Markets are ALWAYS uncertain

Emotions drive markets. The big two, as it were, are fear and greed – with hope right along with them. Emotions also, and almost always, trump investor logic, or what passes for it, which is used after the fact to justify their actions or inactions.

A major challenge for advisors during unsettled markets is to help our clients deal with the emotional pushing and pulling. That’s tough, especially if those clients read a newspaper, watched the news or reviewed most financial blogs. As a result, they probably haven’t had any difficulty finding a menu of items those media folks have decided investors need to worry about. Distilling it all, the two leading menu choices for worry currently remain: China’s internal difficulties and the timing of a Fed interest rate increase.

One of the biggest issues is that simply saying that there’s nothing to fear usually doesn’t cut it as fear is a highly personal thing. In spite of that, I’d like to provide you some facts and the occasional personal opinion to help you keep that fear from creating bad decisions of the “act in haste, repent at leisure” variety. Here’s some of them.

China syndrome

The China slowdown isn’t exactly breaking news at this point. The plunge in China’s share prices since 9 June may be an indicator of a worsening economic situation. More likely, it’s the bursting of a bubble that inflated over a very short time, i.e., since November of last year and then deflated even faster. Again, please recall that the Shanghai market, which is the focus of all this activity, isn’t even effectively open to non-Chinese investors.

Further, growth in China has definitely not stopped as some seem to imply – it’s simply just not growing as rapidly as in recent years. As for them directly affecting our market, Gluskin Sheff’s David Rosenberg says that China’s economy has only a 16% correlation to our economy and is therefore “insignificant”. Additionally, China isn’t a big driver for the earnings of US corporations as exports to China make up just 0.7% of US GDP.

Volatility

Markets move daily – sometimes rapidly for no apparently understandable reason. Some of that’s due to high-frequency trades, but most of it goes back to the emotions of the humans involved in the markets.

Volatility is not a factor separate and apart from the market’s recent direction. Markets don’t go down due to volatility. Rather, bad markets are the primary cause of volatility. Bull markets tend to be long and slow while bear markets are short and quick. Even in secular (long-term) bear markets, most of the pain is confined within a short period of time.

It’s fear, not economic reality, that’s the usual cause of volatile stock prices. The link between investor (individual and/or professional) fears and the stock prices is hedging techniques, typically involving the use of options contracts. This can be expressed in something referred to as the VIX, i.e., volatility index. Higher VIX numbers usually accompany volatile markets. All the VIX is really is like a thermometer measuring the status of current investor fear or lack of…

I think it’s also good to recall that stocks can volatile higher too – sorry for the grammar.

Why shouldn’t I worry?

Here’s a very few of the many reasons why you shouldn’t be wasting your money on Maalox.

Market participants are being pulled between good US economy and not so good rest of globe. While there’s no one way to know for sure what caused this latest downturn, it’s my best opinion that a number of investors were simply looking for a reason to sell after a six years of very fine gains.

The fact is that the fates of the world’s financial markets aren’t decided in a couple days’ worth of gains or losses. Markets are so noisy over short time periods that trying to come to any reasonable conclusions based on how they’re acting over even a quarterly basis is nearly impossible.

It’s really important to keep in mind that while stock prices have changed and emotions have been over-stimulated, our economic fundamentals haven’t…we’re still seeing solid US economic growth. For instance, the current 5.1% unemployment rate says the economy is doing a good deal better than average.

The recent second quarter GDP revision showed that inflation-adjusted compensation was up 3.3%, year-over-year, and real (inflation-adjusted) wages and salaries gained 4.0%. That represents significantly solid growth rates in income. With about 70% of our economy being driven by domestic consumption, that’s outstanding news. Check out the record levels of car and light truck sales as reinforcing that. (Makes you wonder why “everybody” is so flustered about the Fed raising rates. Think of them as moving the level closer to what it should be…)

Finally – for now – the Houston Chronicle reports that the price of gasoline is now more than $1 a gallon cheaper than last year! The drop in the crude oil price is a great boost for consumers, of course, as well as for industries like manufacturing, agriculture and transportation. Petrochemicals also directly affect plastics, adhesives, fertilizers and coatings, among others. And, lower oil prices help boost producers’ net profits.

Closing

To further reinforce the case against trying to guess the next market moves, consider this. Tom Lee, Fundstrat’s co-founder and head of research says, “Over the last 10 years, if you missed just the best five days, you had negative years seven out of the last 10 years, even though the market was up eight out of the last 10.”

While weak spots always steal headlines, on balance, the latest numbers point to global growth. Seems to me markets are still trying to shake out the fearful, though only time will tell whether the correction re-tests the lows. Either way, we believe the bull market remains ongoing, with plenty of fundamental support.

A strong asset allocation strategy involving diversification and periodic rebalancing are tools you can use to help you deal with goofy markets. Having the right investment mix for you helps strike the right balance between risk and the return you need to get to where you want to go. So, consider your goals, time horizon, risk tolerance and overall financial situation whenever you make an investment or asset allocation decision.

Call us if you’d like a second opinion or help in creating an individualized strategy.

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly. http://www.russell.com/helping-advisors/EconomyMarkets/EconomicIndicatorsDashboard/EconomicIndicatorsDashboard.aspx

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