Market Downturn: What’s Fact or Flatulence?

iStock_000017803492XSmall-market-tickersClients of HMC Partners have heard for months from John and me that we believe a downturn of at least 5% was in the offing. No pullbacks in 2013 and only two so far this year of any consequence means the markets were due. The average market has at least three pullbacks of 5% or more in any given year. Pain in the form of volatility returned and most of the gains achieved this year in portfolios were erased at least temporarily. So what happened? Well, Europe’s woes lead the charge and the fact is the European Union (EU) is facing recession with deflationary pressures. Deflation can be more devastating than inflation as consumers are apt to continue to wait to purchase homes, durable goods, or other discretionary items because they might be cheaper next month. It’s a very dangerous climate to have a region with consumers saying, ‘I won’t buy that car until next month because it’ll be cheaper.’ Then next month rolls around and they continue to wait.

Truth be known, Europe represents less than 15% of our total trade and has minimal impact on our Gross Domestic Product (GDP). However, as the Euro weakens to our dollar (currently a US dollar is worth 79 cents Euro), it becomes more expensive for the EU to import our goods so they will look elsewhere for importing solutions because of the exchange rate differential. There’s no doubt that this is could be a long-term issue if steps are not taken by Mario Draghi who is President of the EU Central Bank and the other EU members.

You mix in a little flatulence in with the aforementioned facts and you have a recipe for a market dumpster fire. Where was the offending air blowing from….West Africa. Overbought markets with inflated valuations look for reasons to sell and that reason was Ebola. Never mind that no one infected in the US has yet to die. Never mind that the family of the deceased African has yet to show any signs of infection. Let’s face it, I have a better chance to:

1. Marry Kim Kardashian than contract Ebola. 2. Play in the NFL. 3. Win the lottery. 4. Strike oil in my backyard like Jed Clampett.

Sanity returned to markets late last week after a close to 8% sell-off over the last month, and markets focused on facts:

1. Earnings continued to meet or beat the expected 6.7% increase Year-Over-Year (YOY) and while revenue growth is expected to exceed 3.6% YOY.1 2. Oil prices have plummeted 25% from summer highs which could provide a boost to consumer spending because 4% of household income is spent on energy.2 3. Foreign investments have moved into our Treasuries continuing to keep our interest rates lower. Currently, our 10-year yield is just above 2%.3 4. Valuations in our markets have become more attractive since the sell-off. The current Profit-to-Earnings Ratio (PE) of the S&P500 is now 16 and was close to 18 just a month ago. (as of 10/21/2014) 5. Leading Market Indicators were up in August 0.2% from July continuing the trend upward.4 6. Core inflation is still approximately 2%.5 7. The 6-month Treasury continues to yield a whopping 0.01% while the 10-year Treasury is currently 2.21% indicating no inversion in the yield curve which would be a true indicator of impending recession.5 8. The Volatility Index (VIX) reached levels unseen in several years topping 25 only to fall back to a tepid 16 currently.5

Sometimes when the air is filled with foul smells, you can wait and the wind will shift. Last week, markets focused on these smells versus concentrating on the facts. The pullback was expected and welcomed and hopefully will allow for a year-end market rally expected by most pundits and us.

 

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Stock investing involves risk including loss of principal.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive it does measure the current degree of fear present in the stock market

 

(1) “US Stocks end higher despite drag from IBM.” Yasmeen Abutaleb. Reuters. 10/21/2014. (2) “Oil Hits the Skids.” LPL Financial Weekly Market Commentary 10/21/2014. #1-320410 (3) “US Treasury prices surge most since financial crisis as traders seek out low-risk investments.” Ken Sweet, www.startribune.com 10/15/2014. (4) “Global Business Cycle Indicators.” The Conference Board, www.conference-board.org. 10/21/2014. (5) yahoofinance.com as of 10/21/2014