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

Know When to Sell

Most investors would agree that a decision to buy a stock is much easier than a decision to sell.  Watch the video below to see when it is a good time to sell and when it is not.

March 3, 2015 at 11:35 pm Leave a comment

Investing and Emotions Don’t Mix

For many people, investing can be very emotional.  In declining markets, fear takes over and the natural reaction is to sell to prevent further losses.  In advancing markets, greed is in control and produces a desire to buy more.  These emotions are extremely dangerous to the health of your portfolio and if followed through, will inevitably lead to regrets later.  Emotions do not belong at all in investing, only hard logic and reasoning does. For Star Trek fans, you should always be Mr. Spock as far as your portfolio is concerned.  Live long and prosper!

February 25, 2015 at 5:22 am Leave a comment

A Common Misconception of Index Funds

It is now a well known fact that 80% to 90% (depending on the study) of actively managed funds underperform S&P 500 index funds.  The reason for that is two-fold.  First, active fund managers charge higher fees.  Second, they tend to trade often which results in commission costs, unfavorable capital gains tax treatment, and most importantly, underperformance due to continued attempts to time the market  stemming from frequent trading.  Index funds, on the other hand, change composition very rarely and thus almost never trade.

As a result, there is a flow of cash from actively managed funds to index funds.  Many prominent investors, including Warren Buffett, advocate to consider only index funds for individuals.

However, many investors don’t understand exactly how index funds are structured.  Most indices, including S&P 500 index, are not equal weighted, but instead market capitalization weighted.  This means that dollar amount of each fund holding is proportional to its market cap.  So if you invest $1,000 into S&P 500 index fund, you will not put $2 into each of 500 companies.  Instead, you will own approximately $50 worth of Apple, $30 each of Microsoft, Google and ExxonMobil, etc. — because these are highest market cap companies in the index.  And you will invest only $10 combined into hundreds of mid-cap and smaller companies with less than $5 billion market cap.

While market capitalization is appropriate to measure performance of the overall market, no reasonable investor will construct his or hers individual portfolio in the above manner.  The best way is to select high quality companies with excellent management teams and own these companies for a long time, selling only if business fundamentals deteriorate.  That way, you can have your own properly constructed “index fund”, and without market timing, it will have a good chance of beating the venerable S&P 500.  This is exactly the strategy I use for my clients’ and my personal portfolios.

February 22, 2015 at 1:58 am Leave a 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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