Clearly the bulls and the bears are fighting it out in the trenches now. Today’s market action typifies what happens when these forces collide in an effort to control the trend. Understandably, this volatility has some worried, especially in the context of the military buildup in Ukraine.
- Ed, I’m getting a little concerned about the situation in Ukraine. What do you think? Is the market going to tank if the fighting starts? Tough question, but should I have a plan?
Actually, the question is not so tough; it is the answer that presents difficulties because, as is often the case, the market can move on a single issue, such as a rumor, or it can move on two unconnected events happening at the same time, such as geopolitical strife and a perceived overvaluation in certain sectors (think technology and biotechnology), or it can move on several catalysts connected, disconnected, or, simply, coincidental. Thus, any answer is not simple, so a lengthy discourse is required to adequately address the question.
My point: predicting dramatic market movement on any single event, or any combination of events, is nearly impossible and predicting is what the TV talking heads and celebrity analysts do. Other folks look at the market drivers, such as the economic and market fundamentals (retail spending, consumer sentiment, earnings, and margin debt for example), the global economic context (the economies of the US, China, Japan, Europe), as well as geopolitical events, such as Ukraine, and then make a guess for the immediate future and the longer term in the context of the macro view, not the latest “catastrophe di jour.”
My guess is the Ukraine/Russia military buildup will exacerbate the current market volatility only as long as the political bluster is credible, and if Russia decides to “send in the troops,” the short-term effect on the market will be harsh, but, that too will pass, just as the other recent “end of days” geopolitical events have passed and the market recovered (global financial collapse, Greece, emerging economies freak out, Iran, Syria, euro crashing, European debt crisis, Cypress, US debt default, and the list goes on).
One important reason the market will go on this time, even after it corrects (which it does when it perceives the need) from the Ukraine events or a perception that technology is too hot, is the US economic fundamentals are still intact and seemingly getting more sound as 2014 wears on.
- U.S. retail sales recorded their largest gain in 1-1/2 years in March in a decisive sign the economy is bouncing back from its weather-induced slumber.
Another, and arguably the most important reason the market should move upward after the Ukraine “storm” passes, is earnings. If earnings come in again within historical norms, as they have now for almost five years, the market will move up.
- U.S. consumers grew more confident in the labor market last month with younger workers in particular seeing a greater chance of finding work should they lose their current job.
This will happen because, ultimately, the most important reality for the market is earnings. Are companies making money? In times of economic growth, which has been the case for the almost the last five years, this has been the reality and the market has gone up. Keep in mind, serious money out there is seeing lots more money making in the near- and longer-term future.
- U.S. venture funds raised $8.9 billion in the first quarter, the most in six years and almost double the amount raised the year before, underscoring the growing enthusiasm of investors for start-up companies.
The argument that the liquidity and low rates the Fed has been providing is the only reason the market has been on an upward trajectory for so long is, simply, wrong. True, the Fed has contributed mightily, but, in the end, investors don’t bet on the market going up if the US economy is not sound and companies are making money (2000 and 2007), which has been and still is the case, at least up to this earnings season. We will see if the positive trend holds up, but my guess is it will.
Now, one thing that deserves a watchful eye, even more than Ukraine, is margin debt in the market.
- One thing which arguably is flashing as red a sign as it ever has is margin debt – money borrowed to buy securities. Margin debt hit an all-time high in February, according to the most recent reading from the New York Stock Exchange, up 27 percent from the year before and nearly 70 percent over two years.
Although I don’t see it as a problem relative to 2000 and 2007 for the simple reason that both those periods preceded major bubble pops and recessions, and, in the case of 2007, a near global financial collapse, I do see it as potential problem for the current market, as a selloff to correct that situation can go on for some time.
- While some margin borrowing can be used to bet against stock gains, the overall historical trend is for margin borrowing to trace the lines of exuberance in the stock market. Margin debt peaked, at lower levels, just before the tumble of 2000 and just after things began to get hairy in 2007.
Enter the Fed and its contributions to the market rally of the last five years.
- If anything the chief difference between today and 2007 or 2000 is not the story behind the technology or the mania for property. It is instead that we all know that, to some unquantifiable extent, the rally of the past several years has been engineered by official policy.
Again, it is true that the Fed has contributed mightily to the US economy and, thus, to the market, and it is now lessening its contribution (QE easing). It is also true that it is forecasting a rise in interest rates sooner rather than later (within a six months, more or less). Both of these catalysts contribute to a certain “freak out” from those who believe the economy and the market cannot stand on their own without Fed help, thus, the sell-off in the high flyers – take the profit and run. This too shall pass when the market digests the reality of the Fed stepping down and the US economy stepping up. As to margin debt, for now, I don’t see it as a problem because I don’t see a bubble popping, a recession coming, or a financial collapse in the near future. I see just the opposite.
The market will adjust and readjust in the context of Ukraine, Libya, Iran, China, Europe, Japan and the US, but, after the dust settles from the latest sales push from the breathless media and the hilltop screamers have wandered too far to be heard, and the talking heads have given their wisdom “full of sound and fury, signifying nothing,” the market will look for its cues from the global economic fundamentals, such as US and European data, and market fundamentals, such as earnings and excessive debt in the market itself.
For now, stick to your current plan, even if it means you take a nip now and then to calm the nerves and keep having fun in life.
Trade in the day; Invest in your life …
