In a week that will go down in history for its incredible volatility, prices ultimately didn't change too much, declining though. Here is how the models look as of 8/12:
Top 20 didn't fare particularly well despite very strong performance from one of our largest positions. For the week, it fell 3.08%, while the S&P 500 declined 1.63%. Our exposure to smaller companies has been costly over the past few weeks.
Conservative Growth/Balanced held in very well and outperformed its benchmark. For the week, the model declined just slightly, increasing its year-to-date advantage to 2.32% from 2.12%. Conservative stocks held in better than the market, helping us to overcome our lack of exposure to bonds, which were very strong.
Sector Selector ETF had another challenging week, with exposure to Financials and Emerging Markets hurting performance. The model had been in line with the S&P 500 a week ago.
Outlook
As I mentioned last week, my bullish outlook from earlier this year now looks overly optimistic. While I didn't officially yet change my year-end target for the S&P 500 down from 1500, I spent considerable time last weekend reviewing all of the stocks in the models, lowering most targets. More important than a specific target for the S&P 500, I want to make sure that I get the general direction for the market right. I shared my views earlier this week on My Own Analyst that I think that there is a 35% chance this is all a big mistake (i.e. we rally hard the rest of the year starting soon), a 50% chance that we come out of this higher down the road but struggle for the next two months or so) and a 15% chance that we are now in a new Bear Market.
While many like to question whether this is "2008 all over again", and it sure felt that way this week at times, I think a better working model would be 1987 or 1998. These were very painful declines in the overall market that weren't followed by recession. The 1987 analogy is tougher to understand, as it is less about the particular circumstances and more about the heart-wrenching declines and the "obvious" bearish conclusions that never played out with regard to the economy. We just crashed in some ways earlier this week, though it hasn't been all in one day. There is another common theme - machines or algorithms leading to a selling crescendo. As far as 1998, which saw a similar type of decline from July into August (with the ultimate lows being set in September and then October), there was a global flavor as there is to this crisis. Then, it was Thailand, the Asian Tigers and then Russia. Oil crashed to $10 a barrel at that time. Junk bonds were under pressure. Sound a little familiar? This proved to be a correction and not a bear market, but it was a very frightening time, with the obvious conclusion that we were headed into a recession. That was true, but it was 3 years later. This much I have learned in my almost 30 years of watching the markets closely: When things are really great (like at the end of 2000), the market usually has priced it in, and when things are horrible (like late 2002 or early 2009), the market has usually priced it in. The markets tend to be ahead of the news, not behind. So, this leaves me curious as to what lies ahead (actual negative GDP growth, perhaps?) but also cognizant that these types of headlines (Europe, our own deficits) are reflected in current prices.
We have moved well beyond 2008. Retail investors haven't embraced the market like they had in 2007 - valuations have generally remained very low. The corporate sector has probably never been in better shape - cash hoardes, extended debt maturities (with very low rates locked in), etc. Many don't understand this, but it wasn't just the fear of earnings that drove many stocks down in 2008-2009 - it was the risk of not being able to roll over debt and seeing the bondholders seize the company. This is why GE, for instance, hit 6 and change. The real challenge in 2008 was contagion, and those risks, while still here, seem so much lower today than they did with more leverage in the system still.
While a sluggish economy is certainly more prone to a shock than a resilient one, I am not exactly sure what the "shock" is right now. Credit remains ample in its availability. Energy prices are falling - the reverse of a shock. It's true that our fiscal condition means the government can't continue to spend more aggressively than normal, but government is a small part of the economy. The fact of the matter is that the Consumer is what really matters. While confidence may decline due to to concerns about political leadership and a stall in economic improvement, it's likely to prove temporary. The more thought I give to our circumstances, the less concerned I am. I have expected and continue to expect that the recovery path will be long and steep. If stocks were priced more expensively, I might be concerned.
So, while I thought that stocks might become less cheap relative to future earnings this year, the opposite has occurred so far. While I am reducing my outlook, it remains positive. As far as the models, the extreme volatility creates opportunities, but, like 2008 and early 2009, I am somewhat hesitant to make adjustments to the models when the market is extremely volatile (since I have to put the trades in a day ahead of the actual prices at which we transact). This week, we were able to make some minor adjustments, and I have several others I would like to do as the market calms down.
Articles
- How to Buy Big Decliners - Part 1(Uptrends Still): Seeking Alpha
- How to Buy Big Decliners - Part 2 (Value): Seeking Alpha
- Huge Insider Buys: Seeking Alpha
- 3 Industries for Slow Growth: TradeKing
Regards,
Alan Brochstein
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