Hang in There, Markets Are Going to Get Better, Soon

by Ed Elfenbein | November 17, 2012 10:00 am

Hang in There, Markets Are Going to Get Better, Soon
“Investing is where you find a few great companies and then sit on your ass.” – Charlie Munger

So true, Charlie. So true. Unfortunately, sitting on our rear ends has been rather unpleasant lately as the stock market has thrown yet another temper tantrum. On Thursday[1], the S&P 500 broke below 1,350 for the first time since late July.

For several weeks now, I’ve warned investors to be prepared for a difficult market this autumn. The hour cometh, and now is. The day after the election, the S&P 500 dropped 2.37% for its second-worst day of the year. This was unusual because the electoral results were largely expected. The next day, the index closed below its 200-day moving average for the first time since June. That apparently gave the bears a shot of confidence. Yesterday, the index fell to its lowest level since July 26th.

In this week’s CWS Market Review, we’ll take a closer look at what has the market so grumpy:  let’s look at why the market’s recent downturn is running out of steam.

Why This Sell-Off Will End Soon

Measuring from the market’s closing peak on September 14th, the S&P 500 is now down 7.64%. That’s hardly a horrifying drop especially considering the market’s tremendous run over the last three-and-a-half years, but it caught a lot of professionals off guard. Actually, it’s not even the worst drop this year. We’re still short of the 9.93% sell-off the S&P 500 put on between April 2nd and June 1st.

If we dig beneath the numbers of this current sell-off, we can see it has been unusual which leads to me believe that it’s a reaction against events rather than a sober judgment of future corporate cash flow. As sophisticated as we may think Wall Street is, the truth is that traders often act like hyperactive children at a swimming pool (“hey, look at me, look at me, are you looking??”). Simply put, this market is an attention whore.

big.chart111512 Hang in There, Markets Are Going to Get Better, Soon[2]

I’ll give you an example. When the market initially broke down, the Financial sector led the way[3]. That’s to be expected. But what’s interesting is that it didn’t last long. After two weeks, the financials turned around and started leading the market (meaning, not falling as much). That’s unusual. Investors don’t normally turn to financial stocks for comfort during stressful periods.

Broadly speaking, the cyclicals have had similar reactions. For example, the Industrials have been particularly strong and until very recently, the homebuilders were acting like all-stars[4]. We can also see a lot of strength in the Transportation sector. Again, that’s not the usual pattern that a recession is on the way. The economic data continues to suggest that housing is helping consumer spending get back on its feet.

Nor has the bond market reacted as strongly as you would expect. The yield on the 10-year Treasury is back below 1.6%, but it is well above the ultra-low yields we saw this summer. Furthermore, the volatility of Treasury bonds has nearly dried up. Despite the problems in Europe, our economy continues to recover, albeit at a tepid pace. Expect to see Treasury yields gradually creep higher as investors migrate towards bargain stocks.

A worrying market would be when investors bail out of Financials and Cyclicals and crowd into bonds and Defensive stocks. That’s pretty much what we saw during the spring. This time around, the laggards have largely concentrated on the Tech space. This is where things get truly weird. Intel (NYSE:INTC[5]) dropped for nine days[6] in a row and now yields 4.5%, and Microsoft (NASDAQ:MSFT[7]) is at its low for the year. And look at Apple (NASDAQ:AAPL[8]). Heavens to Murgatroyd! That stock is down more than $180[9] in less than two months. That’s a loss of $170 billion in market value, or $540 per every American.

Another reason for optimism is that downward momentum is starting to exhaust itself. An important gauge that a lot of chart watchers like to follow is the 14-day relative-strength index[10]. The 14-day RSI closed below 30 for the first time since June. This may cause some bulls to jump back into the fray. Plus, the earnings outlook is holding its own. While earnings estimates for Q4 have come down, the consensus on Wall Street still expects growth of 9.4% which is a nice change from the earnings decline of 3.5% for Q3.

Investors are clearly concerned about a number of political factors. For one, there’s the prospect another stand off between the White House and Congress over the impending “fiscal cliff.” Personally, I doubt this will be as serious as some people fear. The business community is clearly not in the mood for more political drama. I have to think that some sort of deal will be reached before any economy-wrecking plans take effect. There’s too much to lose.

Investors need to be disciplined and not expect the market to gain 20% overnight. Continue to focus on strong dividends[11], especially companies with long histories of raising their payouts.

Endnotes:
  1. On Thursday: http://investorplace.com/2012/11/thursdays-ip-market-recap-aapl-tgt-wmt-znga-petm/
  2. [Image]: http://www.crossingwallstreet.com/wp-content/uploads/2012/11/big.chart111512.gif
  3. Financial sector led the way: http://investorplace.com/2012/11/banks-tanks-a-troubling-indicator-jpm-wfc-ms-gs-bac-c/
  4. acting like all-stars: http://investorplace.com/2012/11/beazers-weakness-is-all-its-own/
  5. INTC: http://studio-5.financialcontent.com/investplace/quote?Symbol=INTC
  6. dropped for nine days: http://investorplace.com/2012/11/intel-value-or-value-trap-intc/
  7. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT
  8. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  9. down more than $180: http://slant.investorplace.com/2012/11/wondering-what-to-do-with-apple-stock/
  10. 14-day relative-strength index: http://www.investopedia.com/terms/r/rsi.asp
  11. focus on strong dividends: http://investorplace.com/2012/11/dividend-investors-dont-panic-tax-rate/

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