Trick or Treat
October has definitely been more of a trick than a treat for investors in the stock market. We are searching high and low for what’s spooking the market this time. There doesn’t seem to be consensus among the usual market pontificators as to the cause. Maybe the witches and goblins of Halloween have arrived early. Last March, with markets down 10% from their highs, we introduced you to GreenPort’s Crying Wolf Barometer. https://www.greenportcapitaladvisors.com/single-post/2018/04/10/Crying-Wolf As a reminder, the CWB looks at the many sell-offs (21 so far), followed by a recovery, within the current 10-year bull market. Importantly, the CWB also reminds us that in the Boy who Cried Wolf story, the wolf eventually does show up. The town folk however became complacent after many false alarms and didn’t heed the warning. The 10.2% selloff in March was attributed to trade war fears. At the time, we reasoned that the fears of a trade war were overdone. When both sides stand to lose, reason wins out. Markets eventually rebounded and made new highs in September. We are currently off 5.6% from that September high but are having trouble identifying why.
Eventually we will need to come up with a reason for the sell-off when we update the CWB, so lets take a look at what others are saying: Rising interest rates – This is definitely one of the stronger arguments. The Fed continues to tighten, and 10 Year Treasury Bonds hit their highest level in 7 years last week before closing at 3.15% yesterday. We think the fear of rising rates, more so than how much rates have actually risen, is a better description. Jamie Dimon, J.P. Morgan’s CEO is calling for 10 Year Rates to eventually get to 5%. That would definitely cause a problem for stocks. We don’t think that’s going to happen anytime soon. We’ve mentioned in our prior market commentaries, until global rates rise we expect U.S. Rates to remain subdued due to global arbitrage. Germany and Japan are still close to 0%. Also, we believe the inflation threat is overstated due to an under appreciation of the disinflationary forces of technology and globalization. In the meantime, U.S. rates remain quite low relative to their long-term history. We are being vigilant shepherds though and keeping a watchful eye over our flock of stocks. We think this wolf will likely show up at some point, but for now it’s just prowling.
Saudi Arabia – Lets go from the most likely reason to the least likely, perhaps even absurd. A few analysts suggest that the heinous murder of a journalist at the hands of the Saudi Kingdom will lead to a bear market. The reasoning is that the U.S.-Saudi relationship will be ruined, the huge defense contract with the U.S. will be cancelled, and oil prices will triple. If despicable acts made stocks sell-off these analysts would indeed be correct, however markets are unemotional. This is a great example of certain market analysts feeling a need to explain every market move. Economic numbers – In one corner we have job numbers that are increasing too quickly which will lead to inflation. This will crush earnings margins and lead to more rate hikes. In the other corner deficit numbers are worsening and supply side economics cause depressions. Here’s the number we think matters – Q3 earnings up 22.1% YOY. ETF’s – This is an important one. We do believe that Exchange Traded Funds are adding to the daily volatility. Extremely high liquidity and extremely low, if any, trading costs makes ETF’s the ideal vehicle for market timers. It’s obvious that program traders are using momentum based trading algorithms to jump in and out. Markets are moving materially on a minute-to-minute basis. It’s been argued that this will lead to a market collapse if all the traders get on one side of trade. We have researched this and believe ETF’s actually enhance liquidity. Liquidity lessens market risk. We don’t think ETF’s are a structural issue, we do acknowledge their role in increasing the intraday volatility. Seasonality – We have a winner. This is what we are going with. September and October are witching months for stocks. We’ve mentioned that seasonality is a secondary factor in our process. It confirms the primary factor, but it does not override the primary factor. Therefore if our longer-term frameworks were bearish on stocks, we would further sell stocks in the September-October period. Our frameworks remain bullish, and so do we. Our guess is that once we get to Halloween the market will eat enough candy to get on another sugar high. There is plenty to be concerned about and we are monitoring the many concerns. Our conclusion remains that until we see a slowing economy, earnings that continue to increase at a record pace will overshadow these concerns. That’s what history tells us. As of this writing, the S&P 500 is up about 5% YTD. Volatility is almost double what it was at the beginning of the year. We expect a wild ride over the next few months, with stocks eventually moving higher. We have one more piece of advice. Don’t hand out apples for Halloween. Enough said. Happy Halloween, The GreenPort Team