Coronavirus update

Here are some thoughts on the latest market turmoil:

  • With major market indexes down more than 25% from their peak, the longest bull market in history is now officially over at 11 years.  With an exception of 22% drop in a single day back in 1987, this bear market appears to be the fastest.   No one likes to endure bear markets; however, they create compelling buying opportunities: indeed, S&P 500 is up four-fold since its previous bear market low.
  • The impact of coronavirus on economy is clearly going to be significant; however, no one knows just how significant.  Market may be overestimating or underestimating its impact, and therefore we are seeing this wild volatility in prices.  It will likely persist for at least a few weeks until we get a better picture of the virus trajectory.
  • In such an environment, it is likely that strong companies will emerge stronger, and weak companies will get weaker.  Bailouts may be needed for some industries hit hardest, such as airlines.
  • If you have cash, investing now and continuously over a period of a few months is a great idea.  Invest in strong quality companies with earnings and revenue growth.  If you don’t have cash, sell weak companies and reinvest proceeds in the strong ones.
  • All companies have suffered price declines.  In the short term, home oriented companies will have better financial results.  Examples: Amazon, Netflix, Mercado Libre, Zoom Communications, Roku.
  • Coronavirus pandemic will be over in the course of months, not years.  The economy has been very strong prior to this outbreak, and it will bounce back.  It is not clear if it will be a V-shaped recovery as various restrictions may be lifted gradually, but recovery is certain.
  • Finally, some general market perspectives.  Markets go down a lot faster than they go up, but overall they go up a lot more than they go down.  And having to endure days like these is the reason equity investors are earning the highest returns of any investment vehicle.  Use this opportunity to acquire a piece of great companies at discounted prices.

March 13, 2020 at 1:48 am Leave a comment

Market Update

Well, that was quick. After a panicky Q4 of last year, when S&P 500 almost entered a bear market, stocks raced back up this year, erasing all losses and touching new all-time highs. While no rational explanation can be given for such erratic moves, the most likely reason is changing earnings expectations. Six months ago, analysts were busy lowering estimates, and there was talk of so-called earnings recession, which is at least two quarters of declining year-over-year earnings. As of few weeks ago, Q1 earnings were expected to decline by more than 4%.

With about half of announcements in, that doesn’t look likely. 77% percent of companies that already reported exceeded expectations, and there is actually a chance that there will be a small gain once the earnings season is over. After a slow but likely positive Q2, earnings are expected to accelerate later this year and in 2020. No recession is in sight so far.

On the valuation basis, stocks are not cheap, but neither they are expensive. The forward PE ratio is at 16.8, only slightly higher than 5-year average of 16.4. Of course, no one knows where the markets go from here, and a correction is always possible.  But it is futile to worry about this. Instead, it is always advisable to tune out short term noise and macro headlines and instead concentrate on well managed businesses and their earnings. For example, so-called FAANG stocks reported quarterly results, and all of them exceeded expectations with an exception of Google which slightly missed on revenues.

April 30, 2019 at 10:34 pm Leave a comment

A Sharp Pullback

In my previous letters, while commenting on strong and consistent market returns over the last few years, I noted that such performance is hard to maintain and that a correction is inevitable. And that is exactly what he had this quarter. From the top, S&P 500 dropped nearly 20%, a classic definition of a bear market.  In the last ten years, there were only two quarterly drops of similar magnitude: in Q4 2008 and in Q3 2011.

It is very painful to experience drawdowns like this, and in such situations it always helps to zoom out. For the full year, the market declined 6.2% for the year, still a loss, of course, but not so dramatic. Over the last 5 years, however, it climbed 36%.  And for the last 10 years, it is up by 178%. Obviously, sharp declines happen, but they are rare, and often forgotten in the overall context of the historical performance. So let’s see what happened in these two quarters I mentioned above.

In Q4 2008, we were in the midst of the banking crisis and the Great Recession. So at least one could argue such a loss was justified. However, I could not remember what caused the drop in Q3 2011, so I actually had to look up my own posts and to google historical facts. Then, as is the case today, the economy was doing well, companies had good earnings, and there was nothing present in fundamentals to warrant such a decline. What was present was a fear of European bank problems, and specifically the fear of Greek default. Remember PIIGS? Also, there was a government shutdown (sounds familiar?) that summer and S&P downgraded US debt a notch. That was good enough for the market to react the way it did. Market performance since then? 122% gain. Performance since Q4 2008? 178% gain.

I find issues in Q3 2011 quite similar to what we are experiencing today. The economy is strong, and companies are expected to continue growing earnings this year (although at a slower pace than in 2018). Global economy is projected to grow at the same rate as last year. But we have a lot of fears. Such as tariff wars and a possibility that they could cause a global slowdown, concerns that Fed is raising interest rates too quickly, that Brexit can hurt European economy, and apparent chaos at the White House. No one knows whether any of these fears materialize. However, we do know, looking back at market history, that every decline has been overcome by an inevitable advance to the new highs. If you have funds to invest, I would strongly suggest putting them to work in the market.

January 7, 2019 at 2:09 am Leave a comment

Market Update

October can be a scary month for stocks. Famous crashed of 1929 and 1987 happened that month. While there was nothing similar in magnitude this October, wave after wave of relentless selling produced another correction this year (the first one was in February). One can point to a number of fears contributing to market decline: fear of tariff wars, fear of rising interest rates, fear of peak earnings, fear that the current bull market may be nearing its end, and, most recently, fear of falling oil prices (which is normally a good thing, but could indicate a slowdown in the economy).

Short term market behavior is dictated by such fears on the way down and by hopes on the way up. A number of pros and cons for these fears can be provided at any stage of the market, but in the end fundamentals always determine the price. Currently, forward PE ratio stands at very reasonable 15.5, below 5 year average of 16.4, but above 10 year average of 14.5. So far this year, S&P 500 is essentially flat, while earnings rose more than 20%, and so the market is considerably cheaper than it was at the beginning of the year. In the third quarter, earnings rose some 25%, and so the fear of peak earnings is correct that such rate is not sustainable. However, in 2019, earnings are still expected to rise by 9-10%, and sooner or later the market will have to follow.

The current correction may end tomorrow or it may continue and turn into a bear market (a decline of 20% from the top, we are halfway there). There is no way to know. The good news is that corrections and bear markets are short lived, and are always followed by advances that take the market to the new highs.

November 14, 2018 at 11:05 pm Leave a comment

Market Madness

After many months of very smooth sailing and steady uptrend, the markets seemed to turn on a dime last week and produced two largest point drops in the Dow in history (both over 1,000 points) within the same week. There wasn’t any apparent reason for this sudden turbulence, but of course many market pundits rushed in to explain it. The consensus seems to be that the market dropped because everything is great. Too great, that is — an expanding economy, low unemployment rate, and generally favorable business climate — may awaken inflation leading to higher interest rates. It is true that in theory, higher interest rates put a damper in stocks, as bonds, traditional competition to stocks, become more attractive. The question is, how much higher will interest rates rise?

But these same concerns were valid one week ago, one month ago, and one year ago. Yet the market dropped this week. The simple reason behind it, as is the case in any market drop, was because there were more sellers than the buyers. That’s it. As it why it happened now — well, it had to happen sometime. A correction, or drop of at least 10% from the top, is a very common occurrence and happens, on average, every 18 months or so. The last one was in 2016, 2 years ago. Also, as I mentioned before, we had a very calm and rising market last year. We were overdue. By the way, just this week the market experienced more 1% fluctuations than in whole 2017!

The 4-digit point drops in the Dow, while impressive, don’t even make it to top 20 in terms of percentage drops. For now, I think this is typical garden variety correction. Historically, it takes an average of 4 months for the markets to recover to prior highs. Of course, more pain can always be ahead, but I don’t think this correction will turn to a full-fledged bear market (a drop of at least 20%). For that, a recession is usually required, and current economic situation is just too strong to allow that to happen.

After this drop, S&P 500 forward PE is at 16.3, very close to its 5-year average of 16, but still higher than it 10-year average of 14.3. In 2018, earnings are projected to rise 18.5% and revenue by 6.5%. Full three quarters of the companies reported positive earnings and revenue surprises for Q4 2017, so the analysts keep rising their earnings targets. My advice at this point, as always, is to keep calm and stick with high quality companies with strong fundamentals.

February 9, 2018 at 11:36 pm Leave a comment

Are We in a Bubble?

The year 2017 has been very good for the markets overall. Some pundits say that the gains were driven by anticipation of the tax cuts. Indeed, corporate tax cuts will definitely result in an increase in company earnings. Now that the tax package is passed, the $64 trillion dollar question, of course, is whether the tax reform is already priced into the market.

Overall, stocks appear expensive based on historical PE rations, but that has been the case for the last couple of years. Bulls point out that this is justified because, bonds, a traditional competition to stocks, are not attractive due to low interest rates. The condition of international markets also appear benign, with European Union reporting good growth. U.S. dollar is declining which is good for U.S. international corporations.

After a strong 2017, and last several years as well, sometimes am I asked whether the market is in bubble similar to that of 2000. I believe that there is very little resemblance to the conditions then. While there are companies with very high traditional valuations now, these companies have strongly growing earnings and revenues. In 2000, many companies had no revenues. Today, market leaders, including tech bellwethers, such as Apple, Google and Facebook, actually have reasonable valuation metrics. Finally, there is no euphoria — one doesn’t hear hot stock tips from taxi (or Uber nowadays) drivers. However, my mother-in-law asked me whether she should invest in bitcoin. So, if you want to worry about a bubble, you can legitimately worry about one in cryptocurrencies. The estimated earnings from bitcoin are exactly zero. We will continue to invest in what we know works and stick with quality companies with good earning growth.

January 12, 2018 at 8:05 pm Leave a comment

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

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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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