Commentaries

The Envestnet Edge, January 2016

Markets are a mess, but don't jump to conclusions yet

Download the full PDF

2016 has not been a happy new year for investors thus far, with a January plagued by market volatility and some of the worst index returns observed in years. Have these first few weeks set the stage for disastrous markets throughout the rest of the year?

In case you have been otherwise engaged, it will not come as news that this has been a month marked by market turmoil. As far too many commentators and analysts have emphasized, the first two weeks of the year marked the worst start for U.S. equity markets ever. The S&P 500 was down 8% in the first ten days of trading. Global markets, starting with China, were even weaker, and the energy and commodities markets continued their 2015 swoon, with oil plunging below $30 a barrel to lows not seen in more than a decade.

What that rather dismal start means for equities, however, is another story entirely. The mantra for investors is: don’t panic at the first sign of volatility, and rarely has that been more apt than this past month. The other mantra should be to ignore the naysayers of doom as much as possible. It is always possible that this is the start of the Big One, and it is always incumbent on all of us to assess whether now is that time. That said, now is not that time.

Rather, it is precisely the moment to ease off the fence many of us have been perched on these past months while waiting for some clarity. The year ahead remains as unknown as ever, but a substantial pullback in stocks and lessening volatility in bonds offer a slew of opportunities.

Reading the signs

There’s no dearth of those making the bear case, and it’s the same case that’s been made repeatedly the past few years: too much easy money from central banks did little to boost the real economy, and instead created asset bubbles that now are deflating. Stocks are exhibit A for this argument, which continues in the vein that earnings are slowing, prices for equities and bonds are frothy, the energy complex is collapsing, and dangerous volatility is returning now that the Fed no longer is dampening it.

There is one equivocally accurate aspect of the bearish stance: energy and commodity prices are collapsing along with global demand. Oil may soon “find a bottom,” either around $30 or in the $20s, especially if Saudi Arabia and OPEC shift gears and agree to curb output to prevent further price erosion. But most experts (including those who did not see these price falls a year ago) agree that
these sharp resets in commodity prices and global supply (too much) and demand (too little) have in the past lasted many years, rather than months, and there is little reason to suppose that this time is different.

Outside the oil and commodity complex—along with some waves negatively affecting industrial companies whose contracts have been cancelled—the bear story lacks heft. Or rather that story has been in play for some time, and while a global rout cannot be dismissed as a possibility, it lacks several key fundamental ingredients.

First among these is global economic weakness that extends much beyond the oil, commodity, and related industrial industries. Although it is likely that Brazil, South Africa, Russia, and other smaller countries could see significant dips into recession, such signs are not evident elsewhere. Yes, the International Monetary Fund (IMF) recently lowered its estimate of global growth from 3.6% to 3.4% in 2016 to adjust for that weakness, but that rate still represents expansion, not contraction, and much of that will be felt outside Europe and Japan, and hence in the developing world.

There is global weakness, in short, but it is insufficient to fuel a financial market meltdown. The high-yield and emerging market fixed income stress that was evident at the end of 2015 has stabilized in spite of the equity volatility of late, even though the fundamentals of those sectors barely have budged. That is a good indication (albeit short term) that this weakness is not yet causing general contagion.

The second ingredient is that although China may be rocky and transitioning, it clearly is not imploding. The fear at the beginning of the year was that structural liabilities and hidden debts in China, along with capital flight and plunging stock markets, presaged the long-feared “hard landing” of the Chinese economic miracle. While the government-reported 6.9% GDP growth was met with some skepticism in mid-January, Apple’s iPhone sales reported on January 26 are not amenable to the same political pressures. Even though Apple CEO Tim Cook noted some roiling in the Hong Kong market, Apple still managed to generate $18 billion in revenue in China, up more than 50% from the year prior. Wall Street analysts judged Apple’s quarter a mixed one based on expectations, but that says more about Wall Street’s expectations than either Apple’s performance or China’s economy.

The final point is the valuation of stocks and interest rates. A 15x multiple on the S&P 500 based on earnings of $120 for 2016 makes the index neither all that cheap nor all that pricey. There is the usual heated debate about what the proper multiple should be. That debate never has been settled, and it will not be now. But the idea that there is a perfect multiple that tells us when to buy and when to sell is an illusion.

Only in rare cases, such as the extreme multiples of the NASDAQ in 1999, can we say stocks are either genuinely too cheap or expensive. Investors always are weighing where and how to invest, and the cost of each asset always is assessed relative to other assets. So multiples on stocks must be judged in relation to interest rates, to inflation, to the growth rate, and to what returns theoretically are available elsewhere. Prices do not exist in a vacuum.

It is fairly impossible to conclude what the right price of equities should be, just as it is a parlor game with no resolution to game out what interest rates would be without central bank intervention. What is clear is that rates are low globally where banks are modestly tightening (the United States and the United Kingdom) and where banks have a loose monetary policy (the European Union and Japan). Although there has been an upsurge in volatility in stocks, that situation has not been evident in the credit markets, which would be a more troubling sign of systemic weakness.

Stocks have sold off significantly, and indeed the majority of names are down more than the 10-15% that the indices were in mid-January. That is a normal correction, which was made much more dramatic because it took place at the beginning of the year, and hence was perceived as a harbinger. That too is a mistake. Over the past 35 years, January has been an ambiguous gauge at best. Sixty percent of the time when January ended down, stocks ended down for the year, and 40% of the time they ended up. Hardly a strong signal, but one that generates much noise.

What to do

What remains unknown, of course, is what is unknown. Few knew in 2008 that the housing bubble was attached to a much greater and far more dangerous derivatives and bundled security bubble. There is no sign today that debt problems in China are magnified by either of those issues, nor does it appear that the leverage in the energy and commodity space has been magnified and securitized to anywhere near the degree that housing was in 2006-2008. That doesn’t mean that we are in the clear—only that it does not
seem likely we are in circumstances resembling 2008.

We may, of course, be in for a prolonged period in which neither stocks nor bonds move much overall, but instead oscillate significantly month to month. That was certainly the case for much of the 1970s. The goal in such times is to identify sound fundamentals and pick good price points that volatility inevitably provides. We have been through a period of downward resetting, and unless you believe that we are on the verge of a major decline, this is when you look to buy—carefully and deliberately.

It’s not about trading and timing. Rather, it is about the calculus of collapse versus chugging along. Whenever the collapse narrative reaches a crescendo, and markets roil in response, fundamentals disappear, and the long-term is forgotten. That is the time for investors to invest, and those times are as precious as the long months of low volatility that characterized much of 2014 and the early months of 2015. This has been a challenging period, but unless there is fundamental fuel to feed the market frenzy, we will look back at these months of reset as the perfect opportunity to position for the future, and not the time to seek shelter from the storms.

January Take-Away:

This month’s volatility is an ambiguous gauge for what lies ahead, rather than cause for panic. Global weakening signaled by the reset in commodities and oil has been confined largely to a few countries, and appears insufficient to fuel a major meltdown. China’s economy is in transition, not imploding, witnessed by its coffers contributing $18 billion in revenue to Apple, a 50% increase year over year. Equity valuations are in line relative to available returns in other asset classes. Times like these offer investors a slew of opportunities to identify situations with sound fundamentals and attractive price points to invest carefully and deliberately. And in conjunction with rebalancing portfolios and revisiting financial objectives, investors can be better prepared for—and take advantage of—even more waves of volatility.

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results. Indices are unmanaged and their returns assume reinvestment of dividends and do not reflect any fees or expenses. It is not possible to invest directly in an index.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet | PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Neither Envestnet, Envestnet | PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2016 Envestnet, Inc. All rights reserved.

Featuring

Articles By This Author

The Envestnet Edge, May/June 2018 Video: Five (Investing) Rules To Live By The Envestnet Edge, March/April 2018 Video: Buy The Dips Video: No Place Like Home? Market Bias Perceptions and Realities The Envestnet Edge, February 2018 The Envestnet Edge, January 2018 Video: Raging or Aging: How Much Longer Will the Bull Last? Webinar Replay: 2018 Market Outlook The Envestnet Edge, December 2017 Video: Bitcoin, Bubbles, and the Bigger Picture The Envestnet Edge, November 2017 Video: Taxes are certain, but don't obsess about tax reform The Envestnet Edge, October 2017 Video: Time to stock up on growth or value? The Envestnet Edge, September 2017 Video: Time To Take A (Measured) Risk? The Envestnet Edge, July/August 2017 Video: Bitcoin: Buy Or Buyer Beware? The Envestnet Edge, June 2017 Video: FANG, FAAMG: Too Big a Bite of the Market? The Envestnet Edge, May 2017 Video: Invest "As If" The Envestnet Edge, April 2017 Video: What To Do In Quiet Markets The Envestnet Edge, March 2017 Video: Bull Or Bear: Should Investors Still Care? PMC Weekly Review - March 10, 2017 The Envestnet Edge, February 2017 Video: Separating markets from politics, is it really a "Trump rally"? The Envestnet Edge, January 2017 Video: Investing in Trump’s Economy? Proceed With Caution The Envestnet Edge, December 2016 Video: Have We Only Just Begun? The Envestnet Edge, November 2016 Video: Rotations, Reversals, Rising Rates: A Time to Reposition Post-Election, Will Markets and Portfolios Emerge Winners or Losers? Webinar Replay: Post-Election Winners and Losers The Envestnet Edge, October 2016 Video: In a 2-2-2 world, look for modest economic growth and expansion PMC Weekly Review - September 16, 2016 The Envestnet Edge, September 2016 Video: Diversification is working in 2016 (so far) The Envestnet Edge, July/August 2016 Video: Valuations: it's all relative Brexit: Plunging into the Unknown? The Envestnet Edge, June 2016 Video: Equity valuations and bond yields: reach no further PMC Weekly Review - June 17, 2016 The Envestnet Edge, May 2016 Video: Hitting singles: a measured approach for this investing season The Envestnet Edge, April 2016 Video: Investing with impact: increasingly a matter-of-fact Video: In this election cycle, will investors be winners or losers? The Envestnet Edge, March 2016 PMC Weekly Review - March 11, 2016 Video: In a low-growth world, less could be more The Envestnet Edge, February 2016 The Envestnet Edge, January 2016 Video: Markets are a mess, but don't jump to conclusions yet A Most Challenging Year Video: Interest Rates and Energy: The Highs and Lows of Year-End The Envestnet Edge, December 2015 The Envestnet Edge, November 2015 Video: We'll always have Paris The Envestnet Edge, October 2015 Video: Politics and the markets: déjà vu all over again? Video: China, Commodities, and Crisis: What's Next for Emerging Markets? The Envestnet Edge, September 2015 PMC Weekly Review - September 11, 2015 Is This The Big One (Financially Speaking)? Probably Not. The Envestnet Edge, August 2015 Video: In a "meh" market, look again at U.S. stocks The Envestnet Edge, July 2015 Video: Is this the Big One? What to do in a financial crisis Don't Worry About China Don’t Believe the Hype About Greece The Greek Catastrophe Is Finally Here (Unless It Isn’t) The Envestnet Edge, May/June 2015 Video: When Following the Herd is Risky, Where is the Safety? The Envestnet Edge, April 2015 Video: The End of Short-Termism is Long Overdue PMC Weekly Review - April 24, 2015 The Envestnet Edge, March 2015 Video: Keep Your Friends Close and Your Robo-Advisor Closer The Envestnet Edge, February 2015 Video: The Return of the Comeback: Is 2015 the Year for International Stocks? PMC Weekly Review - February 13, 2015 Why the Jobs Report Means Diddly Don’t Turn America Into Europe PMC Weekly Review - January 23, 2015 Video: Active and Passive: The Yin and Yang of Investing The Envestnet Edge, January 2015 Will Politics in 2015 Catch Up with the Economy? Video: Our Perspective on 2015: Maintain Yours The Envestnet Edge, December 2014 PMC Market Commentary: December 12, 2014 No, This Is NOT the '90s Economy Again PMC Market Commentary: November 14, 2014 Video: 2014 U.S. Midterms: A Win for Stocks? The Envestnet Edge, November 2014 Whose Economy Will It Be in 2016? PMC Market Commentary: October 17, 2014 Video: Special Video Commentary: Market Volatility and Fundamentals The Envestnet Edge, October 2014 Video: You Know What’s Not Sustainable? Ignoring the Opportunity in Impact Investing Don’t Panic! PMC Market Commentary: October 10, 2014 Greenberg’s Folly Naomi Klein Is Wrong PMC Market Commentary: September 26, 2014 Subprime Loans Are Back! The Envestnet Edge, September 2014 Video: When it Comes to Interest Rates, Who Says What Comes Down Must Go Up? PMC Market Commentary: September 12, 2014 Why Indie Bookstores Are on the Rise Again The Fed Is Not As Powerful As We Think PMC Market Commentary: August 22, 2014 Americans' Sour Mood on the Economy Doesn't Square with the Fact The Envestnet Edge, August 2014 Video: The World is in Crisis... the Markets are not PMC Market Commentary: August 8, 2014 PMC Market Commentary: July 25, 2014 Punitive Damages Video: Market Valuations and The Theory of Relativity The Envestnet Edge, July 2014 Don’t Kill the Export-Import Bank. Clone It. How India’s Economic Rise Could Bolster America’s Economy Video: Separating Risk from Reality PMC Market Commentary: June 27, 2014 No Sex Please, We're French PMC Market Commentary: June 13, 2014 The Envestnet Edge, June 2014 PMC Weekly Market Review, May 23, 2014 The Envestnet Edge, May 2014 Don't Bet on Rising Wages PMC Market Commentary: May 9, 2014 The Sharing Economy: Why Are So Many So Afraid? PMC Market Commentary: April 25, 2014 The Obsession with CEO Pay Won't Help the Middle Class PMC Market Commentary: April 11, 2014 Time to Face Reality: Our Unemployment Problems Are Structural PMC Market Commentary: March 28, 2014 In Defense of Relentless Optimism The "Made in China" Fallacy Forget GDP - Use Big Data