March Market and Economic Update
The U.S. stock market has given investors a bumpy ride so far this year, but it has been more than 500 days since the S&P500 experienced a correction of 20% of more, a run which has occurred only 10 times in the past 100 years so we really ought not complain despite the increased Pepto on Wall Street. January gave the market jitters as the S&P500 closed down 3.6% from its December 21st close. Cupid brought some respite in February, recovering some of those losses with the S&P closing down only 0.6% from the Dec 31st close. As of March 14th, the S&P was essentially flat from last year’s close, making the broader indexes in 2014 so far Shakespearean much-ado-about-nothing. In comparison, the Dow and the S&P 500 were up around 10% at this point last year.
The CNN Money’s Fear and Greed Index shown above illustrates that in the past week, the markets have experienced a shift from “Extreme Greed” to entering “Fear” territory. This index looks at seven indicators, shown below. Stock price strength indicates that the number of stocks hitting their 52-week highs is at the upper end of its range. The yield demanded on junk bonds is higher than what has been typical for the last two years, while the S&P 500 has typically been further above the 125-day average than it is now, indicating that investors are committing capital to the market at a slower rate than they had been previously. We are also seeing puts at among the highest level seen in the last two years, indicating significant concerns that the market’s direction is likely to change for the worse. Overall, the market today is a lot like a sophomore headed to his first dance, sitting on her father’s couch as he waits for his date to emerge; understandably nervous, but still holding onto hope that the night could be a success.
While the U.S. markets have been pushing higher and higher, other markets around the world have been even more ambitious.
From June 2012 to December 30th the Nikkei rose over 90%, (up 52% in 2013 alone) but has since stumbled from its Dec 30th high and is now up around 70%, having briefly entered into a bear market (20%) contraction by last month. The index as of March 14th sits down 12.21% from its year-end high, falling 3.3% last Friday. I’ll bet there’s a bit more sake being consumed this quarter in the after-hours!
The Euro Stoxx 50 Index, the leading blue-chip index for the Eurozone, has gained over 50% since June 2012, outperforming the S&P, despite the region’s sluggish economy. The chart at right illustrates the growth rates, (or lack thereof) for the Eurozone and its major economies through 2012. Estimates for 2013 aren’t much better, with the region as a whole contracting 0.4%, Germany up just 0.5%, while Spain and Italy are estimated to have contracted as well by, falling 1.2% and 1.8% respectively.
Unemployment in the region started 2012 at 10.2%, but has frustratingly worsened to 12.1% today and is anything but consistent across member nations. Unemployment in Spain, Italy and Greece are 26.7%, 12.7% and 28% respectively with youth unemployment shockingly high at 57.7%, 41.6% and 61.4% respectively! In contrast, German unemployment is just 5.2% with youth unemployment an enviable 7.5%. The impact of these employment levels for the young in the southern European nations will be a drag on those economies for decades to come as studies show the early years are critical for developing skills which impact an individual’s income generating potential over their entire career. I imagine many parents in these nations would be happy to be able to complain about not seeing their kids enough as they start their careers and build their young lives!
Meanwhile over in Japan, despite the massive run up in its stock market and levels of monetary stimulus that could make Bernanke blush, things are also not rosy either. Japan’s economy grew even more slowly than initially calculated in the final three months of 2013 and posted another record current-account deficit in January, increasing the likelihood that an economy already struggling with ugly demographics is in for yet more near-term angst. According to government figures, the overall economy grew just 0.7% on an annualized basis in the final three months of 2013, a downward revision from the initially projected 1% growth. The slight silver lining is business investment, which grew by an annualized 3% in the fourth quarter, compared with a preliminary reading of a 5.3% increase. Consumer spending was up an annualized 1.6%, revised lower from a preliminary 2% rise.
China too is showing signs of slowing. Forecasts for China’s GDP growth were cut by many in the investment banking world on Thursday after Beijing reported the biggest slowdown in investment for more than a decade coupled with the slowest retail sales expansion in nine years. Confidence was further undermined by news that a well-known steel mill has failed to repay loans that came due last week, the first default on corporate debt that the government has allowed.
European growth in aggregate just isn’t happening and the reforms needed to induce it are politically challenging to say the least. Japan continues to try and get out of its decades long funk. The Chinese engine which fueled much growth post-financial collapse is sputtering. In the US, as we predicted in last month’s newsletter, GDP growth for Q4 2013 was revised downward from an initial estimate of 3.2% to 2.4% versus Q3 2013 growth which is estimated to have been 4.1%. GDP growth for the full year of 2013 is estimated to be about 1.9% falling from 2.8% in 2012. Even with the downgrade, growth for the second half of 2013 is now estimated to be 3.3% versus 1.8% in the first half, showing an improvement, but not exactly a robust economy.
On the global front, keep in mind that for almost 30 years, the U.S. ran growing trade deficits, which effectively provided a lot of stimulus for foreign exporters; in other words we bought a lot of stuff from other countries, (funded in part by increasing debt levels) which helped their economies grow in a global form of seller-financing. We’ll buy your stuff if you lend us the money by buying our Treasuries. The chart above shows the magnitude of this trade deficit over time. Notice that since 2006 the deficit has been shrinking which may please those who prefer “made in America”, but is bad news for the countries from which we used to buy!
I’ll leave this review with one of my favorite sayings, hat tip to Warren Buffet for refreshing my memory in his most recent letter to shareholders, “A bull market is like sex. It feels best just before it ends.” Something to always keep in mind when one is tempted to chase returns.
Bottom Line: The economies of the largest nations and regions around the world continue to struggle to grow in line with historical norms, while their respective stock markets have experienced a wild run up in recent quarters. This makes continued across-the-board-increases in broad indexes increasingly unlikely, thus having a broadly diversified portfolio, with exposure to various markets and asset classes is even more important. The reduction in correlations between investments provides opportunities for those who are patient and pay attention.
