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Friday, October 10, 2014

What Goes Up

What goes up…must come down…and up…and down

October of 2014 has been an interesting month so far, just in the first seven trading days.  In seven days, the Dow Jones 30 industrials have moved (up and down) over 1,300 points.  That is significant volatility, especially since the movement tends to oscillate, in an ugly fashion reminiscent of early 2009.  I can’t help but wonder why.  Market movements are of course related to human behavior:  Mr. Market (as Warren Buffet calls the market), can’t make up his mind if he’s bullish or bearish.  Lately, it’s almost an even bounce:  down 270, up 270.  What’s the cause, and what do we do?  We could attribute this to a variety of causes: 

·         Ebola.  Ebola is a significant problem, both from a pandemic standpoint and economic standpoint.  Western African nations stand to lose possibly more than $32 billion of economic growth, just when they were getting out of the woods.  On the other hand, the S&P 500 lost about the same amount on October 9th.  So far, one person has died in the US (out of 330 million people) and three in the EU.  From a global standpoint, the death rate is bad, but it stands at 0.000001% of the world population.  The Ebola outbreak started earlier this year, and the market seemed to shrug it off.  I’ll suggest Ebola is sinister, but maybe not the major fear driver.

·         ISIS.  ISIS is a significant problem, actually more deadly than Ebola.  ISIS has killed, by reports in July, over 5,600 civilians in Iraq alone.  And, like Ebola, ISIS seems to be spreading (and possibly treatable), with a couple of billion dollars, tens of thousands of fighters and some very good (our) military hardware.  However, ISIS has been around for a while, is sinister, but we’ve had bigger and badder opponents. ISIS is a fear driver.

·         North Korea.  Huh?  North Korea?  Haven’t heard anything from them.  That’s exactly the problem.  We haven’t even seen little Kim Jong-un since September 3.  Is he around?

·         Mario Dragi.  Now we may have something.  The head of the European Central Bank (ECB) promised he would take all steps to get the EU out of recession.  However, all steps appear to involve only talking.  The ECB has not engaged in any serious monetary policy (at least compared to the US Fed).  As a result, we’re now seeing signs of weakness in the German manufacturing economy.  Maybe we can remember when the Grecians didn’t have a formula.  Right now, it’s possible the ECB doesn’t have one.  Definite headwind.

·         US Economy.  Back to good news.  The US economy saw a drop in unemployment (down to 5.9%), and the dollar is rising (don’t get too excited: a strong dollar is a double edged sword).  Exports are up, bankruptcies are down.  Business optimism is up, but business confidence is down.  The bellwether consumer confidence is up, as are retail sales and consumer spending. The US economy is providing a nice tailwind.

·         Interest Rates (US).  I only say US because the bond market is kind of silly right now.  The 10-year Spanish bond is at an all-time low yield (a hair over 2%), lower than the US 10-year, which is at a 15-month low.  By way of reference, Spain’s GDP is shrinking at a rate of 1.2%, compared to the US’s growing rate (2.9-4.65%, depending on how you measure it).  Spain’s unemployment rate is 24.5% (versus our 5.9%).  Yet those Spanish bonds are considered lower risk?  The simpler reason is that our Fed is ahead of the European’s, already tapering their bond buying, and trying to get our rates higher, which is good for everybody. (As long as they are not too high).  I’ll say the threat of inflation is modest, compared to the benefits of somewhat higher interest rates.  This is a tailwind.  And think about it:  what sounds better, a Spanish bond paying 2% in euros or a nice global stock paying 3.6% in a dividend in dollars?

·         Elections.  I could say that TV advertising will be off significantly after November 4.  I’ll use the mute button less, but the outcome will probably be rather anticlimactic.  As long as there is rancor in Washington, the sequester forces the deficit to be reduced.  So the infighting is actually good at cutting the budget, albeit not in the way anyone really wants it to be cut.  But, as a wise man once said, “gridlock is good.”  I predict continued gridlock, which means no tax cuts or increases, and less spending. Election results are probably a non-factor.

·         The ‘Orange Car’ syndrome.   There’s a psychological exercise that we find what we look for.  Try it:  for 48 hours, count how many orange cars you see.  You probably never noticed them before (unless you drive an orange car), but now you start looking for them and they appear everywhere.  The last time we had a 10% decline in the S&P 500 was the third quarter of 2011, over 1,100 days ago.  This is on a market that is up 189% off its 2009 lows.  Many investors are waiting for the correction to buy.  And maybe, if you look hard enough for a correction (or an orange car), you’ll find one.  (I saw 38 orange cars in a 48 hour period).

See why the market is getting volatile?  World jitters, behavior, economic data.  But when this happens, recognize that volatility provides the opportunity to rebalance, the opportunity to re-price and more importantly, the opportunity to let markets regroup.  My take is that global GDP is still growing at about 3.3%.  Inaction by the ECB can (and probably will) turn into action.  The US is still continuing to slowly grow, but grow it will.  ISIS and Ebola are sinister, but solvable threats.  The glass is half-full.  Maybe tomorrow it will be half empty.  But note that in my research, all downturns are followed by upturns.  So far, that’s been running at a 100% observation rate.


Leon