Thursday, July 31, 2014

Today's significant equity market decline is difficult to brush aside

During 2014's slow but steady move upward in the equity markets, there have been some days of poor performance, even most of the month of February, but almost any downturn has been relatively quickly shrugged off.  Today's decline is a little more alarming.

It was uniformly negative.  The Dow was down 2.07, the S&P down 2%, the total market index down 2.01%, the small cap extended market index down 2.07%, the mid-cap 400 down 2.07%, and the QQQ down 2.02%.  This was obviously not a sector driven or market cap driven decline.  It was affected all U.S. equity categories.

Was it simply just some end of quarter wipe out to set up better performance for later in the year. Not likely.  It looked like widespread profit taking as some of the stocks with the best performance in all sectors took the biggest tumbles.  Was it also significant liquidity building based on the expectation of more negative performance ahead or, on the other side of the coin, better opportunities ahead.  Could it have just been building a bigger wall of protection, meaning building bigger cash positions to protect against the possibility of some longer term economic and geopolitical issues ahead.  Then again, was it just an early morning market fall that gained momentum as the herd felt as if it could not be ignored.

All or most of these factors are possibilities.  Certainly the deteriorating situation with Russia is not helpful, the Israel Gaza war is unsettling, the collapsing of a Portuguese bank provided no help, the default of Argentina on its debt being upheld by the courts means some upheaval broadly although that is not such an unusual event every ten years or so, and given all of that is there just a growing sense that overseas economies are not participating in the modest U.S. style recovery, not just in many emerging markets but in some of Europe as well(it should be noted that EEM, the emerging markets index that is dominated by larger cap names within that sector has had a meaningful rebound over the last six months, but did drop 1.75% today, participating with everyone in the fall).

The problem with this explanation is that none of this is really news.  Put it all together however, and it does add up to a possible troubling alert to some institutional investors and just one more reason for retail investors to keep hoarding their cash.

As to the U.S., jobless claims were at an eight year low, corporate earnings for approximately three quarters of mid-sized to large corporations have met or exceeded expectations so far, and U.S. wage growth(labor costs) had the highest gain in five years.  It must be noted that those companies that did miss their earnings or revenues targets were often heavily penalized by those who were disappointed.

Apart from those minority of shortfalls, in the aggregate this is all good news for the economy at large but for the equity market it raises a red flag.  Will interest rates and inflation begin to rise sooner than expected and thus increase the cost of capital for calculating equity values.  That must eventually happen to have a stronger economy, but the market wants it to be painlessly gradual, and not something that comes sooner than expected.  This could well be another reason for today's rout.

Today's experience may not be extended tomorrow but it is unlikely that the losses will be recouped either.  There is a lot to think about now for investors.

One thing that is not an issue is the one mentioned by some of the more out of touch CNBC and other media contributors and that it now is summer and everyone is on vacation.  That's a pre-1995 truism that some floor traders and pundits still repeat.  Communications technology does not allow lead steers or successful portfolio managers in the market to step aside, nor have they ever really desired to do so. Volumes have not decreased markedly, and on some days have been relatively strong.  The thought that this is an old time vacation time slump is a joke.  There is something real going on here, and we will as always learn more in the coming days and weeks.

Opportunities and weaknesses will soon become more clear.  The answer here is of course stay the course for the moment, trim a few big gainers that look frothy and maybe pick up a company or two that have been envied but too expensive.  Also, let the indexes ride.  Whether today was a constructive reset or a harbinger of coming market challenges is unknown amidst all of the somewhat informed but personal speculation in this speculative post.


Post a Comment

<< Home