The Dow Jones Drop? Put Away Your Sharp Objects
Fifteen years ago Sunday the entire world was numb.
Most were transfixed to their television screens as the fires from Ground Zero in New York burned and a new reality started to set in.
What a pathway we’ve been on ever since.
The Numbers
We have covered the record-breaking lack of bullishness in the crowd many times to date, even as record highs in major market indexes have been reached.
And we’ve repeated three points throughout the summer lull:
1) More red ink would make the crowd even less bullish,
2) Fear will return quickly with each spate of negative headlines, and
3) Keep praying for a correction.
Well, last Friday's abrupt 400 point Dow Jones drop sure woke everyone from their summer slumber.
The Friday evening media (and the weekend’s articles) were filled with dire projections.
This was my favourite: "A Correction is Coming and There is Nothing You Can Do About It"
Well, let's hope so anyway.
Regular readers of these morning notes should not be surprised by the events of Friday past.
That’s because it’s perfectly normal to see a market move back into previous breakout ranges for support.
The summer bounce saw a chunk shaved off in a single day as volumes spiked and the crowd quickly showed their real feelings about risk: they want none of it.
And this is just what long-term investors want to see.
The Problem?
The structure of corrections is changing.
Machines, stops, too many "hedging" tools and public fear all work to make these seem more volatile than they really are in the larger picture…but they end just as quickly.
The Reality?
Most investors are in cash and bonds, and are extremely underweight stocks.
As a percentage of the large crowd few likely did anything on Friday, though the media process will lead you to believe it was massive.
Don't fall for it.It's a game that has been played since markets began.And while all that fear unfolds history will once again prove that markets rise over time.
Put Away Your Sharp Objects
Ok, sure, Friday was a bad day for bonds and an ugly day for stocks.
The S&P 500 plunged 2.5%, and managed to find support at 2015’s highs (see the chart below).
The VIX rose from 12.5 on Thursday to a 10-week high of 17.5 on Friday.
Any Good News?
Long-term investors need to remain focused on the cushion provided by the Barbell Economy – the slow and steady process of the Baby Boomer generation handing over the economic baton to the Millennials of Generation Y.
Don't overlook this unrelenting fact:The Barbell is where most economic energy is being exerted as the two largest generations in the history for the US churn forward.
Better News?
The forward P/Es of the S&P 500/400/600 dropped sharply on Friday to 16.5, 17.5, and 18.3, respectively.
Meanwhile, the forward revenues of these three stock indexes rose to new highs during the first week of September.
And forward profit margins also continue to firm up as we edge closer to the energy debacle round-trip.
The Bottom Line?
While most fret over short-term price action and run again from stocks, the top and bottom lines of the S&P 500 are looking very good according to the consensus of reports, even as the struggles continue.
The overall business environment remains extremely competitive and that process increases at each turn.
Companies’ main focal points remain simple: Stay laser-focused on cutting costs and maintaining/improving profit margins.
Oddly enough, these are not events that history suggests investors should be running from.
The Two Charts Above
The first chart shows the trade ranges we covered for close to two years as the markets worked through their "earnings recession" and those energy fears became deeply embedded.
I recently noted how surprised I was that we had not yet seen markets go back and test the breakout region from mid-summer.
In the long run it’s very positive to see this change unfolding now. I’m confident we will find this is a productive step for the markets, even though I do not expect it to cause anyone to rush in and buy stocks (also a good thing).
On the contrary, if it can last for more than a couple days (unlike the Brexit panic) I suspect we see continued outflows from equities, inflows to bonds and a more bearish tilt in sentiment.
Note the red line at the bottom of chart 1 (above). It highlights volume levels.
After being paltry all during August (as expected) volume levels quickly rose on Friday past as selling ensued.
Why point this out?
Well, we reached into the region of volume pace which typically goes along with the ends of things, not the beginnings.
How quickly we panic these days.
The second chart is a great one from Dr Ed Yardeni.
As noted above, forward multiples fell sharply on Friday as markets shaved points and the forward earnings increased.
As such, take another look at the paths of green, blue and red lines on the second chart (above).
Forward P/E ratios have now fallen back in all three weighted indices:
- For the large caps - we are back to levels first seen in late 2014.
- For the mid caps - we are back to levels first seen very early in 2014.
- For the small caps - we are back to levels first seen in late 2013.And pretty soon we’ll all be focused on 2017 and 2018 projections.
Time certainly flies when you’re witnessing a secular bull market grind its way higher while almost no one believes it’s real.
Generation Y is Deflationary
Years from now this will become far clearer.
The technologies, from apps to the cloud, that are being unleashed on our economy by Generation Y are very deflationary.
That's not something to fear; it creates a nice balance in the structure of things.It also helps margins expand and, in time, they will flourish as Gen Y moves higher up the corporate ladder.
We can see it in real-time today.After being warned for years that QE would destroy the value of the US dollar and that inflation would burn us all the exact opposite has unfolded.
Yet today we’re told the now strong dollar is hurting overseas profits and experts are nearly begging for inflation.Far from the expert calls for the ghosts of inflation rates remain subdued near zero.
There continues to be significant undershooting of actual inflation rates, and the 2% inflation target of the BOJ, ECB, and US Fed.In the US, the core personal consumption expenditures deflator, excluding food and energy, was up 1.6% year-on-year for July.
Meanwhile, average hourly earnings rose just 2.4% year-on-year during August.
Silent Period?
As the window of time closes for any Fed-related chatter about US rate hikes can everyone please take a breath and count to 100?
Check your Barbell Economy Portfolio data and relax.
Let them chatter, let them meet and let them raise rates.
A rate hike or two will mean almost zero to the average company, and even less to many others.
Those fears have become monsters that wreak havoc only on our emotions, and because of that response very poor long-term investment decisions are being made.
But these fits of mini-panic tend to be good for the market.
History suggests your best results come right after the worst pricing nightmares.