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Monday, October 20, 2014

Why we are rebalancing now

Unless you’ve been on a beach without cell phone service (in which case, I envy you), the market is exhibiting a vast amount of volatility and uncertainty.  In today’s world, we can find explanations for everything.  Amongst those is how the drop in oil prices and strong dollar are hurting the market, or that Europe is slowing (I hate to tell Europe, but they have been slow).  We see the glass half-full, and not half-empty.  Here’s why:

 Oil.  Oil prices have “tanked” (down over 20%), which is bad for oil companies and good for everyone else (OK, it’s bad for ISIS, Iran, Iraq and most of the Middle East, but I’m not overly concerned with their financial well-being).  Low crude is a stimulant for the consumer and for profits.  My family spends about $10,000 a year on gas; so a 20% drop in oil prices is like $2,000 in my pocket, tax-free.  Low oil prices are good for consumers and corporate profits.

·         Europe.  Most of the volatility centers around the inaction of Mario Draghi and the European Central Bank (ECB).  The ECB has been too tame in monetary policy, despite many verbal pledges to do whatever it takes.  This may be sending Germany into a recession, and Germany is the strongest EU member.  Greece suffered under the assumption that they may default on their debt.  Not a big surprise since Greece was the first sovereign nation to ever default on their debt in 377 BC and has five debt defaults modern times.  Spain has defaulted 13 times.

·         Talk is cheap. The ECB has been talking but not doing.  This leaves two options:  they can keep doing nothing (which lets the economic march continue), or they can do something (like Quantitative Easing).  A QE type move would probably be good for stocks in Europe.  I’d predict the pressure is on the ECB (and the Chinese Central Bank) to do something, and rather quick.

·         Our economy.  The budget is being cut, unemployment is down, and sentiment is up.  Profits are not terrible, and consumer spending is up along with industrial production.

·         Strong dollar.  The dollar is strong against other currencies.  Why?  Because we are improving our account deficit, booming energy production (hence low crude prices), and reduced unemployment.  Because we are growing, we look good, and it shows.  It also makes imports cheaper, and hurts foreign companies who sell in dollars, but build in other currencies (like Airbus or Swatch).  

·         So why the volatility? I think a bunch of this is the market looking for an excuse.  A few days ago, I joked that the S&P 500 was about to break its 200 day moving average and that it would tank when the program trades kicked in.  It did.

·         Ebola.  Scary stuff.  It’s a horrible disease.  Right now one person has died and two have it in the United States.  So that’s 3 out of 330 million.  In 2010, 53,826 people died of influenza and pneumonia, 576,691 died of cancer and 1 in 700,000 people were struck by lightning.  I offer this as perspective.

·         Factoid on elections.  Interesting fact on mid-terms:  since 1950, there have been 6 calendar years when a Democrat was in the White House and the Republicans controlled the House and the Senate.  The average gain on the S&P 500 during those 6 years was 21.3%. 

What’s our prognosis?  Low oil is good.  Strong dollar is good.  Fundamentals for the US look good.  We believe in capitalism and free enterprise.  If you think owning businesses (stocks) is way to increase wealth, you are right.  So volatility like this requires us to look at the big picture and see if equities are actually vastly worse than they were a month ago, or whether they are merely on sale.  It’s like a big rain storm.  Eventually the sun comes back out.  We choosing to rebalance and take advantage of the opportunity.

If you’d like my commentary on the economy, markets and the elections, I’ll be giving a talk on October 28th at Walsh College at 1:00 and 6:00.  I’ll cover oil, the dollar, gold, stocks, taxes, and whatever else crosses my mind, and will predict that political advertising will decrease abruptly by November 4th (this one I’m sticking by).  If you’d like to join us, RSVP at events@ljpr.com or 248-641-7400.  Space is limited.

Leon