Market Perspective for 12/21/15
- On December 16th the big day came when the Federal Reserve raised interest rates by 25 bps. They had not raise rates in seven years. Markets soared in response, but gave it all back over the next two days. See Figure 1. Perhaps we can’t draw much of a conclusion about interest rates and stock market direction after all. Maybe the correlation, as most academic studies have shown, is surprisingly low. So what then is driving stocks? To a large extent, it has been oil prices. We have been led to believe that stocks benefit from low oil prices because high oil prices act as a tax on consumers. That has certainly not been the case recently. In the short run at least, lower oil prices are hurting the profits of energy-related companies (and there are so many more of them than you would think) more than they are lifting the profits of consumer-oriented firms. The market’s movements this entire month have been in lockstep with oil, not interest rates.
- Much of the commentary in recent days has been about how the first hike by the Fed does not signify the end of the bull market. The third hike, we are told, is the one you have to watch out for. The evidence for this over the last thirty years is pretty good. That said, I’m telling you to completely ignore this advice – it’s dangerous. This economic cycle is nothing like the cycles of the past thirty years. This cycle is not going to be ended by the soaring prices of commodities and labor. This cycle has been characterized by low demand due to the high global debt burden. This is a 19th century or 1930s type environment where the global economy has more to fear from deflation than inflation. There is no precedent for how a service-based, internet-era economy escapes this situation, so we all need to be very careful when we hear strategists tell us how this is going to play out. My best guess is this: in an inflationary scenario cash hurts you, because it is constantly losing purchasing power; in a deflationary scenario on the other hand, cash is your friend because falling prices improve its purchasing power. Be careful committing your cash.
- It has been alarming, frankly, how poorly the weakest parts of the stock and bond market have done. High yield credit spreads have been soaring, and energy and materials stocks continue to drop 3-7% or more on bad days, even though many are already 50%-70% below their 52 week highs[i]. This is not healthy. I believe the lack of liquidity has created opportunities where some decent bonds and stocks have been unfairly punished. That said, I think these are only trading opportunities. I fear the overall market tide may have turned in the wrong direction, so I would be careful about bargain hunting. For example, a lot of things that seemed like bargains in July 2008 compared to where they were at the start of that year would get a lot cheaper a few months later. I don’t believe this cycle ends with plunges as steep as we saw in 2008, but it still could be painful.
- This is shaping up to be another rough year for taxable fund investors. Substantially higher volatility and the breakdown of the transportation, energy, utility, and industrial sectors have meant unusually high turnover, which is producing some alarmingly high capital gain distributions. We have seen more than one distribution at over 20%. com is a great website that tracks each fund’s 2015 distributions. You may still be able to sidestep big taxable events at funds like Yacktman, so this site is worth a look.
- I’m sure you’ve heard the axiom, “buy the rumor, sell the news”. It just may be the most reliably profitable bit of wisdom of all. If one had been long the US dollar leading up to Mario Draghi’s December 3rd speech and then gone short the dollar just prior to the announcement, he would have profited handsomely. Similarly, if one had shorted the U.S. Treasury bond the week before last Wednesday’s Fed rate hike and then gone long right beforehand, he again would have done quite well. Moral of the story – you may be able to make money betting on what the market thinks it knows, but you will seldom make money once the market knows it for sure.
[i] Many years ago there was a robust community of value investors willing to buy and hold cyclically disadvantaged firms. This does not appear to exist today. The activist investors who used to target asset rich firms with weak stock prices for LBOs now stalk cash rich tech companies trying to obtain large special dividends or spinoffs.