I love the weather! Just as it is a reliable conversation starter (everyone has an opinion on it), it provides seemingly unlimited analogies to the financial markets for me to write about. That’s because while many attempt to forecast both, the weather and the markets are moved by an endless stream of random events.
Like everyone else in the Midwest, last week we were stuck in a deep freeze. We even closed the office (except for essential trading functions) on Tuesday, something we rarely do in the face of bad weather. (Thank you for your patience if you tried to contact us on Tuesday.) The title of last week’s Hotline was “Snowed In” and it was accompanied by a picture of my backyard under over a foot of freshly fallen snow.
As the picture today (a week later) shows, the setting has changed. Yes, we still have snow on the ground, but a lot has melted. Look at the lake, though. It’s covered with puddles caused by melting ice. After a week of below-zero temperatures, we now sit at over 40 degrees on the thermometer.
The ice that covered the lake a week ago was frozen solid. One look and you knew (and felt in your freezing toes and finger tips) that it was safe to walk upon it. Soon neighbors were snowmobiling, walking the dog and playing hockey on it. Today… not so much! Would you walk on it?
Just a week later, and everything has changed.
So it goes in the financial markets. If we start to take something for granted, you can bet it will soon change. Now don’t get me wrong. Just because last year was a great year for our client accounts and the stock market indexes does not mean that I expect stocks to fall through the ice this year. On the contrary, much of what I review and feel is important to charting the course of the stock market over 2014 points to further gains in the new year.
As I said last week, however, I do expect stocks to be more volatile this year. While we only saw some 5% declines in 2013, I would not be surprised to see some 10% downturns during the course of 2014. But by year end I expect stocks will have rallied by more than the prevailing 10-year bond rate and that makes them a better long-term investment option.
At the same time, over the last two weeks I have explained how the short-term overbought nature of the market and mid-January seasonal weakness could mean some temporary downward pressure on stocks. Tracking both our Political Seasonal Index and the average daily returns for the second year of the Presidential cycle suggests weakness commencing this week.
In addition, a relatively rare event occurred last week. Twice during the week, stocks and bonds moved higher on the same day. One wouldn’t think this to be rare; yet reviewing the data we find that it has only occurred 22 times over the last decade. During the following week, the S&P 500 Index has lost ground 73% of the time!
Still, it’s hard to watch the markets on a Monday and not feel negative. In 2013, Mondays were the only day of the week that the market averaged negative results. And so far this year stocks have followed that script.
Source: Bespoke Investment Group
So the weakness today, while consistent with my expectations, is hard to view as a confirming indicator. We will need to see some follow through over the rest of the week before we can declare that that is the case.
Today’s downturn is being blamed on fears of earnings weakness. As we start earnings season, analysts have been downgrading their expectations at a rate of about 1.5 downgrades for every one upgrade – the worst ratio at the commencement of any reporting period since this bull market began in 2009. Yet the previous record was at the beginning of last year. See the difficulty? Thirty percent gains were registered last year!
Similarly, in most years, earnings season has tended to yield below-average returns. When we are outside of such periods, the stock market has actually yielded higher returns. Yet in this bull market the opposite has occurred. The market has been performing best during these periods and usually in the face of lowered analyst expectations.
Source: Bespoke Investment Group
What’s an asset manager to do? What’s an investor to do?
I don’t believe the answer is to just hunker down into a buy and hold position. Nor do I believe you need run out and immediately buy stocks. Instead, what I do personally is put most of my investable dollars into actively managed portfolios where I let the historical tendencies govern my investment posture. I believe a strategically diversified portfolio of actively managed strategies and indexes will respond best to whatever the weather brings.
All the best,
Jerry
© Flexible Plan Investments
