Making Sense of This Market

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2015 went into the books as the worst year since 2008. Stocks closed out with a small loss, and even though the S&P 500 fell a seemingly small 0.7%, the overall decline felt much worse for the average investor. Individual stocks and sector ETFs alike struggled as easy money is typically more difficult to identify in a bull market.

stock market chart

Source: ©iStock.com/buchachon

Still, there are a lot of reasons to remain bullish on U.S. stocks for 2016 and beyond.

A snapshot of the first week of U.S. trading would suggest investors partied a little too hard on New Year’s Eve. By Friday, the S&P 500 had already dropped more than 5%, making it the worst start to a year, ever.

In addition, both the Dow and the NASDAQ moved into correction territory (defined by a 10% pullback from 52-week highs), which is significant because, until August of last year, the major indices had not experienced a correction in more than four years.

Why Are Stocks Falling?

The headlines of every newspaper, website and media outlet will have you believe the reason for the stock market selloff is the economic numbers out of China. But, that’s only the easy answer to a more complicated question. Yes, the Chinese stock market triggering circuit breakers with 7% losses twice in one week is significant, but we need to look at the reasons behind why the Chinese stock market crashed in the first place.

The Chinese economy is slowing, but it has been slowing for over a year, and it is not as if investors woke up on New Year’s Day and took notice for the first time. Selling was exasperated by the fact that the Chinese government was devaluing the yuan in attempts to increase exports.

A very similar action took place in August 2015 that sent Chinese stocks into a bear market and U.S. stocks into their first correction in over four years.

Still, there are other stories that could be more worrisome to investors who are already prepared to jump off the stock market train. The geopolitical situation has been a bigger concern since the Paris attacks, and the new year kicked off with two headlines I felt were a bigger reason for the global stock selloff.

First, the tensions between Iran and Saudi Arabia have been heating up, and nobody around the globe wants to see an escalation between the two long-term rivals.

Secondly, there is the maniac in North Korea who has claimed to have successfully tested a hydrogen bomb. Most experts, however, question reports that the bomb was a success. Whether it was or not may never be known, but what is known is that it adds fear to investors who are already scared of their own shadows.

Diversification Is Key

The fear-mongering so-called “experts” are enjoying their short-lived time in the media, touting the coming of the next apocalypse. Buying everything from gold to land in Bolivia will be thrown at investors as a strategy to escape the inevitable death of the stock market. But, the last time I checked, the 130-year chart of the U.S. stock market moves in one clear direction — UP!

During times of panic-selling, it is difficult to find a sector or asset class that will completely avoid the scared investors who are hitting the sell button. The gold bugs will argue that the precious metal is the best safe haven investment in the market. They may be correct for a week or two, but the chart of the price of gold shows a distinct downtrend since 2011. Gold is down more than 40% from its highs while the S&P 500 is up more than 70% in the same time. The numbers do not lie — gold has been a losing bet as a safe haven for five years.

The key is not to shift a portfolio into safe-haven investments, but rather to have a diversified portfolio during a time when corrections are more likely. Attempting to time the market by rebalancing a portfolio from week to week is not as easy as it appears on paper, nor as simple as late-night infomercials will lead you to believe.

The yield on U.S. Treasuries remains well below historical levels, even though the Federal Reserve has begun its rate hike cycle. Therefore, companies with stable balance sheets and solid dividends will be considered safe havens during a market correction.

Water utilities are a niche group that I feel are the best positioned during both pullbacks and market rebounds. There are only a few such companies traded on major exchanges, and they typically have a beta below 0.50, suggesting they have little correlation to the S&P 500.

One example is small-cap Connecticut Water Service (CTWS), which has a beta of 0.2 and a dividend yield of 2.74%. Even more impressive is the fact that the stock is beating the market by 800 basis points in the first week of 2016 trading.

Another strategy is to search for stocks that were able to outperform during the last bear market. In 2008, the S&P 500 lost 38.5% and nearly every stock in the index was down for the year, sans Wal-Mart (WMT). The country’s largest retailer closed out 2008 with a gain as investors assumed a terrible economy would mean every American would be shopping at Wal-Mart in order to save money.

Could the same thought process be going through the minds of investors today? The mega-cap retailer is up more than 5% through the first week of 2016, beating the S&P 500 by approximately 10%.

Stay the Course

There’s one last statistic I want to use to hammer home my thoughts on the current pullback. Since the beginning of the bull market in March 2009, there have been 19 pullbacks of at least 5% in the S&P 500. The pullbacks ranged from 5.1% to 21.6%. The market last topped out on November 3, and since that time the index is down 8.2%, which just happens to be the median decline of the 19 occurrences.

Nobody knows what the market will do tomorrow, or the rest of the year. However, we can all gain an edge by looking in the rearview mirror at the stock market’s history and analyzing how stocks react in different market environments. Right now, all signs indicate that the current stock market pullback is a garden variety correction. Nothing less, nothing more.

As of this writing, Matt McCall did not hold a position in any of the aforementioned securities.

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