The Cheese Stands Alone

PaulNolte-2“One day it’s fine and next it’s black…Should I stay or should I go?” This has been investor’s refrain for much of last week as well as last year. China’s devaluation surprised investors, indicating China is very interested in boosting their exports and calling into question their economic growth prospects. Although far from being an open economy, China has been the key to global economic growth. Could it be that the economic data out of China is not quite correct? Does the devaluation point to larger problems within their economy? Those questions are a long way from being answered, but financial markets reacted quickly, dropping over 450 points from Monday’s close to mid-day Wednesday (after China’s second devaluation). By the end of the week, stocks recovered 300 of those points and actually finished higher on the week. This week we’ll get to see what was on the Fed’s mind in July, as their minutes are released. China was not in focus, but they will be closely analyzed for indications of the next rate hike that is seen as most likely in September.

Wednesday’s recovery kept the trading range for the SP500 in place, with a bottom around 2040 and the peaks around 2130. Even with the deterioration of the market internals, the various market averages are holding up. “Should I stay or should I go”: holding more (or less) in equities has kept more than a few investors up at night. To add to the worry list was the crossing of two longer term averages (50 & 200 day). Commonly called “the death cross” when the 50 day average goes below the 200 day average (or the golden when it crosses above) is seen as a sure sign the equity markets are heading lower. While the moniker is scary, the historical record isn’t as scary. When looking back over the past 50 years, there have been 34 such instances described above. The following return on the market six months after “the signal” show, on average, stocks are higher by roughly 2.6%. While not too bad, it is about a percentage point below the average “anytime” six month return. Making an investment change based upon the crossing of these averages does avoid some scary periods; it also has had many false signals as well. There are always plenty of things to worry about when buying stocks, but the growth in earnings drives the long-term results. Many of these more “technical” indicators are interesting to look at, however they generally fall well short of “calling” the markets overall direction. Patience and giving the markets the benefit of the doubt before making rash investment decisions is the best way to avoid short-term decisions that may be detrimental to achieving long-term goals.

Bonds continue to do relatively well, acting as a good diversifier of the more volatile stock market. Commodity prices continue to descend into the abyss, providing the Fed with their own problem: can they raise rates in a slow and declining interest rate environment? The release of July meeting minutes this week could provide a small window into their thoughts about beginning to end the seven year zero rate environment. The conundrum for the Fed (and the markets) is that world economies seem to be slowing and many central banks are engaged in easy monetary policies. In this environment, can the US (and the Fed) be the island of growth, allowing the Fed to increase rates. Commodity prices are indicating inflation is not a worry. Employment growth has been good, but wage growth anemic. While the Fed will likely raise rates, another hike is not likely very soon afterwards.

One of the concerns we have expressed over the last few months has been the lack of participation in the markets: more declining than advancing stocks and poor performance from the various asset classes outside of the SP500. This week marks the first week since November ’12 where only one major asset class was above their long term average price. At the time, it was bonds, today it is the SP500. This is the first time since we began tracking the data early in 2009 that the only asset class is the SP500. Bonds usually get that distinction. So what are the implications? That is an open question. We are beginning to see some better performance from some of the down and out industry groups, so the “correction” may actually be closer to ending than starting. Of course, time will truly tell which way the markets will go.

Investors will continue to be tugged in various directions, from signs of slowing global markets to higher interest rates in the US. We continue to sit tight, expecting some additional weakness, but not yet enough to warrant a shift in overall portfolio holdings. One thing to note on interest rates, the short-term treasury bills have increased significantly over the past few weeks, so investors are anticipating a rate increase in September.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.