“She Moves In Mysterious Ways”[i]
The markets can have unexpected reactions to news headlines. Sometimes good news inexplicably gets sold and at other times prices rally after bad news. While this can be maddening to the professional, it is especially confounding to the retail investor. It doesn’t help when the financial media talking heads and internet headlines assign some superficial and often misleading sound bite to it.
Often, it’s this reaction to the news that is more important than the news itself. When a market doesn’t react as expected it could be a sign that something else is going on. For example, a market that doesn’t go down on bad news can be a sign of underlying strength. Similarly, a drop after some positive news report can be a forecast of continued selling pressure.
Part of our job, in managing risk, is to understand both sides of a trade. In other words if we are bullish, we have to have a sense of what the bears are looking at. This also applies to when we are less optimistic – we need to know what the bulls are thinking. The headlines don’t always provide the information needed and sometimes the mystery runs deep. When the markets act especially illogical and we can’t find a reason, it’s a sign to keep digging.
The markets have had to digest some big headlines recently. Just within the past few weeks we’ve had Larry Summers remove his name for consideration as the next chairman of the Federal Reserve, the current chairman decided not to “taper”, and the federal government is shutdown. While these are whipsawing the capital markets, we think there are some other less obvious influences that need to be considered.
We mentioned in our last newsletter, the employment situation, as measured by the labor participation rate, is troublesome. Also corporate earnings growth might be decelerating. According to FactSet, Q3 earnings growth was expected to be 6.5% (6/30/13 estimate). That growth estimate shrank to 3.2% by the end of September.[i] Analysts are typically optimistic especially as the forecast period increases, but the size of this decline is worrisome.
Furthermore, of the S&P 500 companies that have issued Q3 guidance, 82% lowered earnings forecast which is well above the 5-year average of 62%.[ii] The summer’s interest rate spike has slowed housing sales. Consumer confidence has fallen slightly. And the emerging markets have taken a big hit during the summer. Whether this is a function of rising U.S. interest rates (which increases the cost of debt in the EM’s), falling commodity prices (less revenues), or a temporary correction is unknown, there has been significant slowing in emerging market economies.
Of course, with stocks at record levels, the news can’t be completely bad. Over 4 years of quantitative easing has helped risk assets like equities. While reasonable people might debate that the economic benefits of spending $85 billion per month (or over $1 trillion per year) do not outweigh the costs, the Fed’s policy of monetizing the government’s debt has helped the capital markets.
In early September, Verizon Communications sold $49 billion of bonds which is the largest debt deal ever. It is almost 3 times Apple’s much talked about bond sale earlier this year. Undoubtedly, these offerings probably wouldn’t have gotten done or, at least, not at the size that they did without QE. This milestone by Verizon helped push September’s investment grade corporate debt sales to $145.7 billion.
QE has helped the economy as well. The U.S. private sector growth has averaged 3.4% since Q4 2009. The overall GDP numbers have been lower because of reduced government spending which ultimately is an economic positive. Moreover, corporate profit margins are at record levels. This once again proves that U.S. businessmen and women figured out the changing landscape and have been successful despite questionable fiscal and monetary policy.
Looking forward, there are more positives. An index of OECD leading indicators is rising. The GaveKal Q Indicator (a monthly series of leading indicators and market prices that indicate global growth) is positive. And the Citi G10 economic surprise index is at a 2-year high.[iv]
The U.S. stock market has rebounded from some turbulence in August as the Dow, S&P 500, and Russell all reached record highs in mid September. 2013’s first nine months have provided good returns. Here are the numbers for the major averages through the end of last week.
Dow Jones Industrial Average +16.4%
S&P 500 +18.6%
Nasdaq Composite +25.2%
Russell 2000 +26.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
Mark Twain said “October. This is one of the peculiarly dangerous months to speculate in stocks.” (He followed that by saying, “The others are July, January, September, April, November, May, March, June, December, August, and February.”)[vi]
Entering the 4th quarter, the markets are facing some strong cross currents. Such things as possible monetary tightening, dysfunctional political leadership, some not so cheap valuations, and really bad football being played by the MetLife Stadium teams are countered by an American manufacturing revival, a drive toward lower costing energy independence, and dynamic growth in our society’s growing digitization.
Whether the bullish view wins out over their ursine opponents, our ongoing prediction is that the markets will offer opportunities. Future headlines might not easily reveal these situations, but when bad news gets bought, it’s probably time to take notice.
 Clayton, Evans, Hewson, Mullen, Kidjo
 FactSet.com/insight, 9/27/13
 GaveKal, Quarterly Stragegy Chart Book, September 2013.
 The Wall Street Journal, September 28-29, 2013
 “Pudd’nhead Wilson”, Mark Twain, 1894
This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.
Past performance does not guarantee future results
Jeffrey J. Kerr is a registered representative of
LaSalle St. Securities, LLC, a registered broker/dealer.
Kerr Financial Group is not affiliated with
LaSalle St. Securities, LLC. Securities are offered
Only through LaSalle St. Securities, LLC
940 N Industrial Drive, Elmhurst, IL 60126-1131
Past performance does not guarantee future results