According to my decidedly non-scientific survey, there have been 7,777 articles written this year (so far) on whether the Fed will raise interest rates, and when. The conclusion they’ve reached? Nobody knows — but everybody still gets a dime a word to speculate.
The conclusion I’ve reached? Who the hell cares when they raise rates? Whether in October or December or sometime later, they are going to raise interest rates at some point. They have to. In order to retain a shred of integrity, relevance and ink spilled, they must act. And in order to protect against another recession (not that they have that power, really, but we like to humor them) they need arrows in their quiver.
Let’s say for the fun of it that they raise rates in October by 0.25%. And again in December by 0.25%. Now they at least have 0.50% they can lower to maintain the illusion they can control the economy or at least “do something” when another economic malaise threatens. Does anyone really believe a 0.5% rise merits all this tearing of hair, gnashing of teeth, and spilling of ink? More interestingly, why do so many believe that any bit of good economic news warrants a triple-digit sell-off in the markets because then the Fed will feel secure in raising rates?
Markets go up because there are more anxious buyers than there are anxious sellers.
Put another way, if investor perception of the future value of their investment in Company X or Market Z is strong, persistent and optimistic, markets rise. If investor perception of the future value of their investment in Company X or Market Z is weak, agitated, and pessimistic, markets fall. Enough already of this incessant “will they or won’t they; only Janet Yellen’s hairdresser knows for sure.”
What we are now certain of is the fact that investor perception has changed for the worse and even if the Fed doesn’t do a darn thing this entire year with interest rates, it was an overvalued market ready for any excuse to fall back to and, if history is any guide, below the mean of the past year or two. China provided that excuse. The Fed is providing that excuse. A drifting, incoherent foreign policy and so-so economic recovery is providing that excuse.
Of course, we’ve been warning clients and subscribers away from China for the last year or two, anyway. I believe that China is what Churchill described the then-Soviet Union as: "...a riddle, wrapped in a mystery, inside an enigma..." I would only add that the Chinese economy is all this and more, a riddle, wrapped in a mystery, inside an enigma surrounded by a black hole. The only light that escapes is that which the Chinese government wants the world to see. For me, such purposeful opacity is simply not congruent with intelligent investing.
Will a further slowdown in China affect the bottom line of American, European, Japanese, Australian and other companies? Of course it will! Will that contribute to the headwinds US markets will face going forward? Yes, but not as much as most might believe. As a percent of worldwide exports, less than 8% of US company products and services went to China. Canada was the top recipient at more than 19%, followed by Mexico at just under 15%.
Could the slack be taken up elsewhere? Yes, of course. If India outpaces China in terms of GDP growth this year—and that seems a slam-dunk at this point—it would be the new growth leader among large-population nations. Or the US could have enlightened regulation, a lower tax burden, and a more collaborative executive branch and grow that much right here in the US. There are national elections in the US in barely more than a year. One never knows what a new and more economically enlightened administration might do to free American innovators from the shackles that currently bind us.
So does the Fed’s schedule for raising rates determine the course of the market? No. It has an effect, though not a great one immediately. Now if they raise rates 4 times in 6 months or in galloping 1/2% increases every time, it will have an effect. For those few of us old enough to remember Edson Gould’s famous “three steps and a stumble” rule, it will take more than a single, simple, small rate increase to hold anyone's continued contemplation.
If that’s the case, then what did make this market suddenly so volatile? It was time. The market has risen almost non-stop from the day in March 2009 when it finally hit bottom the last time around. All the signs of market fatigue have been there for months now. This is evidenced by the fact that most companies’ revenues have declined, followed by a year-on-year decline in earnings. The stock price is then levitated by corporate buybacks and by Wall Street analysts steadily lowering their earnings forecasts, over the 12 weeks between earnings announcements, from $2 per share to $1.92 a share to $1.83 a share to $1.75 a share so they can trumpet (declining) earnings of $1.76 a share as “beating estimates.”
The other factor that clearly shows both market fatigue and investor confusion is that the S&P 500 is up, yet most of their stocks are down. How can this be? Easy — it has happened many times before. In the 1960s and 1970s, for instance, they had the Nifty Fifty “one decision” stocks marketed as the safest of the safe and the biggest of the big, all with (what proved to be illusory) moats that all but guaranteed these companies would do well even in a bear market. Not so.
Repeat after me, “No long position does well in a real bear market.” For the most part, the Nifty Fifty fell during the Chinese water torture bear that was the mid-70s until 1982.
Our current variation on this theme is the Internet / search / social media Terrific Ten or Fabulous Five. Make no mistake — most stocks have been declining since May but their decline has been masked by the market-capitalization-weighted performance of the S&P 500. The broad sector called “Information Technology” is 20% of the S&P. As a matter of fact, Apple (NASDAQ:AAPL) is the biggest constituent. Through July 21 this year, when the rest of the market began to exert a pull on even the Fabulous Five, AAPL was up 22%, Facebook (NASDAQ:FB) was up 28%, Google (NASDAQ:GOOGL) was up 29%, Amazon (NASDAQ:AMZN) was up 65%, and Netflix (NASDAQ:NFLX) was up 138%. Companies that big up that much can really skew the index!
But they can’t forever hide the underlying weakness. That’s why one of the many indicators we review for ourselves, our clients and our subscribers is the Relative Strength Index. RSI measures the velocity and magnitude of price movements. It is a simple indicator that basically compares the number of higher closes to lower closes of the market, forgetting all the intraday noise. The signal that emerges of late is that it has just violated its channel on the downside (more S&P days closing lower than higher.) It is but one indicator we review but, in this case, it may be the final straw. And that’s the way we’re now positioning.
If you agree, you might consider hedging your current long portfolio with some of the inverse ETFs we have employed and discussed previously, like Direxion Daily CSI 300 China A Share Bear 1X Fund (NYSE:CHAD), Ranger Equity Bear ETF (NYSE:HDGE) and ProShares UltraShort MSCI Emerging Markets ETF (NYSE:EEV). Or others we own in slightly lesser quantity like ProShares UltraShort Russell2000 ETF (NYSE:TWM) and ProShares UltraShort S&P500 Fund (NYSE:SDS). Either way, as Sergeant Phil Esterhaus of “Hill Street Blues” used to say at the end of each roll call, “Hey – Let’s be careful out there.”
Disclaimer: As Registered Investment Advisors, we believe it is essential to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as "personalized" investment advice.
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