False Recession

With the S&P 500 down 10.5% through February 11th, questions about the health of the economy seem to intensify daily. The concerns typically go something like this:  If the financial markets are a predictor of where the economy is headed, has the plow horse finally lost traction?  Is a recession looming?  

An old joke says the stock market has predicted 19 of the last five recessions.  Stocks don't always lead the economy, and earnings clearly don't show that things are awful.  With 375 S&P 500 companies having reported Q4 earnings as of February 11th, 70.7% have beat estimates, although earnings are down 5% from a year ago it's all due to just one sector, energy. Of the 375 companies that have reported, only 23 of them have been energy. Excluding those 23 energy companies, earnings for the other 352 companies are up 1.0% from a year ago.  So, for those claiming the market drop is due to declining earnings, it seems more like an energy story than an economic one. It's plow horse earnings growth outside of energy, but it's earnings growth.

The Ghost of 2008 and Pouting Pundits of Pessimism

The ghost of 2008 (a once-in-a-century economic panic caused by mark-to-market accounting) is influencing many analysts, journalists, money managers, and policy-makers, who still don't really understand what happened.

As a result, with the Federal Reserve on the verge of lifting interest rates by ¼ of 1%, these pouting pundits of pessimism are freaking out because it's the first rate hike in a decade and junk bond yields are soaring in a way reminiscent of the Lehman Brothers failure in September 2008.

 A story written in the Wall Street Journal by the well-connected John Hilsenrath says, many economists believe the Fed will lift rates now only to cut them back to zero in the future. This argument is based on some relatively obscure historical data and fears that something bad "might happen."

But these arguments are just forecasts based on fear, and a misguided narrative that economic growth and rising stock prices since 2009 have been a "sugar high," caused by the Fed's easy money policy. We don't believe that. Yes, the Fed bought a lot of bonds, but the banks hold a vast majority of that money in excess reserves. That's why inflation remains low.

Growth has been powered by new technology, not Fed policy. Oil prices are down because of new supply, not a "potential" set of rate hikes sometime in the future. In addition, regulatory over-reach, otherwise known as Dodd-Frank, has limited the depth and breadth of bond markets as banks fear being labeled proprietary traders.

Three small High Yield (junk bond) funds are in various stages of shutting down due to a lack of liquidity combined with redemption requests.  Other funds face redemptions as well, leading many to argue that there is a lack of liquidity in the high-yield bond market.

Is this Lehman Brothers all over again? We highly doubt it. A Fed rate hike has been a long time coming and any investor or fund that wasn't prepared for this is highly suspect. Moreover, now that overly strict mark-to-market accounting rules have been fixed, any systemic problems are highly unlikely.

In 2008, Tier One capital ratios at the four largest banks were just 7.5%. Today, these banks have 12.1% capital ratios. Moreover, after the Fed does tighten, the banking system will still have over $2.5 trillion in excess reserves. In other words, raising rates will not reduce available liquidity in any significant way.

In the past year, the M2 money supply is up 5.8%, commercial and industrial loans have grown 11.4% and corporations have record amounts of cash on their books. There is no evidence of tight money or liquidity constraints. Any business, individual, fund, or institution that needs zero percent interest rates to survive should not exist.

In 2013, when Ben Bernanke said he would like to end Quantitative Easing, the markets had a "taper tantrum." Today's market turmoil is the equivalent of that emotional upheaval. In the end, tapering happened, the economy kept growing and the stock market moved to new highs. The same will be true for this rate hike as well.

Bryan S. Westbury  Chief Economist at First Trust

Stock Market Corrections

Data from Bespoke Investment Group shows that, since the 3/9/09 market low, the S&P 500 has experienced 20 declines of 5% or more but less than 20%, according to USA TODAY. The smallest pullback was 5.30% (8/31/11-9/9/11). The biggest drop reached 17.27% (7/7/11-8/8/11). In 2014, the S&P 500 posted 53 record closes. The index, however, also suffered four pullbacks ranging from 4% to 7%. The S&P 500 has not endured a 10% correction in more than three years. Historically, 10% sell-offs occur about every 18 months or so.
Thanks for reading, David Eckess

Finance Gurus, Crystal Balls and Predictions

By David Eckess

Every January investment experts and firms publish their market forecasts for the new year.  You will hear about top down, bottom up, qualitative analysis, quantitative analysis, proprietary forecasting models and the list goes on. These experts, with some degree of fanfare, proclaim where they believe the financial markets will end the year and their reasoning for it.  Then, at mid-year the revisions pour in as "adjustments" to first of the year forecasts have to be made.

 If any of these experts, economists, strategists or others are lucky enough to predict the year-end values correctly, they will pull out a soap box, stand up and profess their brilliance. The firms they work for will create a marketing campaign around them. The commentators at CNBC, Bloomberg TV and Fox Business will be stumbling over themselves to get the first interview and ask what is in store for the next year. But that doesn't happen very often. Rarely do the experts get it right. Indeed some investment gurus will come close to forecast but most will miss and others will flat out blow it! Early in my career, one of my mentors gave me a gift with a note attached saying "everyone in the industry needs one of these" and I unwrapped a brand new, bright, shiny crystal ball. I still have that crystal ball, the base is a bit tarnished now but still a useful paperweight.

Last year (2014) was another good year for the equity markets. The S&P 500 gained 12.63% and the Dow Jones Industrial Average was up 8.54%. In reviewing forecasts for 2014 I was unable to find any experts that predicted the years performance . In all fairness there are some who have consistent records of success; and while they don't particularly nail it, they at least come close and were on the right track. When we find these strategists we listen to what they say and maybe lean toward them. However, it is not a matter of if but when they too will get it wrong.

After 29 years as a financial advisor I have heard many aphorisms that tend to hold true as they pertain to the stock markets. Consider these as you gaze toward the rest of the year and beyond:

Don't fight The Fed (Federal Reserve Bank).

Don't tell the market what to do, let the market tell you what to do.

Never confuse brilliance with a bull market.

You pay a very high price in the market for a rosy consensus.

Market forecasts for 2015 are no different than other years. The predictions run from one extreme to the other. Perhaps next January there will be an expert who can stand up and profess their brilliance, but don't hold your breath.