And this now puts the Fed Funds rate at the range of 2%-2.25%.
Now, the markets will pick apart the statement and endlessly parse the Fed Chair’s words in the press conference. But let’s step back and take a look at the impact of these Fed hikes thus far.
We know the economy is running at the best pace since before the financial crisis. We know that the jobless rate is near record lows. We know that consumer credit worthiness is at record levels. This has all happened, despite the Fed’s rate hikes.
What about debt service coverage? As rates are moving higher, are consumers showing signs of getting squeezed?
If we look back at the height of the credit bubble in 2008 (just prior to its burst), 13.22% of household income was going to service debt–within that number, 7.2% of household income was going to service mortgage debt. What about now? Debt service is now 10.2% of household income. And the mortgage piece is down to just 4.4%. This is the result of six years of zero interest rates, a massive QE program (which included the Fed’s purchase of mortgage bonds), and a government program that subsidized banks to refi high interest rate mortgages.
So the big question is, how has the Fed’s exit of QE effected the consumers ability to service debt? Are higher rates hurting?
Well, they started hiking rates in the fourth quarter of 2015. Total debt service at that time was 10.1%. That’s virtually unchanged from today. And the mortgage piece was 4.5%. That’s actually a touch higher than today.
Bottom line: The Fed’s normalization on rates has not damaged the consumer, nor has it killed the housing market.
But that’s only because the yield curve has been flattening. That is, longer term market interest rates have been steady. That means the benchmark rate from which consumer and mortgage rates have been set, has been steady. And those longer term rates have been steady, in large part, because Europe and Japan have remained in QE mode (buying global assets, which includes our Treasurys).
With that, while most have been watching the Fed closely for how it’s delicately handling the exit of QE, the more important spot to watch will be how Europe and Japan manage their exits. Hopefully, the U.S. economy is hot enough, at that point, to withstand the move in longer term U.S. rates that will come with the end of global QE.
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Last Friday we talked about the technical breakout in rates. And we looked at this chart as the benchmark 10-year U.S. government bond yield hit 3%.
This week yields traded as high as 3.09%. These 3%+ levels have proven to spook stock markets on all other occasions this year. But it hasn’t this time. In fact, the Dow closed the week on new record highs. The prospects that Fed normalization might be slowing, and that 10-year rates may be carving out a new/higher range, reduces the prospects of seeing the yield curve “invert.” That’s positive for stocks.
As we close the week, let’s take a look at Chinese stocks, which put in a double bottom earlier this week, and closed today threatening a technical break of the big downtrend of the year. Believe it or not, Chinese stocks could be the best buy in the world right now.
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