Market Insight - October 2015
October is most often singled out as the worst month for the stock market. However, it is September that holds that distinction, and on that count, September 2015 did not disappoint. Fears were fanned by perceived Fed uncertainty on the timing of its key short term interest rate hike, as well as an unexpected slowdown in the Chinese economy and a deep dive by Chinese stocks. Global markets took a big hit, leaving investors to contemplate the worst quarter since 2011.
Almost all asset classes were affected; only Government bonds made gains as investors fled to a safe haven and yields fell to 2% on the ten year benchmark. The S&P 500 has fallen nearly 7% from its January levels; the Dow more than 8%. Smaller stocks, measured by the S&P Small Cap 600, are down 6.8%. Emerging markets plunged more than 15 %, while developed markets lost 5.3%. Real estate, measured by Cohen and Steers Realty shares (CSRSX), fell 2.6%. The Nasdaq biotech index (IBB) is flat for the year, but has given up its substantial gains, down more than 20% from its high.
Sadly, skittish investors jumped off this careening train at the worst moment, pulling over $46 Billion from equity funds during the weeks in which markets hit their low. U.S. stocks recovered slightly mid-September, and then tested their August lows near the end of the month. This is often the sign of consolidation, indicating the concerns that triggered the sell-off have been mostly incorporated into stock prices. Panic selling seems to have subsided, and markets have been making late day recoveries rather than late day collapses. These most frequently signal the latter stages of a correction in asset prices, rather than the precursors of a prolonged decline in equity values.
Our attention is focused on earnings as we move into October, and they present some concerns. Analysts have relentlessly slashed away at corporate profit forecasts for the third quarter; consensus estimates now project a 3 to 4.5 % decline in year-over-year earnings, down from an anticipated 1.5% decline at the end of the second quarter. Negative forecasts from the S&P 500 companies typically outnumber positive forecasts by a margin of 2.7 to 1; most recently they are at 3.2 to 1. Other challenges include a US dollar that has strengthened by 20% over the last 18 months making U.S. exports more expensive abroad. While exports only account for around 13% of our GDP, the largest companies in our portfolios are big exporters, and issues here impact large-cap stock returns. While lowered expectations can partially mitigate the effect on stock prices, the market may not have yet priced in deeper disappointments that the strong dollar and weak commodity and oil prices might inflict on profits.
Is this much pessimism really warranted?
While the environment is certainly challenging, we think it has been overdone and oversold. The most recent jobs report showed a disappointing slowdown in hiring; still, it is too early to say whether this is just normal data variance or an early warning of the impact of a slowing global economy. Since early March, however, jobless claims have held below 300,000, a level that is typically consistent with an improving job market. Steady growth in payrolls and more job openings have so far helped to sustain consumer spending, the biggest part of the economy. U.S auto sales are at their highest level since 2005, and household income is on the rise.
Corrections and Bear Markets
From 1945 through August 2015 there have been 59 market corrections of between 5-10%. On average markets fell for 30 days, and took 60 days to recover. Corrections of between 10-20% have occurred 20 times since 1945. During these declines markets took 5 months to reach the bottom and an average of 4 months to recover. Bear markets, in which stock prices declined 20% or more, have occurred 12 times, took an average of 14 months to reach the low, and 25 months to recover.
The strongest market advances since 2009 have occurred after periods of the worst sentiment. One useful measure of sentiment has been the relative negative or positive tone of investment newsletter writers. Bearish newsletter writers outnumber bullish ones now, and three other times during the last 6 1/2 years, in April 2009, August 2010 and October 2011. All turned out to be buying opportunities as the S&P 500 rallied for two straight quarters each time, with gains exceeding 20%. Since 1963, the S&P 500 Index has advanced an average of 11% in the year after newsletter writers surveyed by Investors Intelligence were as pessimistic as they are now.
The Bedminster Group
We are of course disappointed with the market this year, but not at all disheartened; this is part of the process through which balanced portfolios gain value and build wealth. We don’t think the evidence suggests that the worst is yet to come, although markets are still vulnerable, and may test their August low points before consolidating and moving forward. Nevertheless, we view the current level of stock prices as an opportunity to selectively rebuild equity allocations that have been reduced by the market. The probabilities are overwhelmingly in your favor that these investments will add significantly to portfolio returns over the next several year, our realistic time frame.