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Volatility is Back - 05/07/10

It seems just yesterday that all of us were enjoying steady market march higher.  Until this week.  All of 2010 gains in S&P500 were erased and it is now in the negative territory for the year.  On Thursday, the intraday swing in the market was over 1,000 points, greatest in history, although the reason for most of that swing appears to be some erroneous trading -- the Dow lost some 700 points in 15 minutes, only to recover most of in the next 20.  The VIX index, aka the fear indicator, rose from 2 year low to 1.5 year high.  It seems that not-so-good old days of 2008 are back.  But the main objective reason for market drop is, of course, debt situation in Greece, which I have mentioned several times in my previous communications.
 
The news that the markets chose to ignore this week were continuing stream of excellent earnings reports and good economic headlines.  Today, for example, the government employment report indicated that 290,000 new jobs were created in April, much better than expected, to the extent that the recovery can no longer be seen as the jobless one.  Nevertheless, selling continued on Friday despite lack of any new developments in Europe.  It seems that the traders were looking for an excuse to sell -- and they definitely got one.   And it is not really surprising, as we haven't had a sizable correction since the markets started their advance in March 2009.   Note that the pullback in January was also caused by Greek worries, but in time markets overcame it.  
 
While euro zone issues are quite troubling and the euro is likely to slide further, I don't think Greek problems are a repeat of 2008 Lehman Brothers collapse.  That said, it will take time for confidence to recover, and there is a good chance that volatility may persist in the short term, which I view as an opportunity to add quality companies at good prices.  If the last two years taught us anything, it is that great companies will prosper. 

Good News Don't Help the Market - 01/29/10

About of half of S&P 500 companies reported Q4 results, and so far, these results are very similar to those of previous few quarters.  Not only most of the companies are beating estimates, the guidance going forward is also generally exceeding analysts' expectations.  That had been the case with a number of bellwether companies, such as Intel, Apple, Goldman Sachs, etc.  The economic news have also been fairly positive.  While there were some disappointments in recent employment and housing data, manufacturing and consumer confidence are on the rise.  During the fourth quarter of 2009, U.S. economy grew at 5.7% rate, much higher than expected.
 
Nevertheless, the markets reacted in decidedly negative fashion to these benign reports and good earnings.  We saw a drop of about 8% from the 15 month market high reached just two weeks ago.  Skeptics are ready to point out that such a negative reaction to positive developments indicates that good news are already reflected in stock prices and that more trouble lies ahead.  Indeed, back in March 2009 the news were overwhelmingly negative, and yet that marked the beginning of the rapid market rise.  On the other hand, a correction such as we are experiencing is normal and is to be expected on a regular basis and especially after a huge rally we had last year.  In fact, since March 2009 there were three corrections already of the similar magnitude and the market kept marching higher after each one.
 
Who is right this time?  You know that no one can possibly answer this question.  In my view, we have reached a point where easy money has already been made on the way down and on the way up.  Any "dartboard portfolio" lost money in 2008 and made money in 2009.  I think that at present, stocks are reasonably valued and the skill of stock selection will once again become important going forward.
 
There are some global developments that definitely merit watching.  Financial crisis in Dubai, downgrade of Japanese bonds rating, and high debt obligations of Greece are troubling.  You are probably familiar with the acronym BRIC, which refers to fast-growing developing economies of Brazil, Russia, India and China.  Now we have another acronym: PIIGS.  This one stands for Portugal, Italy, Ireland, Greece, and Spain -- countries in European Union that have high debt loads and face a possibility of default that would strain the whole Euro zone.  I even heard views that the euro as a currency may cease to exist within the next five years.  If indeed any of the PIIGS of the world comes even close to a default, you can be quite sure that this will not do wonders for any of the world stock markets.
 
We do have a lot of uncertainty at this point but this is nothing new.  In my view, a sensible investor must keep a well diversified portfolio of high quality stocks and be always positioned to take advantage of positive market moves.  This has worked extremely well for me last year.  In addition to that, caution and certain downside protection would also be warranted.

Has the Market Topped? - 08/14/09

The second quarter earnings season is almost over, and what a season it has been!  About three quarters of companies soundly beat earnings estimates, and many firms raised their guidance for the rest of the year.  That, together with a number of rather benign economic news, propelled the markets to their yearly highs, and to nearly 50% gain from the March lows.  Did this 5-month run happen too fast and is it too much?
 
While the rise has been extraordinarily swift and sharp by any standards, one needs to put it into perspective.  Year to date, S&P 500 is up solid, but unremarkable 10%.  It is still down nearly 20% compared to one year ago.  And it is still more than a third off its top reached in the fall of 2007.  There is a similar, and often even more exaggerated, situation with individual stocks.  A number of them tripled since March, but they are still down 20-30% compared to one year ago.  In fact, if we could erase tremendous volatility of the year past, we would be in the run-of-the-mill, ordinary bear market.
 
So where do we go from here?  Will the rise continue or is the bear still in charge?  No one is qualified to make a short-term prediction.  However, it does appear probable and even likely to see some consolidation in the market during the next two months, especially since little new earnings reports will be coming out until Q3 results start rolling in mid-October.  First and second quarter results were better than expected, and according to cockroach theory, this is likely to continue.  In fact, analysts are already increasing their Q3 projections from a loss of 8.5% to a loss of 2%.  I wouldn't be surprised to see a gain.  And in Q4, earnings are expected to rise by massive 270%.  Year 2010 will also see easy earnings comparisons, which bodes well for stocks.  This should also put a lid on P/E ratios -- currently they are elevated for many companies as is always the case during difficult times.
 
As I mentioned, the economic news have been rather positive lately.  We have seen improvements in housing market; manufacturing activity and industrial production are increasing.  The Fed finally stopped calling the economy contracting or slowing.  Most likely, the recession is already over, and we will see slight GDP growth in Q3.  Not just the US is improving: the recession is now officially over in France and Germany, and emerging markets continue their growth.  On the negative side, consumer sentiment is still rather grim and unemployment is high.  Until it improves, the growth is likely to be rather muted.
 
The huge market move in late 2008 - early 2009 took practically everything down, and the recent move took practically everything up.  Now, however, I think that we are returning to more or less normal market conditions, where the skill of stock picking will make a difference again.  Some stocks are fully valued, but there are still plenty of bargains and many opportunities for a long-term investor.

Earnings Season Update - 04/24/09

The earnings season is in full swing; about half the companies issued their reports. On the absolute scale, the results are quite terrible, as expected; however, in comparison to expectations they can be called respectable. More importantly, forward earnings guidance, when provided, are also better than expected. Here are some examples of positive surprises for selected companies from various industries:

- Banks and financials: Wells Fargo, Goldman Sachs, Bank of America
- Technology companies: Intel, EBay, Amazon, Netflix, IBM, Apple
- Restaurants: P.F. Chang, Chipotle Mexican Grill
- Retailers: J.C. Penney, TJX, Wal-Mart

There also a number of encouraging signs in overall economy and the state of the markets, such as:

- Successful IPO of Rosetta Stone and acquisition of Sun Microsystems by Oracle point to increasing confidence of investors.
- Seven banks have already paid back their TARP money.
- Increasing sales activity in real estate; some markets in California experience multiple offers again (albeit at much lower prices).
- The tone of media reports is changing. While a typical news story a few months ago would describe how newly unemployed make ends meet, now we are seeing discussions of how to prepare for a coming recovery.
- Consumer confidence is up (although still rather low on absolute scale). While this measure is psychological, it is clear that consumer optimism at some point will translate into consumer spending.
- This last point is corroborated by anecdotal evidence from my flying club: it has become increasingly difficult to reserve a popular model, especially on weekends. That wasn't the case just several weeks ago.

Of course, this doesn't mean that we have clear skies ahead. There is still plenty of bad news to go around: unemployment is still rising, home sales are still dropping. Economy is still contracting, although at a slower pace than before. Nevertheless, the fact that we do have some positive news is encouraging -- just a short time ago, vast majority of reports were negative. In the months ahead, we are certain to hear of more disappointments. However, emerging signs of future recovery listed above could indicate that we have already seen the lows of this bear market.

Blog Site Launch - 12/21/08

Our brand new blog site, Sensible Investing, is now operational!  Please make sure to bookmark that page, and visit it regularly.  I will be updating it several times a week with the latest developments in the financial markets.  I would encourage you to leave your comments so that we can have a real discussion.

This year shapes out to be one of the worst years in stock market history.  For the last 10 years, the market declined(!) by about 15%, also nearly matching the worst 10 year period around the Great Depression.  With statistics like this, it is hard to continue viewing stock market as a wealth generation vehicle.  This article from Charles Schwab presents some historical perspectives on secular market moves, and argues that significant rebounds follow wipeouts such as the one we are now experiencing.  While no one can call the bottom and more down moves are certainly possible, the foundation for the next bull market is being created right now.

To many of us, 2008 was a financially disappointing year (and that's putting it mildly). I thank you for your support and offer all of you my best wishes for the upcoming holidays, and for a prosperous 2009.

Historic Week for the Markets - 09/19/08

By all measures, this week was a memorable week for Wall Street.  Major news included bankruptcy of Lehman Brothers, the Fed's bridge loan to insurer AIG, and a congressional plan to buy bad debt from financial institutions.  This was accompanied by extreme volatility of the markets: Monday and Wednesday were the first and the second worst days for the Dow since the terrorist attacks in 2001, while Thursday and Friday were nearly the best. 
 
Without a doubt, the crisis in the financials is of historic proportions.  Just over the last two weeks, the Federal government helped Fannie Mae, Freddie Mac, and AIG to stay afloat, while allowing Lehman Brothers to fail.  Everyone is wondering who is next on the list, and for a good reason.  While Bear Sterns, Lehman Brothers, and AIG had it coming to them, Goldman Sachs and Morgan Stanley are arguably solid.  Nevertheless, even they are facing crises because of loss of confidence in the financial system.
 
Over the next days, it is likely that books of all financial-related companies will be thoroughly scrutinized, and that is a good thing.  All of us would rather see remaining skeletons in the closet sooner rather than later.  In the meantime, however, expect more wild days and volatility from the markets.  No one knows whether the markets hit the bottom this week.  SEC action to ban short-selling of financial companies may have caused a rally on Friday, but these kinds of market manipulations rarely work.  On the other hand, a comprehensive congressional plan to buy illiquid assets, as well as actions of foreign governments to add liquidity could help in calming the financial markets.
 
The liquidity crisis will need time to work itself out.  There are, however, powerful forces that are aligning to help:
 
- Oil prices dropped from nearly $150 to below $100 in less than two months.  This will put more money into the hands of consumers.
- Due to cheaper oil and other commodities, inflation is abating, and this could give Fed an option to lower interest rates further, if needed.
- The Fed's takeover of Fannie Mae and Freddie Mac resulted in lower mortgage rates, and mortgage refinance applications are on the rise.
- A record amount of cash is sitting on the sidelines waiting to be reinvested.
 
Another noteworthy action this week was Warren Buffett's purchase of Constellation Energy Group.  It shows that he is still true to his motto: "Be fearful when others are greedy and greedy when others are fearful". 
 
The most important factor in causing this financial crisis is the steep correction of the housing market.  There is still no concrete evidence that it is improving.  Even though sales have stabilized, the average price is declining, and foreclosures are increasing.  Many experts agree, however, that foreclosures will reach their peak later this year, or in the first half of 2009, because risky adjustable loans with teaser rates became a thing of the past nearly two years ago.  A drop in foreclosures will help housing prices, and, in turn, the financial companies. 
 
Thank you for your continued support and confidence.

Market Update - 08/16/08

The second quarter earnings are out, and overall, they were somewhat better compared to reduced expectations.  That, together with declining oil prices, helped the market to mount a comeback from the lows of mid-July.  Whether this rally will continue, or turn out to be as short-lived as the earlier advance in the spring, is, of course, anyone's guess.
 
There are two major factors that caused this bear market and the economic slowdown (we still don't know if we are in a recession and most likely won't know for at least another two quarters).  The primary factor is the crisis in the financial industry and the corresponding collapse in housing prices.  And the second factor is the high price of oil.  The oil prices did come down from their peak by over 20%, and this trend could well continue.  High oil prices are obviously not in the interests of oil consumers, but they are not in the interests of oil producers, either.  Oil-producing countries know that high oil prices could cause a worldwide recession, which will decrease demand and will result in much lower prices.  Also, high prices could push other countries into developing alternative energy sources.  Both of these outcomes are against the long-term interests of oil producers.  It appears that recent record prices of oil were caused by investors hedging their positions against declining equity values.  But sooner or later, basic realities of supply and demand will take hold.  This process may have already started.
 
As far as the issues in financial services, the picture there is still murky.  Recent troubles in mortgage giants Fannie Mae and Freddie Mac showed that the crisis is not yet over.  Housing prices are still coming down; but, in the regions of most price declines, such as California and Nevada, the number of sales is actually growing.  This indicates that bargain hunters are finally stepping in and this could be an early sign of stabilization.  Stocks of some home builders seem to anticipate a recovery -- a few of them are trading near yearly highs.  This is worth watching -- these stocks led the current market downturn and could well lead it higher as well.
 
When we get more definite signs of improving housing and credit markets, and assuming oil prices cooperate, the two major drivers of this downturn will be neutralized and this will cause a sustainable stock recovery.  No one knows exactly when this will happen, but it will happen, and the  move could be very swift.  We as investors need to stay the course to be able to participate in it.
  
 
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