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When markets swing, we often warn readers of the cost of trying to time corrections—sharp, sentiment-driven stock market drops, usually of -10% to -20% or so. Human nature often drives investors to want to flee stocks at the exact moments market history shows they are far better off holding—or even buying. “Don’t time corrections” is an easy message to swallow when stocks are doing fine, but it is a very tough sell in real time. When stocks fall fast, getting on the sidelines can feel better. But it can also lead to missing big upside when stocks recover, setting you back from your long-term goals.
It is an unfortunate truth that market movement drives many investors’ decision-making. Fund flows are an imperfect measure, but they do suggest many folks buy after stocks rise and sell after they fall. That certainly appeared to be the case last year. The S&P 500 had two corrections—one in winter, one in autumn. The first was basically a double-bottom correction, reaching its low on February 9 and retesting it on March 23. As Exhibit 1 shows, equity fund outflows spiked both times. In March, they continued even after stocks began recovering. That same mentality showed up—on steroids—in December, as US stocks dealt with their second, much sharper correction. Stock fund flows turned negative in December’s second week, when the selloff started in earnest. They bottomed out the week ending December 28, a period including the Christmas Eve low and a big December 26 rally. And they continued the following week, even as stocks rebounded. People were responding to what just happened in the market, presuming it would continue and snowball. But by trying to steel themselves against what just happened, they took themselves out of the running to capitalize on what was to come.
Exhibit 1: US Equity Mutual Fund and ETF Flows
To sum up the UK’s last two days, everything and nothing happened. Yes, UK Prime Minister Theresa May’s controversial Brexit deal bombed in Parliament on Monday, losing by over 200 votes. Then the opposition Labour Party’s leader, Jeremy Corbyn, tabled the obligatory no-confidence motion in May’s government, threatening to bring her down and force new elections. But surprising no one, her party and its Northern Irish allies didn’t want to do anything that could lead to Corbyn taking power, and Parliament voted 325 – 306 to keep May around. So after two days of political theatrics, nothing has changed. A deal no one expected to pass didn’t pass. A PM everyone expected to remain in office remains in office. And still no one knows what Brexit will look like. Our opinion also remains unchanged: Simply getting on with Brexit, whenever that happens and whatever it looks like, should end the uncertainty that has held back risk-taking and investment, enabling investors and stocks to get over it and get on with life.
Officially, May’s next step is to talk with other party leaders and figure out a Brexit compromise Parliament and the EU will support. She has three working days to create this Plan B, which she must present to Parliament on Monday. We suspect she will take advantage of EU leaders’ tendency to hold emergency talks on weekends in order to get their agreement on something by her deadline.
What that “something” will be is far from clear. Labour is as divided over Brexit as the Conservatives are. The party’s anti-Brexit grass roots and (Tony) Blair-ite wing mostly prefer a second referendum. A few dozen other Labour MPs reportedly prefer a deal similar to Norway’s arrangement with the EU, which the Scottish National Party may also support. Corbyn’s own opinion on Brexit is an enigma wrapped in a mystery locked in a box and buried underground. He has proposed a permanent bespoke customs arrangement between the EU and UK, but whether the EU would bless a customs union that would also satisfy the Conservative Party’s arch Brexit supporters, who want national sovereignty over free trade and regulatory policy, is another matter. And then, of course, there is the matter of the Irish backstop, which kept a large swath of May’s party from supporting her Brexit deal. Looming over everything is March 29, the day Brexit is supposed to take effect. May hasn’t ruled out delaying this, and some of her cabinet members have said it is a possibility. Though, this would depend on the EU agreeing to an extension beyond the two-year exit process stipulated in Article 50 of the EU Treaty.
Last year’s yield curve fears centered on some segments of the yield curve we find arbitrary and meaningless—the 10-year minus 2-year, 5-year minus 2-year and 5-year minus 3-year spreads. Because banks generally don’t fund themselves at 2 or 3-year rates, none of these gauges correspond to banks’ business models or propensity to lend. But this year, commentary has started shifting to a more meaningful yield spread—the 10-year minus 3-month—which is near its flattest point of this economic expansion. The question on folks’ minds: Will it invert soon, and if so, do dark times lie immediately ahead?
The yield curve is one of the most telling economic indicators on the planet. It influences and predicts loan growth, because banks borrow at short-term interest rates and lend at long-term rates. If it is positive, with long rates above short, then lending is profitable, incentivizing banks to funnel capital to businesses and households. If it is inverted, with short rates above long rates, then banks’ funding costs exceed potential loan revenues, rendering lending unprofitable. If the yield curve stays inverted for long enough, it can cause credit to freeze, starving businesses of the capital they need to expand.
Yet none of this means the yield curve is a timing tool—especially not any single country’s yield curve, even a country as big as America. While an inverted yield curve has preceded every US recession in modern history, there is usually a lag between inversion and recession. As Exhibit 1 shows, there were even four times where the yield curve inverted without a bear market beginning within the next 12 months. On these occasions, selling stocks when the yield curve inverted would have led to missing out on some occasionally big returns.
In this episode, Client Communications Group Vice President Naj Srinivas speaks with Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher about 2018’s end-of-year volatility and his market forecast for 2019.
Reading financial media lately, you might get the impression the global economy is grinding to a halt, hamstrung by a lack of bank liquidity that is starving businesses of funding. The coverage implies a global credit freeze is underway. Yet the data don’t agree.
Exhibits 1 and 2 show loan and money supply growth for all nations in the MSCI All-Country World Index on a GDP-weighted basis. Despite its name, this gauge doesn’t include every nation on earth—just those classified as developed or emerging by MSCI. However, the 47 nations it presently covers amount to the vast majority of global GDP. Each country’s lending and money supply are weighted according to the country’s share of collective GDP, making the result a reasonable proxy of global lending and money growth. As you will see, while both measures have slowed in recent years, they remain at quite healthy rates. Global lending has risen 6.0% y/y or higher every month since October 2014. M2, which is the broadest measure of money available from all these countries, has slowed, but it remains robust—5.9% y/y in November. These figures are consistent with a growing, thriving global economy—not frozen credit markets. With few folks fathoming capital flowing to businesses and households, the stage seems set for positive surprise.
Exhibit 1: Global GDP-Weighted Loan Growth
Whether stocks are in a correction or bear market, the downturn’s final throes usually have a few common features. Often, they are steep, with end-of-the-world type stories everywhere in financial media. That backdrop, combined with seemingly erratic daily index movement, spooks investors out of the market. To use a bit of jargon, they capitulate to negativity and throw in the towel. Usually, that exodus happens very near the bottom.
Stock mutual fund flows are one, albeit imperfect, way to see this. They aren’t airtight, as they show you only one half of a decision. We can see people selling mutual funds, but we can’t see what they did with the proceeds. For this reason, run-of-the-mill fund outflows tell you very little about market sentiment. However, extremes can. And in December, extreme they were. Stock mutual fund outflows as a percentage of funds’ assets under management were on par with outflows in March 2009—the bottom of the bear market that accompanied the Global Financial Crisis. The only larger months were September 2001 (the 9/11 attacks), July 2002 (when Sarbanes-Oxley passed) and September and October 2008 (Lehman Brothers’ bankruptcy and the Fed and Treasury’s subsequent dismantling of Wall Street).
In other words, retail investors were acting like this is a major bear market or financial crisis. Yet that sentiment isn’t at all consistent with the economic landscape. Unlike 2001, 2008 and 2009, there is no recession—and there is little sign one lurks, based on the US Leading Economic Index’s continued long uptrend. Major, disruptive legislation on par with Sarbanes-Oxley isn’t on the horizon—a government that is one day from achieving history’s longest shutdown isn’t exactly the type to agree on sweeping change. Meanwhile, as of Thursday’s close, the S&P 500 was more than 10% above its Christmas Eve low, whipsawing those who capitulated.[i] Short-term volatility is impossible to predict, and it is possible some new scare story could send stocks careening back down for a bit. But absent that, it seems to us that spiking fund flows once again signaled a good time to buy, rather than a good time to sell.
In this episode, Client Communications Group Vice President Naj Srinivas speaks with Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher about bear markets, how they begin, their anatomy and timing. Recorded October 8, 2018.
The partial US government shutdown notched its 17th day Monday, officially tying 1978’s shutdown as history’s second-longest. It is also currently history’s most bullish shutdown, with a 5.5% S&P 500 return since December 21, the last trading day before the government closed.[i] And if it lasts until the weekend, it will surpass the 1995 – 1996 shutdown to claim the title of history’s longest. Exhibit 1 has the full leaderboard, in chronological order, and following it are some thoughts on a few shutdown-related news items.
Exhibit 1: US Stock Returns Surrounding Government Shutdowns
Editors’ note: Our political analysis is intended to be nonpartisan and focuses exclusively on political developments’ potential market impact. We favor no party, politician or ideology and believe political biases cause investing errors.
Last Thursday at noon Eastern, 10 newly minted senators and 101 new representatives were sworn in alongside their returning compatriots, officially kicking off a new Congressional session. Democrats took control of the House, while Republicans slightly increased their Senate edge. This is the classic recipe for gridlock—unpopular with many voters but positive for stocks, in our view. As the two parties butt heads and do little of substance, we expect markets to benefit.
Congressional gridlock isn’t new. Even with control of the House, Senate and presidency for the previous two years, Republicans didn’t pass much, as internal disagreements and their tiny Senate majority proved big obstacles—intraparty gridlock. Just a couple Republican defections could—and did—scuttle bills. The highest profile signed legislation was 2017’s tax reform—and even that wasn’t as sweeping as supporters and detractors portrayed. It also got watered down during passage. Heck, the 115th Congress closed amid a partial government shutdown—the third in a year—as the GOP didn’t have sufficient votes to overcome a partisan divide on border wall funding.
Confusion de Confusiones – Jose De La Vega
Whoever wishes to win in this game must have patience … since the values are so little constant and the rumors so little founded on truth. He who knows how to endure blows without being terrified by the misfortune resembles the lion who answers the thunder with a roar. … It is certain that he who does not give up hope will win, and will secure money adequate for the operations envisaged at the start. Owing to these vicissitudes, many people make themselves ridiculous because some speculators are guided by dreams, others by prophecies, these by illusions, those by moods, and unnumerable men by chimeras.
In today’s environment, there are no stronger words for those seeking to meet their long-term financial goals via the stock market. They come from Jose De La Vega, writing about the Amsterdam stock exchange (specifically, and mostly, the Dutch East India Company) circa 1688, 331 years ago. Confusion of Confusions is thought to be the first book ever about the stock market. This amazing work of striking insight has scarcely been improved upon since, and it is the little book I return to whenever the “confusion,” i.e., market volatility, grabs our attention most.