20 Jan 2016 Beacon Flash – New Market Disturbances
Today we experienced yet another round of greater-than-usual market volatility. We empathize with your concerns. While we cannot say how long or how deep the declines will go, it may be helpful to give some insight into some of the underlying causes, look at what the impact has been on the major asset classes, and to provide some historical reference to put it into context.
The catalyst, once again, is a slide in oil prices taking futures below their earlier-established floor of $30.00. The fresh weakness has re-ignited fears that the slowdown in China, Europe, and the developing world could impact the US economy more seriously than earlier thought. According to the Wall Street Journal, “much of the 19-month oil-market selloff has been driven by concerns about ample supplies. What’s increasingly weighing on investors is the fear that demand growth is wilting, particularly in China, which could reflect deeper economic woes.” ESAI Energy LLC quoted in the WSJ today said that the pace of demand growth in China from 2015 to 2030 will be 60% slower than the pace of demand growth from 2000 to 2015.
In Davos, Switzerland, where top corporate CEO’s from around the world are meeting for the annual World Economic Forum, the mood is less sanguine than in years past. A poll of 1,409 of them from 83 countries indicates that only 27% think global economic growth will improve in the coming year compared with 37% last year and 44% in 2014.
One of the best gauges of investor fear is interest rates, specifically US Treasury rates. Treasurys, unlike gold or cash, are seen as safe havens that offer a return (aside from any appreciation that occurs when uncertainty becomes persistent). The latest volatility in stocks has caused an “inversion” of the yield curve where short term rates are higher than long-term rates. Usually bond holders demand higher premiums (higher yields) on long-term bonds to offset the risk of inflation down the road. At least two forces are at work to cause this unusual event (that has become more usual since the financial crisis of 2007). One is that investors and traders are rushing into longer-term bonds for return reasons, albeit small, with little concern for inflation. Traders will be out long before inflation worries return while longer-term investors believe that inflation will remain low for years to come due to persistently weak economic growth and heavy debt loads.
Current rates provide the second reason for inversion. There remains a slight threat (though it’s fading with each market drop) that the Federal Reserve will continue its monthly policy of raising interest rates (these moves directly impact short-term rates) to more normative levels. But the latest release of Fed meeting minutes argues against an increase soon. Many Fed members were shown to be against the December increase pushed by Chair Janet Yellen. The latest round of economic uncertainty strengthens their case and resolve for standing pat.
Where all this really matters of course is in your portfolio. Since the beginning of the year the Total US Stock Market Index (our core equity holding) is down 7.5%. The more widely reported indexes, the Dow Jones Industrials and the S&P 500 are down 10.5% and 10%, respectively. Over the same period, our ‘shock absorber’–the 7-10 Year Treasury Index–is working just as designed, up 3.3%, dampening the bumps in your portfolio caused by stock volatility. The indexes we use to build our portfolios through last night’s close are down as follows: (these index returns are not actual portfolio returns and they are gross of fees. Past performance is no guarantee of future results.) The portfolios are named for their percentage of equities – the Beacon 30 contains 30% stocks and 70% 7-10 year US Treasurys and cash.
Finally, there’s nothing like good ol’ fashioned perspective when all the media can do is fan the emotions of our fears. Michael Batnick of the Irrelevant Investor provides some great observations in the context of market history going back to 1928. The details may be difficult to read in the chart below, but the imagery tells the story. It depicts annual annual returns of the S&P 500 along with the worst decline for the index during that same year. For instance in 1928 (far left) the S&P was down 10% at one point during the year, but finished up 44% by year’s-end.
Here are Michael’s observations from the annual data:
- The S&P 500 began the first ten days of this year with an 8% loss, it’s worst opening performance ever, and worse than 98% of all ten-day returns. Still, there are 475 10-day periods that are worse than the 2016 10-day open.
- The average declines within any year period of the S&P 500 is 16.4%.
- Double digit annual declines are to be expected – They occur 64% of the time.
- It is not unusual for double digit declines to reverse significantly: 57% of the years with 10% draw-downs or more finished positive for the year.
- Stated another way, 36% of all years saw a double digit decline and still finished in positive territory for the year.
- Draw-downs of 20% or more happened 23 times since 1928, or 26% of all years. On five of those 23 occasions, stocks still finished the year up.
It’s easy to let our imaginations run a bit wild, especially when fanned by our insatiable appetite for news and unlimited access to it. Media outlets are all too eager to sensationalize their coverage, because their revenues are driven by the amount of time we spend with them.
To paraphrase President Franklin Delano Roosevelt, “the only thing we have to fear” ‘is the media’ (and any of our friends who have bought in to the point of allowing their emotions to rule them).
If you are concerned in any way, please give us a call.