Posts by the Contributor
Katrina Lamb, CFA
Head of Investment Strategy & Research
Katrina Lamb’s international investment industry career spans more than 25 years and includes both buy and sell side experience. She specializes in the research, analysis, and evaluation of the capital markets opportunities that... Full Bio
Last week we wrote about the strange relationship between economic news and recent market performance. Major stock indexes were turning sour ahead of a possible Fed taper in mid-December, even as the economic news looked more promising than it has for a number of years. The sourpusses have continued to hold the upper hand this week. As of the Thursday close the S&P 500 was down by just under 1% for the month to date. Hey, wait a minute! Isn’t the “month to date” of which we speak December? Isn’t there some kind of a special thing that happens this time of year, a little good cheer to close out the calendar?
In search of lost Decembers
Marcel Proust apparently could reconnect to the distant times of his childhood by smelling the aroma of a madeleine soaked in tea. We’re not nearly as poetic, but we do remember the markets of Decembers past and indeed the memories are, for the most part, good ones. Since 2000 the S&P 500 price return for the twelfth month of the year has been negative only three times out of 13, up to the end of calendar year 2012. The average return for the ten positive Decembers is 2.1%, a good-sized holiday present indeed. Theories abound as to why December may be a better month on average for stocks than others. One thought, which makes sense to us, is that brokers and portfolio managers hasten to dress up their portfolios with whatever assets are in favor, providing momentum for companies and industry sectors that have shown recent outperformance.
Actually, there is not much momentum leadership going on at all these days. For industry sectors, the only truly consistent trend over the past several months has been utilities, and that is a negative trend (utilities are up by a bit over 11% this year, substantially less than half what the S&P 500 has gained year to date). Others, from consumer staples to industrials and financials, have had their day in the sun, but in general the trajectory has grown more directionless in recent weeks. The money movers seem to be in no particular rush to spruce up their portfolios with crowd-pleasing names. Perhaps they’re not feeling the pressure quite so much, given how well the broader market has done this year.
There is no “average December”
Of course, just because the average performance for the month is good doesn’t mean it will be thus every time. Every December – for that matter any defined period of time at all – has its own unique aspect. There are many factors that influence the short-term direction of the market, and hanging your hat on some “effect” theory for predicting the performance of any specific December is probably unwise. It may well be that there just isn’t much more goodness to extract from this current, long-standing rally. The trailing twelve month return on the S&P 500 has not been negative for one single day since the beginning of 2012, which is extraordinary. A pause for profit-taking surely should not come as a complete surprise.
Month not over yet
Finally, lest we forget, we’re not even at mid-month yet. Two weeks is a long time in this world – enough time for anything to happen. We’re keeping an eye on lots of different moving parts including, of course, next week’s Fed confab. But whether or not we get a late December effect tailwind, we’ll take 2013 as a whole over most of the other calendar years the 21st century has served up thus far.
Just in time for the holidays, recent headline economic news should bring on a rush of good cheer. Nonfarm payroll gains have topped the critical 200,000 level for three of the past four months, while the unemployment rate has fallen to 7%. GDP was revised upward for the third quarter to 3.6%, the highest it has been for two years. Inflation is nowhere to be seen. The housing recovery continues apace. These all make a reasonable case for a return to more normal levels of growth than we have seen for a while.
Good news. Except, that is, for the folks who are too busy throwing a “taper tantrum” to notice.
The $85 billion question
The market opened sharply higher today, largely on news of the jobs numbers, but prior to that the S&P 500 had lost ground for five days in a row. The building signs of economic growth took traders to the dark place where fears of a reduction in the $85 billion monthly bond purchasing program trump all else. The Fed meets again on December 17-18, and taper fears are running high. Nor are stocks the only asset feeling the chill. It is a rare sight to see bonds underperforming stocks on a day when stocks are down, but that has happened several times recently. Even though the Fed has no intention of raising rates any time ahead as far as the eye can see, and there is little in the way of fundamental upward pressure on rates, the equation “taper = rising rates” is lodged firmly in the mind of the market.
Six of one, a half dozen of the other
So are the taper fears grounded, or is this just another irrational outburst from the denizens of Prozac Market, kicking and screaming their way to rehab? Will the Fed actually start tapering and, if so, will that necessarily be a bad thing? These are hard questions to answer, because the answer largely depends on whether the recent growth trend has durable traction. The dismal scenario that keeps the Board of Governors members up is the combination of anemic growth and ultra-low inflation. That’s the combination that has people tossing around terms like “lost decade” and “Japan 2.0”.
But if 3%-plus GDP and below-7% unemployment are in fact the new normal, then the assumption is that a healthier inflation rate of 2 – 2.5% will follow in due course. Under those conditions, the QE training wheels should be able to come off without major disruptions. So the Fed’s dilemma is about how much trust to put into the growth story, and whether the data are strong enough to justify a December taper.
The cautious Fed
The deliberating style of this Board of Governors is cautious, and caution will continue to be the watchword. That caution was in full view in September, and it came through loud and clear in the recent confirmation hearings of soon-to-be chairwoman Janet Yellen. A read of the tea leaves still probably points to a higher likelihood of no taper action in December. But the growth numbers do matter. At the very least, we should expect to see something in the meeting minutes that incorporates the growth scenario into future intentions. In an ideal world, the Fed could communicate these intentions in a way that makes clear that (a) tapering policy does not equal rate hike policy, and (b) they will turn the spigot back on if future economic conditions so warrant.
But we don’t live in an ideal world, and chances are that we’ll have to endure more taper tantrums as the weeks continue. At some point, though, we would expect that the good growth numbers, should they continue, will gain the upper hand in the market Zeitgeist.
Another holiday season is upon us. Whether preparing a traditional turkey meal, pushing the envelope with avant-garde culinary experiments, or celebrating the rare and delightful convergence of Thanksgiving and Hanukkah, this is a time of year when we like to take a moment to breathe, stand back from the daily craziness of our lives, and give thanks for all the blessings that are ours. In that spirit, we’ll spend less time in this week’s Market Flash dwelling on negatives like political dysfunction or corporate wrongdoings, in favor of the more positive attributes proceeding from the investment world for the year to date. For this week, at least, we will prefer to look on the bright side of life.
Recovery Slow, But Steady
We came out of the recession in early 2009 and have enjoyed consecutive quarters of GDP growth ever since. It’s not yet as much growth as we would like, but growth nonetheless. The unemployment rate has come down from over 10% in 2009 to just over 7% today. Now, as investment analysts we look at the unemployment rate as just another macroeconomic data point, an input to our predictive scenario models. But behind the numbers are real people: fathers and mothers, spouses and partners, humans trying to improve the quality of their lives through meaningful employment. Every downtick in the unemployment rate, every addition to the monthly nonfarm payrolls, is a reason to be thankful and hopeful.
In our weekly posts we are more often than not critical of political actors and policymakers. We certainly are not Pollyannas who think all is well with the world and its governments – far from it. But as cynical as we can be, watching another fiscal reform initiative or budget resolution get kicked down the road, we should be mindful of the fact that, with each crisis point, the worst outcome has been averted. For a good part of that we can thank the Federal Reserve and other central banks. Their decisions have in no way been perfect. But they have held the European currency zone together, smoothed over some of the rougher patches in our economic trajectory here in the U.S., and even helped to put long-suffering Japan back into position for economic recovery. We want the world to be a more prosperous place, and are supportive of measures that seek to accomplish prosperity within the boundaries of prudent economics.
Business Innovation Continues
Corporate America also frequently finds itself in the crosshairs of our unsmiling analysis in these pages – again, with good reason. But let’s also give thanks for the spirit of innovation and progress that we believe is still alive and well in our country. With top-line economic growth slow, the corporations that make up our major U.S. stock indexes have still managed to grow their profits to record levels. How have they done this? First, by seizing opportunities in new markets. Companies as diverse as Microsoft, GE and Cisco Systems have some of their largest operations and research facilities in places like India and China, and have learned how to expand their sales in these dynamic countries. Second, businesses are ever finding new ways to improve their cost structures and leverage technology. Profits are good for businesses and good for investors. As much as one can attribute the market’s strong recent performance to the Fed and quantitative easing, strong corporate profits have kept valuations reasonable and out of bubble territory.
As for us here at MVCM, we are thankful for the chance to do what we love doing every day of the week, and for the honor of managing the assets entrusted to us by our clients. A very happy Thanksgiving to each and every one of you.
16,000. 4,000. 1,800.
It’s the harmonic convergence or planetary alignment– pick your divine sign – of the capital markets. The three most widely tracked U.S. equity indexes are all flirting with these perfect round numbers, these Platonic metrics of stock market performance. The Dow Jones Industrial Average closed above 16,000 for the first time on Thursday, while the S&P 500 has moved above 1,800 in intraday trading, and the Nasdaq Composite is closing in on 4,000. The last time Nasdaq saw 4,000 was coming from the other direction, as it fell from the 5,000 level it briefly grazed at the height of the tech bubble in 2000.
Perception Becomes Reality
What’s with the round numbers fixation? It’s just a number, right? Actually, no, it’s not just a number. Sometimes perception has a way of becoming reality. Consider the following chart, which shows the price trend of the DJIA over the past three years.
The chart shows a fascinating repetition of support and resistance levels, all of which coincide with those perfect round whole numbers. Case in point: the Dow reached 12,000 in the first quarter of 2011, after a breakout above the previous support level of 11,000. It had trouble breaking 12,500 (an intermediate round number) but also managed to find intermediate support above 11,500. Then it broke through to rally up close to 13,000, which then became the next resistance level. This pattern of support, resistance and eventual breakout rally or pullback continues all the way to the present.
In fact, today is a textbook day in the annals of the round number fetish. As we write this the Dow is about flat for the day, holding on above the 16,000 mark it reached yesterday. Meanwhile, the S&P 500 is juuuuust below 1,800, trying to make the most of a generally upbeat trading day. As for the Nasdaq, it would simply take an afternoon trading surge to propel it from its current intraday level of 3,985 up above that magic 4,000 level. Perhaps it will be there by the time you read this.
Traders of a Feather Flock Together
The only reason why there is anything special about the round numbers is because traders (of both the human and algorithmic variety) make them special. Professional traders for the most part have a day-to-day mentality. They will take profits, hedge their bets and re-up the ante in measured steps. When the market approaches one of these round number inflection points, the general sentiment will be to stay one’s hand for a bit, maybe realize some profits (or cut some losses), and trade cautiously ahead of the next breakout. If one trader does this, it’s nothing special. If lots of traders do it, it becomes a regular feature of the market.
From 16,000 to Where?
Of course, seeing a pattern of resistance and support is one thing; figuring out where the market’s going to go next is quite another entirely. You can see from the chart that not all round number events are of equal duration or magnitude. For example, when the Dow reached 14,000 in the first quarter of this year it didn’t pause for very long, a couple weeks or so, before breaking above resistance to rally up to 15,000. On the other hand, it took more than a year for the index to finally shake the 12,000 support level for once and for all.
We have to weigh several factors that could be key influences in the weeks ahead. We’re heading into the last month of the year, which is often a momentum month that amplifies whatever trend is currently underway. However, the major indexes are all comfortably above 20% for the year to date, so in the absence of new news there may be a limit to how much farther a year-end “melt-up” can go. There is also quite a bit of chatter among industry pundits about current price levels relative to earnings prospects for next year. We shall have to see what this round number inflection point holds – and whether it holds in the same way for 16,000, 4,000 and 1,800.
If you stand in the check-out line of a supermarket on a regular basis, then you know that a significant percentage of Americans have an extreme interest in the goings-on of anybody named Kardashian, or the unfortunate apparel choices of Miley Cyrus, or the latest rehab adventures of Lindsay Lohan. Now, picking up a celebrity tabloid from time to time is arguably nothing more than a harmless guilty pleasure. However, the same cannot be said for another species of sensationalist reporting, what we like to call the financial tabloids. What’s the difference? Well, you won’t find the financial tabloids bedecked in garish coloring, perched among the likes of National Enquirer and OK! magazine at your local Safeway. The financial tabloids intend for you to take them seriously, and that’s why they are dangerous.
Clickbait Above All Else
The Internet has changed the way we read, and the way that publishers of content earn money. The ultimate goal of an online magazine or newspaper is the almighty click. The more clicks, the more eyeballs, and the more eyeballs, the more advertisers will pay to market their wares on your site. Quod erat demonstrandum – clicks = profits.
Increasingly, the method of choice to get those eyeballs is the “clickbait” technique. This technique usually involves a headline or teaser spiced up with something alluring to bring you in. The online versions of those celeb rags can do this just by dropping “Kardashian” into the headline. The financial tabloids, of course, know that they’re not going to lure the unsuspecting masses into their lair with a lead-in like “Stock Market May Be Trending Towards Higher Than Average Valuation Levels”. They prefer to play the doomsday card: “Market Crash In Next Two Weeks? Find Out What The Experts Think!”. It may be accompanied by what the industry likes to call a “sad trader photo”. You know – the iconic trader at his desk, face in hands, while hundreds of blinking lights flash red behind him. Get those emotions flowing!
The High Art of Cherry-Picking Data
The financial markets are awash in data. Price, valuation, risk and many other metrics abound, as do expert opinions about what the data points are telling us at any given time. When reporting on, say, the outlook for the stock market, a good financial article will present a balanced view of competing (often contradictory) data points and arguments. The financial tabloid will take a different approach. It will cherry-pick the data that offer evidence for whatever sensationalist claim it is making, and usually rely on one or two sources to supply the arguments without presenting other opinions to the contrary. Now, if you read the article closely you will be able to draw out all kinds of hedges and weasel-words (the tabloids don’t want lawsuits any more than anyone else). The hope, though, is that you’ll just skim the article and come away petrified. Maybe even that you’ll click onto that e-brokerage firm ad helpfully placed next to the article, where you can sell all your stocks in a panic and generate fat commissions for someone.
Serious or Sensationalist?
All well and good, you might say, but how can I tell whether the respectable-looking site I’m visiting is a tabloid or a serious financial paper? That’s a real problem, because there are so many financial publications of poor, sloppy and sensationalist quality that dress themselves up to look just like the ones you can usually rely on for sober, relatively unbiased news. Without naming names, we at MVCM tend to stick with a small handful of established media concerns that have built strong reputations over many years of high quality reporting. For us they are reliable, insightful sources for keeping informed about markets, assets and economies, with a refreshing absence of “Apocalypse Tomorrow” headlines.