Volatility is the name of the game
- News across the globe continue to reinforce major concerns of slowing economic growth.
- In the US, employment came near to a halt in February, although one has to remain cautious that one number does not make a trend.
- Now that US equities are back into over-valued territory, investors should take that into account when discussing portfolio recalibration with their advisors.
This week and the next, expect market volatility to be on the high side. Reasons will vary between fundamental, practical and technical.
Economically, bad news continue to trickle in. We all heard about the horrible GDP report from Canada and the weak Canadian banks earnings. Last week, European GDP growth was revised downward. Now, a sluggish 1% GDP growth for 2019 has become probable rather than possible. In China, GDP growth forecast has officilally been revised from 6.5% tom 6%. Most recently, we heard that Chinese exports slumped by 20% in February while imports dropped by 5%. China accounts for the bulk of global economic growth and for demand growth for commodities. It is very difficult not to worry that such weakness from China will not eventtually spill over to the rest of the world.
On the practical side, March is the last month of the quarter, when futures and options contracts expire. As such, the second and third weeks of the month are typically volatile. Moreover, we know that, back in December, institutional investors loaded up on equities (unfortunately most retail investors missed the boat). As such, it should not surprise if fund managers decide to lock in some of the nice profits earned during the quarter. On the buy side, corporations this month enter a lock-up period in which they are not allowed to buy back their shares (to prevent insider trading prior to the release of earnings next month). This will deprive the market from an important source of demand. All such factors have promted several market analysts and traders to warn from an upcoming period of volatility for stocks. Technically speaking, the rally had started to fizzle when the market failed to cross resistance levels of 2800 for the S&P 500.
Having said all that, it is not all doom and gloom out there. Last week, on a Bloomberg podcast, Aby Joseph Cohen of Goldman Sachs was assertive in her belief that the US will not face a recession and that corporate earnings will grow at single digit rates this year. In other words, the equity rally still has steam in it, given there is no better alternative. Moreover, the optimists argue that help is on the way. In Europe, the central bank has announced a program to lend short term money to banks at cheap rates. In China, some economic stimulas (tax cuts) has already been introduced. More importantly, a new scheme to prop up banks has been announced, which could allow them to resume aggressive lending. In China, banks are a key instrument used by the ruling party to manage the economy. Another round of binge lending by the banks can have a strong stimulative impact on the economy, albeit in the short term.
While it is always good to be aware of what the market is doing, and why it is doing it, the last thing an investor should do is try to time the market or consider each good or bad news as triggers to buy or sell. Short term factors are usually tricky and can often lure people into making impulsive decisions. However, for the long term, the more important thing is market valuation. Last week, we were reminded that the S&P 500 was back into over-valued territory. For the long term investor, a market P/E ratio of 19 times is a full 3 points above the historical average. That in itself should be taken into account when you discuss portfolio recalibration with your advisor.
We are not dismissing the possibility that the market could overshoot on the way up. It often does. But it would be unwise to ignore market valuation and news of weakening economies, across the globe, for too long.
March 10, 2019
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