Market Update

It appears that the market keeps hitting new highs almost daily.  From its low at 666 in March 2009, S&P 500 climbed some 260% during the last 8 years.  We seem to be in a secular bull market.

But it hasn’t been smooth sailing.  While these events are distant memories now, at the time they caused significant market angst and often sharp pullbacks.  Events such as U.S. debt ceiling causing near shutdown of the government, debt issues of some European counties (remember PIGS?), and of course, more recently Brexit and Trump election.  Nevertheless, the market overcame these issues and has been rising following what it always does in the long run — improving economic fundamentals.

There is a lot of discussion in financial press about high valuations.  Indeed, forward PE is at 17.5, considerably higher than average of 15.  The economic expansion is 8 years old, considerably longer than average, causing some pundits predicting a recession.  And that 260% gain seems impressive, causing other pundits predicting a market correction or even a bear market.

I think that both pundits are correct — there will be a recession and there will be a market correction.  The $64,000 question is when.  And that, no one knows, and, in my opinion, is definitely not worth agonizing for.  A quote by Peter Lynch is very appropriate here: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

The very fact that there is so much skepticism in the press, and still a lot of caution among individual investors tells me that the bull market has more room to run.  And valuations and appreciation rate are all in the eyes of the beholder.  Indeed, from the peak of 2000, S&P rose only 56% in 17 years, or about 2.7% per year which is far inferior to average 10% annual gain.  For comparison, from the prior major peak in 1972 (when S&P index reached a great high of 118), to the 2000 peak, the index increased 12-fold.  This quarter, earnings increased by nearly 14%, much better than expectations of 9% just a month ago.  And with positive earnings surprises, estimates call for 10% increase in 2017, which is likely to be revised higher.

As happened before, I am sure that the market will continue to be prone to panic attacks.  But it is prudent to keep the course.  In investing, very often, the best course of action is to do nothing.

May 9, 2017 at 9:14 pm Leave a comment

Keep Calm and Carry On

The vote in the UK to leave the European Union took almost everyone by surprise.  Early last week, based on various polls, markets were rising in anticipation of the Remain vote.  As it turned out, the polls were wrong, and S&P500 is now down more than 6% from the top.

The current crisis in the markets reminds on of the one back in 2011, when U.S. credit rating was downgraded for the first time.  Just as no one really knows the effect of Brexit on the world economy, no one knew what that downgrade meant for the future.  As a result of the uncertainty, the market proceeded to decline by 17% from top to bottom that year.

Instead of worrying about the global economic ramifications of the U.S. credit downgrade, I asked myself the following questions.  As a result of that event, will I drink less coffee at Starbucks?  Or watch less Netflix?  Or order less stuff from Amazon?  The answers to these questions are quite clear and they should drive your investment decisions.  These questions are just as relevant today.

Many of you may not even remember U.S. credit downgrade.  Indeed, S&P is up nearly 60% since then.  While Brexit, if it actually happens, is not likely to be forgotten, it is futile to worry about the macroeconomic effects as no one can possibly know them.  Checking on your portfolio holdings will be 100 times useful.

Incidentally, U.K. credit rating was downgraded today.

Anyway, as they used to say in the U.K., keep calm and carry on.

June 27, 2016 at 8:51 pm Leave a comment

Earnings Trends

The first quarter earnings season is almost over, and it is not a pretty picture.  While 71% of companies beat estimates, the earnings declined by 7.1% compared to a year ago, making this the fourth quarter in a row of earnings declines.  According to the analysts, in Q2 the earnings will continue to decline, but will reverse that trend in the second half of 2016.  For the whole year, the earnings are expected to increase by about 1%.

As I wrote before, the “earnings recession” was driven by two primary factors: a fall in energy prices and a strong dollar.  In fact, most of the decline can be attributed to a collapse in the results of energy companies.  Fortunately, both of these headwinds appear to be abating, and, in fact, earnings for S&P500 are expected to grow by 13% in 2017.  Of course, on has to take such long term forecasts with a grain of salt.

Meanwhile, the forward PE ratio of S&P500 is at 16.6, higher than the historical average of 14.3.  The overall market hasn’t really done much over the last year and half, and may well continue to trade sideways for the next several months until the uptrend in earnings is confirmed.  In this kind of environment, it is very important to be selective and choose companies that have been and continue to grow their top and bottom line regardless of the macroeconomic conditions.  Many of these companies are familiar to you (Facebook, Google, Starbucks, etc.), but there are less known firms as well.  Their valuation may appear to be high, but it is deservingly so, and I believe they are the ones worth concentrating on.

May 14, 2016 at 1:13 am Leave a comment

Flat 2015

2015 was a volatile year.  We finally had a 10% correction after four years without one, and daily moves of over 1% in either direction were the most in the same time frame.  Despite all this excitement, S&P 500 ended up nearly at the same level of the start of the year, declining by a fraction of one percent.

The market leadership this year was fairly narrow.  Any gains in the market were driven by companies that were able to grow revenues at a high pace,  such as so-called FANG stocks — Facebook, Amazon, Netflix and Google.  Facebook and Google gained over 30% during the year, while Amazon and Netflix more than doubled.  Of course, other prominent growth stocks, such as Baidu, Mercado Libre, Zillow, Apple, etc. did not fare well during the year.  The fundamentals remain strong, however, and these firms could well take over the market leadership next year.

On the macro level, two issues kept a lid on overall market performance this year: strong dollar and a crash in oil prices.  It appears that even after the first Fed hike since the Great Recession, dollar is finally stabilizing against major currencies.  Barring further appreciation of the dollar, Q4 looks to be the last quarter to suffer from unfavorable previous year comparisons that depressed dollar-denominated multinationals’ earnings in all of 2015.  Thus, we can look forward to currency headwinds to abate or even disappear next year, helping  earnings growth.

Oil prices, like that of any commodity, are driven by supply and demand.  While an argument could be made that demand is weaker primarily due to slowing growth in China, most definitely the collapse in prices was driven by supply.  OPEC is engaged in price war with shale producers, hoping to drive them out of business.  As a result, most oil-producing countries operate at a loss and the world is awash in oil.  Low oil prices clearly are not great for energy companies and this sector had negatively influenced overall market earnings.  However, cheap oil is a boon for other industries and for consumers, and I don’t think that is reflected in the market at this point.

January 5, 2016 at 8:50 pm 1 comment

We Had the Correction: Now What?

The third quarter of this year was a weak one for the markets.  After experiencing the first correction in more than four years, S&P 500 declined by 6.9% for the quarter in a highly volatile environment.  The index is down by the same amount year to date.

Despite strong volatility this quarter, I think that the markets actually behaved rationally over the last several months.  Back in April, I wrote, “For the next couple of quarters, earnings are expected to stay flat or even decline, and that may make it difficult for the market to advance.  While there is no bubble to speak of, we may finally get that long-awaited 10% correction.” That has proven to be correct.  The earnings this quarter are expected to decline by about 4%, driven by primarily two factors: low oil prices and corresponding crash in earnings of energy companies, and continued headwinds of strong U.S. dollar.

If we exclude the energy sector whose dismal results dragged down the overall S&P 500 bottom line, we will find out that many industry sectors (such as technology, for example) continue to grow earnings.  The euro appears to have stabilized against the dollar; in fact, I think that Q3 is the last quarter to have poor year-to-year comparisons due to currency issues.  Assuming continued relative stability of the dollar, the currency headwinds due to prior year comparisons will decrease substantially in Q4 and disappear completely by Q1 of next year.  The dollar-denominated earnings of U.S. multinationals will benefit accordingly.  As markets are always forward-looking, this should have a positive effect on share prices.

October 5, 2015 at 10:07 pm Leave a comment

Correction Is Here, Finally

After more than four years of steady climb, the markets finally experienced a correction — all major indices are now 10% or more below their peak.  On average, market corrections occur every 18 month, so this particular one was long overdue.  In a way, it is a good thing to have that correction box checked — investors who were sidelined waiting for the correction will now how have one less reason not to be in the market.

The market drop over the last few days was, for all intents and purposes, made in China.  Fears of slowdown in Chinese economy and its market crash of over 40% caused worldwide equity rout.  Whether the extent of the drop was warranted is hard to say.  Note that the Chinese economy slowed from 7% yearly growth to probably around 5% – a number that is still much higher than the growth of any developed country.  Also, Chinese stock market had a huge rally earlier this year, and even after that 40% crash, it is still at the level of the beginning of 2015.

What happens now is anyone’s guess.  Often, and especially in situations like these, daily fluctuations of the markets are not driven by economic fundamentals, but by hordes of traders unable to control their emotions.  Historically, once the markets decline by 10%, there is a 50% chance that they will continue to decline further into bear market — that is, a drop of 20% or more from the peak.  That’s the bad news.  The good news is that there is 86% chance that the markets would be at least 50% higher in 5 years.  These are pretty good odds!

What is happening in the markets now is completely normal.  That is what markets do, once in a while.  It is the nature of the beast. The last few days were not fun, and the roller coaster ride will probably continue.  But days like these are the reason why equity investors in the long term are paid more, a lot more, than any other kind of investor.

The financial media thrives when markets are volatile.  You are going to hear all kinds of experts predicting the future, and stories of high-profile investors and entrepreneurs in the likes of Bill Gates or Mark Zuckerberg who lost billions of dollars in a few days.  But after the dust settles and the markets continue their inevitable climb to new highs, it will be clear that they didn’t lose anything.  Because, chances are, they didn’t sell.  And neither should you.

August 25, 2015 at 11:11 pm Leave a comment

Nasdaq at All Time High Again

It took just over 15 years for Nasdaq to finally exceed its previous peak reached in March 2000.  The only comparable event in U.S. stock market history is reclaiming pre-depression 1929 high — and it took Dow 25 years to do that.  So how does Nasdaq of today compare to 15 years ago?

The short answer is, there is nothing in common.  In 2000, internet exuberance affected valuations of most companies.  Even leaders of that era, like Microsoft and Cisco, sported tripe-digit PEs, and of course many dotcoms not only had no current earnings, but no prospects of getting any in the future.  Today, while there are a number of richly valued companies, most of them are solidly profitable with proven business models.  And today’s industry leaders like Google or Apple trade at reasonable forward PE in the teens.  Investor attitude also changed markedly.  In 2000, your taxi driver or your barber was ready to give you hot stock tips.  Today, more than half of U.S. population, burned by market crashes in 2000 and then again in 2008, eschews equities altogether (missing on the gains of this six year old bull market).

With earnings season underway, the results so far are similar to those of several prior quarters: about 70% of companies that reported so far exceeded earnings estimates.  These estimates were previously reduced, however, due to strong dollar and poor results by energy companies because of the fall of oil prices.  For the next couple of quarters, earnings are expected to stay flat or even decline, and that may make it difficult for the market to advance.  While there is no bubble to speak of, we may finally get that long-awaited 10% correction.

Or maybe not.  With no inflation in sight and strong dollar, there is little likelihood of Fed raising interest rates soon, and equities will continue to be the investors’ choice to generate reasonable returns.  But it is not useful to speculate on the direction of the overall market – instead, as always, it is much more productive and profitable to concentrate on the companies in your own portfolio.

April 24, 2015 at 7:53 pm 1 comment

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Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.

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