Selling Begets Selling

PaulNolte-2“Anything you can do, I can do better”. And while everyone stands around arguing (Yes, I can, No, you can’t) the markets are not waiting around to figure out who is right. Sell now and figure it out later. The decent housing data from the US and OK economic data were trumped by still falling commodity prices, highlighted by the energy complex. On the heels of currency “adjustments” from China two weeks ago, other countries tied to the US dollar also followed suit, with the latest being the tenge. What is the tenge? Why the currency of Kazakhstan, one of the globes key currencies! To be fair, the currency crisis of the late ‘90’s was pushed over the edge by the Thailand baht severing ties to the dollar. The ripple effects of China’s struggles continue to push financial markets around the world. When/where will it end? It could be later this week if selling abates as investors poke around for cheap stocks. On the other hand, stocks could struggle to find their footing and fall further/faster than anyone might expect. “We can devalue faster and better than you” has become the war cry.

Many of the technical indicators we regularly review are now at levels that roughly equaled prior periods when stocks began to find a bottom and rally. January’s big decline was wiped out by the end of March. Last October was dramatic, as stocks declined hard four weeks and then rallied to new all-time highs within seven weeks. It took six weeks for the markets to shave 7% early in 2012, again only to see new highs breached by early fall. The message of the markets since the ’08 crisis is to buy any decline and wait it out. Valuations are back to very high historical levels, but those warnings have been ignored as other investment “choices” fail to provide any meaningful return (cash at zero, bonds at 2%). But after the storm clouds pass, many investors look back and realize that near zero beats a decline in value. Timing of the decline is, and always has been problematic. Taking money off the table during those declines highlighted above have only generated scorn as the markets turned higher. Will this time be any different? Maybe. It has been noted elsewhere that of the 28 weekly declines of 5% or more (like last week) since 1980 only three times has the market been lower 3 months out, save for the crash of ’87 and the financial crises of ’08. So the question is: does this look like ’87 or ’08? Right now, we don’t think so, but that doesn’t necessarily mean stocks can’t trade lower early this week.

Investing in bonds has been the Rodney Dangerfield investment: they “don’t get no respect”. However, save for just a few short periods since the beginning of 2014, bonds have bested their stock brethren. Over that same period, this is the third “spike” in bond performance vs. stocks. Each is the result of a stock market decline that was sharp and ultimately very short. Again, these historical patterns have resulted in great buying opportunities for stocks, except when they don’t – like 2008. Further gains by the bond market at the expense of stocks will push us towards holding more bonds until the stocks regain their footing. Unfortunately knowing when the peak in any market has been reached can only be done by looking backwards. The same is true for a bottom. For now, we will be playing more defense than offense, using bonds and cash defensively until the stock market once again starts to behave.

The three plus years of poor performance by emerging markets and the huge decline in energy prices provided a good entry point early this year and we were rewarded by these markets rallying from their steep declines. Unfortunately, the first quarter was merely a respite in an ongoing bear market. We are no longer holding energy and emerging markets, awaiting a future time when they are beginning a bottoming process. We have raised some cash over the past two weeks, primarily from energy and emerging markets. We may do more this week if the markets continue to struggle finding buyers. One surprising outcome of the past two weeks has been the performance of small/mid-sized stocks. They have struggled since the end of the first quarter, but over the past two weeks have done better than the SP500. This maybe the leadership sector after the markets have finished their correction.

There are some signs that stocks may find a bottom sometime this week, but whether a lasting one, or just for the moment will only be known after the fact. We have increased our cash holdings and may do more depending upon how the markets unfold this week. Some glimmers of hope exist in small cap stocks that may be a good long-term investment once the markets right themselves. Until stocks are better behaved, bonds are providing a nice port in the storm.

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.