2015 Q3 Stock Market, Is it 2011 Q3 Again or 2008 Q3?

UPDATE – 1/20/2015 – We posted an article with the results of the 2015Q4 here:

2015 Q4 Update 2015 Q3 is it 2011 again or 2008?

If this past quarter’s stock market performance sounds familiar, it’s because it is.  We have experienced a similar market performance as we did in the 3rd quarter of 2008 and the 3rd quarter of 2011.

POP QUIZ – Which quarter had worse performance, 2008 Q3 or 2011 Q3?

Answer: 2011 Q3 losing 14.92% vs 2008 Q3 losing 8.87% using Morningstar’s Total US Market Index.

Our memory of that ugly 2008 year likely led you to believe Q3 2008 was worse but we actually had worse returns in 2011.

In 2011, we heard story after story about how were were entering into a recession and that investors and how the market was just starting its tumble.   What were the headlines in 2011?

• Sovereign debt crisis in particular Greece was first and foremost on the news cycle
• Bond Bubble’s were prominent headlines and fears of the Fed Raising Rates
• Media Commentators were comparing the bankruptcies of Lehman Brothers and Bear Sterns during the financial crisis and  to Greece, Portugal, Spain, and Ireland and trying to correctly predict a huge market correction.
• It was difficult at that time to find good financial news anywhere.

What did we say at the time?  Quoting our Quarterly Commentary in Q3 2011 appears appropriate to review:

Recession Looming?

The truth?  No one really knows where the economy is headed.  The stock market is currently pricing in a slowing of the economy and uncertainty in Europe.  If the fear causes consumers to pull back their spending, we could quickly see another recession. 

In 1975, the temptation of market timing was as prevalent as is it is today.  William Sharpe performed statistical analysis of how often a person would have to be correct in order to make money through market timing.  Through statistical analysis, Sharpe demonstrated an investor that can be 100% stocks or 100% cash would have to be correct over 74% of the time to make more money than buy and hold.

Furthermore, Morningstar looked at mutual fund inflows and outflows to determine how effective investors were at timing their purchases.  In US Equities, the average investor earned 0.22% while the average fund over that time period earned 1.59% (http://news.morningstar.com/articlenet/article.aspx?id=325664

).  This data shows that investors typically are poor market timers and tend to “sell low” and “buy high”.

What Happened in Q4 2011 and Q4 2008?

Q4 2008, would go on to become one of the worst on record while 2011 Q4 would snap back and for the year, 2011 would be in the green.

What is the lesson here?  After a drop like we have experienced this past quarter, its important to recognize that both outcomes can occur.  The market can get worse or it can get better.  Further, it will likely get better or worse more quickly than we can realize or react to.  These two moments in our history show how difficult it can be to time the market.

Any Similarities Now to Q3 2008 or Q3 2011?

Right now the stories seem to dominate:

• International Economic Weakness  (similar to 2011).
• Bond Market Fears (similar to 2011)
• Recession Fears (similar to both 2008 and 2011).

2008 Q3 was most focussed on sub prime mortgages and if that was the extent of our financial crisis.  As we would find out in Q4, the financial crisis extended beyond sub prime mortgages and took the entire economy with it.

2008 was one of the worst years in the history of the stock market and historically is an anomaly.  While 2011’s Q3 was a bad quarter, 2011 more of a normal stock market year and ended slightly positive.

I am hopeful that 2015 will be similar to 2011 or at least the 4th quarter being more stable that 2008.  I am fearful that the “animal spirits” and unpredictable nature of the stock market could create another 4th quarter similar to 2008 (although in my opinion, it is unlikely).

I am going to leave you with  a quote from our 2011 Q3 Commentary which I think is appropriate now:

Outlook

Relying on our asset allocation models will help us from letting fear or greed lead us to poor financial decisions.  It’s easy to forget that previous times in history have had just as many uncertainties as we face today.  We will end this quarter’s commentary with a reflection on decade’s past challenges:

1. 1910’s – World War 1
2. 1920’s – Rampant Organized Crime (They were so organized they actually had a national convention in Cleveland Ohio December 5^th 1928)
3. 1930’s – Great Depression
4. 1940’s – World War 2
5. 1950’s – McCarthyism and the fear of America being infiltrated by communists
6. 1960’s – Vietnam and the Bay of Pigs
7. 1970’s – Watergate Scandal, Stagflation, Oil Crisis
8. 1980’s – Mexican Debt Crisis, Chernobyl Nuclear Reactor Leak
9. 1990’s – Gulf War, Oklahoma City Bombing, World Trade Center Bombing
10. 2000’s – 9/11 World Trade Center Attack, Dot Com Bubble Bursting, Housing Bubble and Burst

Further relevant reading from our other article about the current market you might find interesting are:

https://investwithsteve.com/2015/08/stock-market-pull-back-time-to-reflect/

https://investwithsteve.com/2015/09/mythical-bears-and-more-stock-market-reflections/

UPDATE – 1/20/2015 – We posted an article with the results of the 2015Q4 here:

2015 Q4 Update 2015 Q3 is it 2011 again or 2008?

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Despite Early Predictions – Fed keeps Rates Steady

The Federal Reserve chose to keep rates steady at 0.25%.   The Federal Reserve has telegraphed a rate hike for a couple years now preparing investors.  The Fed has kept its message pretty simple.  When it feels the economy is strong enough, it will raise rates.

Does That Mean That The Fed Doesn’t Think The Economy Can Handle a Rate Hike?

Yes and no.  In my opinion, the Economy both domestically and globally is not on as firm of ground as the Fed anticipated.  Having come out of a financial crisis in 2008, the Fed has also indicated that they are much more comfortable fighting inflation than deflation.  Their preference appears to be they would rather raise rates a little too late than too early.  The Federal Reserve has a long history of using interest rates to fight inflation.  To be honest, fighting deflation during the financial crisis had very little experience to rely on and involved several more controversial measures such as QE (and all the version of it).  Chairman Ben Bernanke face immense criticism primarily because there was no playbook for monetary policy that was proven after rates were lowered.

Will the Fed Raise Rates in October or December?

In my opinion, the primary factor will be how comfortable the Fed is with the economy.  I would also be hesitant to take to much of what the Fed is saying right now.  The Fed does not want the market to think rates will stay low for a prolonged period of time.  If the Fed signaled that, investors would increase their risk taking.  The Fed prefers at this point to have us investors think a rate hike is around the corner and when or if the economic data comes in weaker than expected, the Fed can delay what most investors have come to expect, the “inevitable” hike.

Anything New or Unique is this most Recent Fed Meeting?

While it should not be to big of a surprise to most investors, the Fed indicated while evaluating the U.S. economy that it also looks a the global economy.  The Fed basically said the were concerned the weakness is the Global Economy could spread to the U.S.  So part of the evaluation of the U.S. economy was how vulnerable the U.S. economy would be with a rate hike versus the remainder of the world.  This fact should not be too surprising.  The rest of the world has slowed down and many countries have devalued their currencies.  The devaluation causes the dollar to strengthen as we have seen.  Usually, a rate hike will also cause the currency to strengthen.  The Fed may have been looking at how much the Dollar has strengthened and adding adding pressure of another rate hike, may have caused them pause.

Going forward, it does appear that the Fed will be unlikely to raise rates on the U.S. economy unless either the U.S. economy strengthens further or even just the Global economy strengthens.  Absent both improving, we may be waiting longer for a rate hike.  Further, I would expect a more “global” Fed going forward.  While the mandate is specifically domestic in nature, I do expect to see the Fed looking globally for clues as our economies become more intertwined.

What Should Be My Takeaway?

A see a couple things important for investors to understand:

1) Predicting interest rates over the short term is very difficult.  Most experts were predicting a hike by this past June and we may not even see on in 2015 at all.

2) If there is a hike, that likely means the economy is on firm footing or that the global economy is stronger.  Our domestic and foreign stock returns would likely reflect this strength with good returns.

3) If the global economy continues to weaken or if the U.S. economy starts to weaken, our stock portfolios will likely suffer.  However, the Fed will be unlikely to raise rates and our bond portfolios would likely do well.

For these reasons, we invest in bonds and stocks and their complimentary nature allows us to build risk adjusted portfolios that match our goals.   Further, market timing of the stock market and the bond market is very difficult so we continue to rely on our diversified portfolios to weather either potential outcome.

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Image by Stuart Miles at FreeDigitalPhotos.net

Mythical Bears and More Stock Market Reflections!

After our previous article:

Stock Market Pull Back Time to Reflect

Our clients have asked for more analysis.   I continue to use JP Morgan’s top notch resource for market and economic data in easy to digest slides.

Myth 1 – Market is going to drop because interest rates are going up.

False, as the chart below shows, when 10 year treasury yields are below 5% the stock market actually is positively correlated and rising rates are associated with rising stock prices.  This fact actually makes sense.  If the market is tanking, the Fed will be unlikely to continue to raise interest rates.  Whereas a market that continues to rise despite the Fed raising rates will cause the Fed to continue to raise rates until it reaches the tipping point where rates begin to hurt growth.  It should not no surprise the number is 5% as inflation is typically in the 4% range.

Myth 2 – Companies are fragile and are poised to drop in value

False, Corporate cash is at an all-time high as a % of assets, dividend payout ratio is increasing but not at an unsustainable level, capital expenditures and acquisitions are on the rise indicating businesses feel good about the future.  So even with dividends increasing and share buybacks increasing, cash on the companies balance sheet has continued to rise.

Myth 3 – Bull Market has run for 7 years, we are due for a major correction

While it has been a long bull market, we typically call a bear market a 20% drop in the stock market.  We have had several recessions that have not resulted in a bear market (as shown by gray areas in chart below).  For example, from 1946 1961, there was 15 years between bear markets.   From the 1987 market crash until the tech bubble bursting we had 13 years.

Further, most bear markets have coincided with multiple factors affecting.  For example, a recession, commodity spike, and aggressive fed tightening were all factors leading the bear market of 2008.

Lets examine these factors now:

• Recession – currently profits and sales are relatively strong but we certainly can dip into a recession.
• Commodity Spike – The exact opposite is happening as energy costs and commodities prices have dropped dramatically.
• Aggressive Fed Tightening – The fed does want to raise rates but they are being far from aggressive. The latest indications are that they are being tentative in raising rates as they weigh economic data.
• Extreme Valuations – As we discussed in our previous article, valuation seem to be reasonable and not out of character.

So currently, the only factor that does concern me is the possibility of a recession and even if we have a recession, does not mean we will have a bear market where we lose 20%.

Myth 4 – Markets Trend up and Trend Down Over Intermediate and Long Time Periods

In the short run (less than a year), markets go up and down and can seem like they are as likely to go up 20% as down 10%.  However, over a very long period of time, the market has trended up.  Over intermediate periods of time, the market has trended up or been a sideways market.  A sideways market is one where it oscillates with no clear trend.   The graph below illustrates its better that our memory of the dot com bust and 2008 financial crisis.

The lack of a downward trend in the intermediate term (5-10 years) is one of the major causes of market timing to fail in my opinion vs traditional asset allocation.  In an flat market, re-balancing a portfolio to the asset allocation model will generate a modest return even when the market is relatively flat.  Marking timing a bear market and missing it during a flat market only locks in your loss, then you typically get comfortable to buy right before the next drop.  In my opinion, that is why the average investor has barely beat inflation over the past 20 years.

Conclusion

Please note that I am not a perma bull that thinks the market will always go up and always get double digit returns.  However, I firmly believe when investing in intermediate and longer time periods it’s important to look at these facts and realize that bear markets are a “cost of investing” because that is the risk of investing.  Further, we need to look at information and reasons we hear in the financial media to see if it makes sense and is a legitimate concern.  Currently, I do not see major red flags for a huge bear market.  That being said, bear markets are rarely correctly forecasted and the same people rarely are correct without several false positives in between.