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Easy To Get Discouraged

Earlier this week the broad NYSE Composite Stock Index was sitting roughly 7% below its 2015 highs. Therefore, it is rational to get discouraged, especially given the wild central-bank-induced swings over the past couple of years. Thus, it may be helpful look at some facts.

Is The S&P 500’s Pullback Abnormal?

The chart below shows the post-Brexit rally push from point A to point B. A normal retracement would take the S&P 500 back to 2116, 2092, or 2068. After the Fed minutes, the S&P 500 was still holding above all three levels.

Does It Look Like A New Bear Market?

A September 2 analysis used the 50-day and 200-day moving averages to compare a bear market look to a bull market look. The present day S&P 500 chart has not yet morphed into an early bear market look. It may, but it has not yet.

Have Key Weekly Levels Been Given Back?

The weekly chart below shows several levels that acted as resistance in 2015 and earlier in 2016. Thus far, the S&P 500 has not seen a weekly close below the levels shown.

Have The Weekly Charts Flipped Bearish?

An August 2016 analysis looked at a rare turn in weekly stock market trends. After the Fed minutes on October 12, the S&P 500 was still holding onto the favorable long-term probability look.

Could The Facts Flip Bearish?

Mitch on the Markets

2015 was a fairly disappointing year for most investors with flattish returns and a sizable summer correction that jarred sentiment. To be sure, we weren’t expecting much to begin with for stocks on the year – modest single digit returns that would, perhaps, move in-line with aggregate earnings growth. Therein lied the problem – the year didn’t produce aggregate earnings growth! The issue, of course, was the Energy sector. We expected weakening earnings with falling crude prices. But, the extent of the damage in the sector was more than substantial given that crude oil prices fell much faster and farther than anyone could have anticipated. The end result is that the Energy sector tugged the aggregate S&P 500 earnings numbers into negative territory, which looks bad on paper but also masks strengths in other areas of the economy.

When 2015 is all said and done, we expect earnings to have fallen 0.3% on the year, and the market’s performance simply to reflect that. Are There Reasons to be Hopeful Going Forward? There are plenty. Perhaps the biggest one is that, if you strip away the Energy sector from aggregate S&P 500 earnings, you’ll find that earnings growth was nicely positive on the year for just about every other sector. Additionally, we think the lion’s share of the big losses in Energy are already on the books. Now, it’s a matter of the strong surviving and earnings in the sector leveling-off as crude oil prices do the same. For the broader S&P 500, consensus has earnings growth for 2016 at +7.8%, which I’d even say is a little too optimistic. I’m looking for earnings more in the 4%-5% range, and I think stock prices could mimic that number just like they did in 2015. Another big part of looking ahead to 2016 is recognizing the forces that held stocks back in ’15. Earnings growth (ex-Energy) was healthy, so we think it’s safe to assume that there’s a ‘lane’ open for stocks to rise through. Aside from Energy, we think some of the other forces restricting stocks in 2015 should fade in the coming year. Europe has started to turn the corner into a growth cycle, and the efforts by the European Central Banks to stimulate the broad economy using quantitative easing have largely been effective. But, there were pesky issues holding Europe back from a comfortable growth pattern – there were issues with Russia and the Ukraine, a humanitarian crisis with Syrian refugees seeking asylum, more Greek bailouts and an awful terrorist attack. The good news is that all of those headwinds we see as temporary and surmountable and, beneath the surface, Europe is gaining real strength. It will start to show once those issues fade and could be a boon to global stocks. Another factor was China’s slowing growth and fears that it is slowing too fast. We see these fears as overblown. China is intentionally making moves to restructure its economy, and a marked slowdown in manufacturing and state investment is the expected collateral damage. It’s weighing on growth, but the media’s fixation on the 7% number seems silly. China’s contribution to global GDP is still enormous if growth falls to 6.5% or even 6%, which seems unlikely. The recent groundswell of attention on the high yield market also has some worried, with spreads rising and some defaults occurring at the margin. But, again, we have Energy in large part to blame. Junk only comprises about 25% of the total corporate bond market anyhow, and it’s not like the entire junk bond market is doomed. When you look at the aggregate credit picture, the troubled area is just a piece of a piece of the debt market. And that piece is really small. Bottom Line for Investors If you take these three headwinds together, what you actually create is that lovely “wall of worry” that stocks yearn to climb. And, that adds to our bullishness. Investors are actively looking for things to fear, and I think this will persist throughout 2016. If it does, and an earnings recovery takes hold in earnest, we expect stocks to do just fine.

FREE Download: Zacks Stock Market Outlook

All the Best in 2016! - Mitch

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

If you’re nervous about where the market is headed (after enduring two eyebrow-raising weeks of pronounced volatility) then guess what - you’re normal. Human nature is to fear losses, and memory of the 2008 bear market still lingers. Nobel Prize-winning psychologist Daniel Kahneman discovered that investors dislike losses roughly twice as much as they enjoy gains. Frankly, I think losses are despised even more than that.

It makes sense then that the current volatility has many questioning the sustainability of this bull market. The knee-jerk reaction is to sell stocks and ride-out volatility from the sidelines. But, I think that’s the wrong move and I still see this current volatility as a short-term market correction, not a bear market. To me, this market is looking more and more like 1998 than 2008.

4 Reasons I Think This Market is More Like 1998 than 2008

Many investors won’t remember this, but in 1998 the market took a steep dive from mid-July to mid-October, falling slightly more than 19% in total.

But in 1998, the market did what it classically does in a correction – it falls quickly and steeply, posts a mini-recovery mid-way through (kind of what we’re seeing now), and then it falls quickly again until the correction finds its bottom. From there though, the market powers through to a very swift recovery, which in 1998 meant climbing some 28% from mid-October to the end of the year. Investors that got spooked out of the market given that volatility would have been majorly whip-sawed. My advice: don’t be that investor.  

Indeed, I see a similar pattern forming today. I wouldn’t be surprised if the market continues bouncing higher after big down days, luring investors to believe the correction is over when in fact there is still more downside left. But that’s ok! We’re only about three weeks into this downside volatility, and corrections can last anywhere from a few weeks to a few months. Investors should brace for continued volatility, but not fear it. I still think fundamentals point to more secular upside from here, and this downside volatility should be short-lived with a quick recovery in the wings – just like 1998.

Here are four similarities I see between 1998 and today:

1) Late Stage Bull Market – 1998 was the eighth year of a ten year long bull market, and 2015 marks the 6th year of our current bull market. A lot of folks think this is too long to be in a bull market, but that’s a false thought – bull markets since the Great Depression have lasted an average of 8 or so years, meaning for this one to last two more years would be quite normal.

2) Concerns over Asian and Emerging Market Currencies – at present, many are worried that the strengthening dollar is going to doom Emerging Markets [EM], especially if you tack-on lost revenues due to falling commodities prices (since many EM countries are energy and mineral exporters). A strengthening dollar also hurts EM countries because their debt is almost universally denominated in dollars, meaning that a strong dollar equates to more costly interest payments. All very true. Interestingly though, the same scenario occurred in 1997, when global markets rattled over the Asian currency crisis. Countries like Thailand, Indonesia, and South Korea rapidly saw their currencies fizzle in value, and experts predicted a complete collapse in the global markets. But it didn’t happen. The stock market corrected then and there was a carry-over into 1998, but it wasn’t enough to send equities into a prolonged downturn. The China economy concern (and currency devaluation) of today shouldn’t either.

3) Interest Rate Hikes Looming – as it turns out, 1998 was the precursor to a series of interest rate hikes by the Federal Reserve – just like 2015 seems to be. From 1999 – 2000, the Fed raised interest rates six times from 4.75% to 6.50%, but the market also annualized 5% over the same period! For everyone that fears interest rate hikes by the Fed, all they need is a history lesson: stocks have done remarkably well during the past three rate hike cycles.

4) Optimism Building, but Not Fully Developed – there’s no quantitative evidence to support this, but my general feeling is that investors aren’t entirely comfortable with this bull market. In my view, there has to be some level of unjustified optimism about stocks in order for me to believe they are overpriced. And I just don’t see that today. In my opinion, stocks thrive on skepticism – they love to climb that ‘wall of worry.’ And that wall very much exists today, especially now.

Bottom Line for Investors

Many are tempted to think that this market’s volatility is somehow unprecedented, and the media are quick to spin the downside. But that is simply the wrong way to think. The market has endured steep quick declines in the past (1998, 2011) and recovered briskly at a moment’s notice. I think the same applies to the current scenario, and that investors should hold their breath a bit and remain patient. Downside volatility is scary, but often times it’s just temporary. I think it is this time too.

Free Download - Zacks Market Outlook - September 2015

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere. And if you look at all the great investors that are as different as Warren Buffett, Carl Icahn, Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved, which was if you see – only maybe one or two times a year do you see something that really, really excites you… The mistake I’d say 98% of money managers and individuals make is they feel like they got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket very carefully. -Stan Druckenmiller

This quote comes from a speech Druck gave at the Lost Tree Club back in January. I’ve read the speech twice now and I’m sure I’ll read it many more times (and recommend you do the same – here’s the link). For those who don’t know, Druck generated 30% average annual returns at his hedge fund over a period of 30 years and never had a single down year – possibly the best track record ever.

I’m sharing this quote with you here because I think it’s central to what we are trying to accomplish. I want to help you close the gap between being an average investor and being a phenomenal investor. That’s my whole purpose with this thing.

But there’s one huge road block we run into. Being a “pig” isn’t easy. For many people, it may not be possible. As Druck explains in his speech, when he and Soros famously shorted the British pound they put 200% of the fund into that one trade. 200%! They put every penny into the trade and then borrowed against every penny to lever up their returns. That’s what he means by ‘being a pig.’ How many people could put this trade on and still sleep at night? This also goes against everything we are taught when learning how to invest. Step one is to diversify, right? What they don’t tell you is the greatest investors of all time look at step one and call, “bulls***.”

The reason phenomenal investors are able to forego diversification like this is because their skill set is different. They are capable of doing the research such that they can have a high level of confidence in an idea. And when they are very, very confident about an idea they can afford to swing for the fences because their batting average with high confidence ideas is very, very good (and, probably even more important, they’re also willing to admit when they’re wrong and get out quickly). And why put any money into anything else when you have one really, really good idea?

Most investors can’t do this simply because they just don’t have very good batting averages. So bridging the gap between being an average investor and being a phenomenal one is first raising your batting average. This requires both knowledge and experience. The second step is trusting your knowledge and experience when you find a high confidence idea (while also limiting the damage when you’re wrong). And when I say, “high confidence idea,” I’m thinking of a quote from another Soros disciple, Jim Rogers:

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers

You have so much confidence in an idea that it feels like a “sure thing” or as sure of a thing as there possibly can be in the financial markets. This is how I felt about Herbalife back in January and that’s exactly what I did. I put about half of my own personal liquid assets into that one trade. That’s what “being a pig” meant to me.

Bridging the gap between being an average investor and phenomenal investor is a process. The average investor should be diversified in order to protect them from their own lack of investing skill. But the phenomenal investor throws it out the window and says “I’ll just be in cash until there’s a trade opportunity so compelling that I simply can’t resist. Then I’ll back up the truck.” (This is probably why guys like Jeff Gundlach and Mohamed El-Erian are mostly in cash right now in their personal accounts – they’re waiting for a compelling opportunity and don’t feel compelled to hold anything just to stay invested.)

It’s up to each individual to determine where they are in the process and how their personal risk tolerance should dictate how they implement these ideas in their own investments. A broad ETF portfolio, like any of the models presented in Meb Faber’s new book, is ideal for a beginning investor or one with a very low tolerance for risk. Just via the cost savings versus traditional investment methods this will vault her performance far ahead of most other individual investors. More advanced and aggressive investors, however, should focus more on the most attractive individual risk/reward opportunities they can find based upon their own analysis because that’s where I believe the Druck/Soros/Rogers-type returns lie.

Can we please stop bashing forecasters already? There is a small but influential faction of bloggers/financial talking heads out there that love to bash everyone who doesn’t invest exactly along their prescribed investment philosophy which is usually some sort of “passive” methodology, writing off non-conformists to their style as “forecasters” (or, even worse, “active managers”).

First of all, there is no such thing as “passive investing.” Picking an asset allocation is, by definition, active investing. Second, there are problems with passive investing they just don’t want to discuss but back to the topic at hand…

Yes, I agree that most forecasts are almost worthless. Just take a look at how many analysts and market gurus were calling for higher interest rates on the long bond in 2014 (nearly all of them), for example. The only “worth” in these sorts of forecasts was in their contrarian message – buying long-dated treasuries turned out to be a great trade.

But I think it’s absolutely imperative to realize that EVERYTHING is a forecast – even a so-called “passive investment portfolio.”

If you tell me to own a total stock market fund over the next decade (or any index fund, for that matter) you are making a forecast about what sort of return you expect it to generate over that time. Clearly, you wouldn’t tell me to own this sort of fund if you believed that stocks were likely to fall 40% over the coming decade (like the San Fran Fed recently suggested may be a real possibility). No, you believe that I will likely receive a positive return, after inflation, or why take the risk of owning equities at all? It’s a forecast, plain and simple.

At the end of the day, then, trashing forecasters is simply a way of saying that THEIR forecast is not as valuable as YOURS. And if you want to make that argument then I’d like to know WHY you think yours is better rather than just bashing the other guy’s.

Ultimately, to be truly honest with individual investors and our own forecasting ability, we should be telling them that the most successful models suggest that, from current prices, they will likely receive a negative real return over the coming decade from equities. And at 1.75% on the 10-year treasury, they can’t reasonably expect anything more from that asset class. Those are forecasts based purely on facts and statistics and it’s probably the best we can do.