Our reduced exposure to China paid off start of this year along with the overall decrease in US equities. Our concerns with high valuations in the U.S. market and the risk/reward of smaller future gains or losses may also finally be realized this year if the first full trading week of January is any indication.
This demonstrates the importance of not timing the market but taking valuations risk/reward probabilities into play.
Remember, over the long-term it’s very difficult to predict the future with any great degree of accuracy. To help demonstrate how hard it is, consider this. CXO Advisory Group measures a group of market “gurus.” These include professional money managers, newsletter writers, and financial columnists. Everyone on the list is a professional. The average accuracy of the group in predicting future price moves is less than 50%. These are the best in the business, and they can’t even predict the future over half the time.
The overall lesson, don’t try to predict the future or time the market. No one can with any degree of accuracy. That said, one of the best ways to outperform the market is to become more cautious when markets become overheated (2000, 2007, 2016?) and more aggressive once markets become severely undervalued (2002, 2009).
In the first week of trading in 2016 Shanghai stocks dropped more than 7% triggering a halt in trading for the rest of day. This caused a bit of panic among investors which spread globally. In an effort to stem a further market slide or outright market crash, Chinese regulators instituted a rule on January 9th, prohibiting anyone from selling more than 1% of a listed company’s share capital every three months. While this may slow the market decline, there is an element of desperation to the ruling which doesn’t sit well with investors.
In last quarter’s issue, we continued to outline the potential economic risks associated with investing in China, our reduced exposure to China and we included a link to a great overview of the potential economic hurdles China is facing: “We recommend that you read the following for a very good overview of the economic risks in China.”
Our concerns, fortunately (or unfortunately for many) have been justified. In addition to continuing declines in Chinese economic growth and manufacturing readings (which may be inflated to begin with), private monies and investment funds continue to flee the country reminiscent of the 1998 Russia financial crisis preceding our dot com crash. In addition the falling Yuan has raised concerns that China is trying to devalue its currency to help its exports.
Until the Chinese market stabilizes, we will be forced to maintain our reduced exposure to emerging markets in our active portfolios due to the heavy weighting of Chinese markets in such funds. While we are able to get around this problem in ETF Authority Pro by investing in sector funds, we continue to stick to broad market index funds in this newsletter to help as many investors as possible. Most investors don’t have access to anything other than general market funds in their 401k, so this will better assist in their decision making process with their financial advisors.
U.S. Stock Market
The U.S. Stock Market continues to show sustained weakness with the majority of stocks already in a bear market. 90% of stocks are down for the year, the average stock is down 23% and only the utility sector is above its 50 day moving average.
The Institute for Supply Management’s index came in at 48.2, which was the lowest reading since June 2009. Any reading below 50 indicates a contraction in the economy. The Bloomberg median consensus was 49, suggesting the U.S. economy may be slowing faster than previously thought. When the reading as fallen below 45; it has coincided with a recession 11 out of the past 13 times.
In December, the US economy added 292,000 jobs compared to an expected 200,000 while the unemployment rate held steady at 5%. The extremely strong job report supports the FOMC raising rates.
With the Tobin Q ratio, median Price-to-Sales ratio and margin still sitting near historical highs at a time when earnings are decelerating, I don’t see any reason why this trend shouldn’t continue. Throw in Fed tightening (although expected to be dovish), historically high debt levels along with the historically low full labor participation rate, and the hurdle for future stock gains in 2016 appear to be high. That said, as this year has demonstrated, past results are no guarantee of future results.
Consumer sentiment has been extremely low due to recent negative news suggesting that many investors have already positioned themselves for a market fall. Typically when this happens, there is a short term bounce which will give investors another chance to adjust their portfolios.
Our financial models going forward continue to show a high risk – low return environment going forward based on current valuations and profit levels for the U.S. Stock Market. Therefore we continue to suggest following strategy number one to improve long-term returns by switching to a more conservative portfolio. If you’re an aggressive investor – move to a growth portfolio, if you’re a growth investor move to the balanced portfolio etc, until company earnings catch up to current stock market valuations or the stock market corrects to more neutral valuation levels.
Second Term Presidential Market Trends
Most investors are fully aware of (and we’ve pointed out in earlier issues) the higher than average returns that occur during the 3rd year of a presidential election. The stock market index has increased an average of 16.1% during the third year of a term, compared with a gain of 8.8% during all years.
In fact, if the market finishes negative this year, it will be the first time such time that is has done so during the third year of a presidential term since 1956. To go against such a strong trend does not speak well for the health of the market.
What most investors aren’t aware of, are the abysmal stock market returns during the final year of a two-term president. The final year of a two-term president has coincided with the stock market crashes of the Oil Crisis in the 70’s, Bond Shock in the 80’s, the 1987 stock market crash, 200 tech bust and the latest financial mortgage collapse in 2008-2009. The question remains, will 2016 be the QE crash?