In the first four months of this year the market was volatile, but it ended close to where it started. In May and June the market has gained enough to be glad that we not adhere to the old adage “Sell in May and go away”.
While the market has increased, the news over the last couple of months hasn’t been all positive. GDP in the first quarter was negative, political unrest is intensifying overseas, and rising gas prices may hurt consumer spending in other areas. However, despite the anemic economy and a rising stock market, we do not appear to be in “bubble territory”. There does not appear to be euphoria for the market, rather there appears to be an atmosphere of caution with the current market valuation.
Given the low interest rates, there are limited options for investors and this may be helping fuel the markets’ growth. While the U.S. is tapering, other parts of the world are increasing their monetary supply. The early year forecast of rising interest rates has not materialized.
At 4-C we remain cautious, but continue to dollar cost average into the market. A correction in the market is a real possibility and as a result, our clients are not fully invested in the market – - so we can both weather a correction and see it as a buying opportunity.
All looked well at the beginning of January, but then the economic outlook, investor sentiment, and the markets become pessimistic. The Dow was down 5.3% and the S&P 500 was down 3.5% for the month of January.
Worries over emerging markets, reduced bond buying from the Federal Reserve ($10 billion reduction to $65 billion), and some well know companies missing earning expectations set the stage for the decline. Two issues that gained headlines were Turkey’s raising its one-week lending rate to 10% and China’s economy appears to be growing at a slower rate. Turkey’s action led to multiple rate hikes in various emerging market countries and help cause negative investor sentiment.
Metals were a bit mixed last month. The price of gold increased, while silver was relatively flat.
The U.S. economy continues its slow growth.
We saw the last few weeks increase in volatility as normal. What was surprising to us is how quickly the markets reversed course and how much value companies lost if their earnings did not meet analysts’ expectations. The other surprise was the dip in interest rates as investors moved to “higher quality” investments.
- While no one can predict the market, we do not see the past few weeks as the “beginning of the end”. However, we continue to forecast increased volatility and believe the U.S. stock market returns may be lower than recent years.
- Our clients have a defensive position in cash, money market funds, CDs, and stable value funds.
- We continue to have a diversified portfolio and are dollar-cost averaging where it makes sense.
Last summer the market declined when the idea of tapering (reducing the current quantitative easing) was discussed. Last month the markets increased when tapering actually occurred. Predicting the market remains a puzzle.
Our government signaled that it is going to keep short-term interest rates low for the foreseeable future. Tapering is occurring which may increase (and did so last month) medium and longer-term interest rates.
Last year many bond funds lost money as bond prices fell – - given the rising interest rates and the lower demand as investors sold their bond funds. Many of these bondholders sold their bonds and bought stocks, creating an increase in demand for stocks and higher prices. At some point medium and longer-term interest rates will be high enough to attract investors back into bonds and this may reduce the prices of stocks (since there may be less demand).
The U.S. economy continues its slow growth. Housing has improved and corporate profits continue. Current market valuations appear fully valued to slightly over-valued.
On the international front, unrest continues and appears to be escalating in the Mideast. A major confrontation could negatively impact the markets. While the European markets had a positive year, the debt situation in Europe continues to be an issue, Europe continues to be in a recession, and the European banks continue to have a large portion of non-performing loans.
Emerging markets did not perform well in 2013 and will continue to have headwinds if the demand for their goods continues to weaken – - given the recession in Europe. However, it appears that many of the austerity measures taken at the beginning of the European debt crisis are being relaxed. China’s economy remains volatile with predictions on its future growth being “across the board”.
- While no one can predict the market, we currently do not forecast a sizeable correction. However, we do forecast increased volatility and believe the U.S. stock market returns may not be as large as in the past.
- We expect the first half of 2014 to offer a positive return for U.S. stocks. We believe interest rates in the first half will continue to be low enough to keep investors in the stock market.
- We continue to have a diversified portfolio and are beginning to slightly increase emerging market holdings. Emerging markets have not performed as well as the U.S. markets this year, and they are becoming more attractive when comparing price earnings ratios to the U.S.
The threat of tapering (reducing the current quantitative easing) combined with a sputtering economy is causing many pundits to discuss that the recent rise in stock prices may be reaching a potential bubble. The general discussion is that stock market prices are not justified by the current economic conditions and that the PE ratios are too high and once quantitative easing slows the market will fall.
The bubble argument is bolstered by the talk that higher interest rates will also negatively impact the stock market as investors will have an alternative that will pay them more interest. The idea is that with interest rates so low, that people are putting more money into the market just because there is nowhere else to get an acceptable return.
The idea that the market may be overvalued is supported by:
- Cash is pouring into mutual funds
- NYSE margin debt is at record highs
- The cyclically-adjusted PE ratio is around 25 which is above the average of 16
- Quantitative easing may continue for months
- Consumer spending is not strong
- Yellen appears pro-Quantitative Easing
- The current PE ratios are lower than the PE ratios at past correction levels
While no one can predict the market, we currently do not forecast a sizeable correction. However, we do forecast increased volatility and believe the U.S. stock market returns may not be as large as in the past.
Over the last few months I have stated that the Federal Reserve has as much and maybe more impact than our economic fundamentals on the stock market. At this time, the budget/debt ceiling negotiations and the resulting partial government shutdown are increasing their impact on the markets.
Last month Syria was a major factor, this month Congress gained the spotlight. As our anemic economy slowly grows, the combination of the Fed, and the impasse between the Democrats and the Republicans added volatility and uncertainty to the market equation. Last month’s surprises included Larry Summers dropping out as a candidate for Fed Chairman as well as the Fed maintaining the previous rate of bond buying instead of a widely expected reduction.
The markets first reacted positively, but as a government shutdown loomed, the markets began to lose ground. Since our economy continues to grow (although at a slow rate), these man-made uncertainties may provide buying opportunities for us. At 4-C we are closely monitoring the markets, looking for any short-term “dips” in the market where we can buy good solid companies at a discount.
We are adapting. We are emphasizing a historically less volatile long/short fund for more volatile funds. We are selectively increasing our buying of stocks as a correction occurs.
My name is Fess Crockett and I am president of 4-C Personal Wealth Management Consultants. My goal is to use my knowlege of my Economics degree afrom Davidson College my MBA degree from Wharton Buiness School, and my real world experience from 4-C to provide readers with insights that they can use to increase their net worth.
I will be writing my thoughts on investing, the markets, and general wealth management topics. I will also be linking to articles that I have found to be useful and insightful.
I hope you enjoy this blog!