Spokane Journal of Business

Deeper look at market factors makes them less scary

Neither China nor oil market is in dire straits right now

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With a tough start to the new year, I want to give you some information to help make informed decisions regarding your investments and not rely on headlines and sound bites. As Ben Graham so accurately pointed out, the day-to-day market isn’t a fundamental analyst; it’s only a barometer of investor sentiment. You just can’t take it too seriously.

A recent weekly American Association of Individual Investors survey found that only 17.9 percent of investors believe stock prices will go up over the next six months, marking the lowest level of bullishness since April 2005.

The survey, released in mid-January, also noted that bullish sentiment among investors has been below a historical average of 39 percent for 43 of the last 45 weeks, and has remained below 30 percent for seven weeks in a row.

Contrarianism can convert other investors’ emotional swings from a menace into a tool. That particular study has been used as a counterpoint for investors for a long time, as in doing the opposite of what the survey indicates. As Warren Buffet says, “buy when others are fearful…”

On paper, things aren’t a whole lot worse than they were at the prior low on Sept. 29, when the MSCI World Index closed 14.4 percent below its prior high (May 21, in U.S. dollars). Yet for many, the decline feels much worse—probably because most media commentary is a lot less calm. Then, “stay cool” was the media’s rallying cry. Today, we’re having a bull market in fear and forecasts of certain doom are everywhere. 

The S&P folk say that just over 50 percent of all annual periods for the S&P 500 since 1950 saw a 10 percent correction or worse. Since 1950, there were only four years—1954, 1958, 1964 and 1995—when stocks didn’t have a least a 5 percent correction at some point during the year.

They add that a bear market is a 20 percent decline from the highs. Based on the most recent highs for each index, for the S&P, that means 1,707. The NASDAQ would be in bear market territory if it hit 4,185. The bear level on the Dow would be 14,681.

Rising rates

I read recently that the market is “down because the Fed raised rates.” That just flat doesn’t make sense.

It’s been more than 2 1/2 years since Ben Bernanke talked about a tapering of bond purchases and the possibility of higher interest rates. How can investors not have had enough time to adjust to the possibility of higher rates and incorporate it into market prices? The idea that it was a significant contributor to the declines in December also makes no sense.

 I read too that, “Analysts and investors attribute the (auto stocks’ recent greater-than-market) declines to worries that rising U.S. interest rates could crimp auto finance and to fears that auto sales may have peaked.”

Does the interest rate outlook really mean significantly fewer cars will be sold, especially given that lower gas prices makes driving cheaper? Same logic, or lack of, applies to real estate. I think it’s just another example of many people not having ever been through a rising interest rate environment.

According to Brian Wesbury, chief economist at FirstTrust, rates won’t become restrictive until they reach about 3 percent. With the three-month Treasury currently hovering at about 0.25 percent, that doesn’t appear to be a near-term concern. Makes sense to me.

Investor psychology hardly ever gives equal weight to both favorable and unfavorable developments.  Likewise, the way they interpret events is usually biased by their emotional reaction to whatever is going on at the moment, as well as current prices. Investors generally obsess about one or the other rather than consider both. 

It all seems so obvious: Investors rarely maintain objective, rational, neutral, and stable positions. First, they exhibit high levels of a mix of optimism, greed, and risk tolerance. This behavior causes asset prices to rise, potential returns to fall and risks to increase. But then, for some reason—sometimes it seems, just cuz it’s Tuesday—they switch to pessimism, fear, risk aversion, and skepticism. They tend to extrapolate the past 12 months into the indefinite future as a reason for doing or not doing. This then causes prices to fall, prospective returns to rise and risk to decrease. Each group tends to happen in unison and the swing from one to the other often goes far beyond what reason might call for, much as this year has started.

While it’s tempting to believe that there are those who can predict bear markets and, therefore, sell before they arrive, there’s no evidence of the persistent ability to do so. On the other hand, there’s a large body of evidence suggesting that trying to time the markets is highly likely to lead to poor results.

For example, a study on the performance of 100 pension plans that engaged in tactical asset allocation (a fancy term for “market timing,” allowing the purveyors of such strategies to charge high fees) found that not one single plan benefited from their efforts. That is an amazing result, as even random chance would lead us to expect at least some to benefit.


Then there’s China. Chinese officials are allowing their economy to slow gradually as they transition from heavy industry and investment to services and domestic consumption. Unfortunately, they’re also still taking a haphazard approach to stabilizing their domestic stock market. The better news is this: That market remains isolated from the rest of the world and isn’t a leading indicator for their economy. Neither issue means that long-feared “hard landing” has finally arrived.

We’ve been talking about a hard landing of the Chinese economy for, at least, the past five years, so it’s not exactly a new topic. They recorded growth in 2010 of 12 percent. In 2012, it was 8 percent, and in 2015, it was 6.9 percent—a 25-year low, the headlines were quick to note.

At today’s level, it’s still contributing about as much to the global economy as it did during its double-digit growth days simply because it’s growing from a larger base. 

China is definitely a big economy, the second-largest in the world, accounting for about a quarter of global manufacturing, so what happens there has implications for everyone. Also, China buys more than $2 trillion worth of goods and services from the rest of the world each year. But, it’s a big world, with a total gross domestic product—excluding China—of more than $60 trillion. Even a drastic fall in Chinese imports would be only a modest hit to world spending.

Remember that China doesn’t play a pivotal role in the U.S. economy, other than as a provider of finished goods. It’s estimated to account for only 1 percent of the combined profits of the S&P 500 companies. Regarding exports, those account for about 13 percent of our GDP. In the first eleven months of 2015, less than 8 percent of our exports went to China. That’s $106 billion of goods, versus an annual U.S. GDP approaching $18 trillion—again, well below 1 percent.


With oil, the important thing isn’t what the oil price decline tells us about today’s market; it’s what it says about tomorrow’s market. Everything else being equal, I think low energy prices today will help better economic growth tomorrow, as well as higher energy prices eventually, due to their effect on supply and demand. It’s just another example of how people are interpreting everything negatively these days. As the old Wall Street cartoon put it so well, everything that was good for the market yesterday is no good for it today. 

It seems clear to me, too, that the effect of the fall in the price of oil is far from being all bad.  Rather, I’d say that it’s a net positive for us and other oil importers. The fall in commodity prices is causing market anxiety because investors worry that it signals a slowdown in global demand. 

Any economic benefit from cheaper costs for consumers and businesses is being counteracted by the cutting of investments and jobs by the resources sector. In other words, they’re inferring that the price of oil declined because demand is off and that this signals economic weakness. 

I believe that the bottom line is that, if you aren’t an oil company or an oil-producing country, low oil prices aren’t necessarily a bad thing. For net oil importers like us, Europe, Japan and China, the drop we’ve seen in the price of oil is like a multi-hundred-billion-dollar tax cut, adding to consumers’ disposable income in all those areas.

The U.S. is both a producer of oil and an importer. That means the overall economy will enjoy the benefit of cost reduction and more income. But, domestic oil companies and those who provide them with products and services and some state and local governments will be hit in the near-term. 

Manufacturing and trade have slowed globally, but this isn’t new and the global economy is still growing. It’s the overall rate of growth that’s slowed. Commodity-heavy countries like Brazil and Russia are deep in recession, but growth elsewhere more than offsets their individual troubles.

We continue to think this is a year to own stocks. Don’t let volatility trick you; the global economy is growing and its strength is underappreciated. For example, the Conference Board’s Index of Leading Economic Indicators (LEI) for both the U.S. and Eurozone remain in a long-term uptrend; that’s a big counterpoint against recession fears.

Again quoting Brian Wesbury, “U.S. equities were relatively cheap before 2015 started and even cheaper today. We recommend keeping a stiff upper lip and waiting for pessimistic investors to realize their mistake. Even with more rate hikes coming, the U.S. stock market is still significantly undervalued.” I agree with him.

As Morgan Housel has said so well, “The past wasn’t as good as you remember, the present isn’t as bad as you think, and the future will be better than you anticipate.”

Michael Maehl is a financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company. He can be reached at 509.747.3323.

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