Often, when making investment decisions, the obvious needs to be questioned. In other words, when something becomes so widely known that virtually everyone “knows” it, it’s a pretty good bet that it is already reflected in the current price. If this obvious information is already in the securities price, future price movement will likely be caused by other reasons.
An example might be our recent financial crisis. Money printing, bailouts, QE, and poorly thought out stimulus programs causing record fiscal deficits were the policy responses implemented to fix things. Many thought these would ultimately lead to more and bigger problems and even those in favor of these extreme and untried approaches acknowledged that they contained risks And when it seemed ‘obvious’ to everyone that things were going from bad to worse, the economy and markets stabilized and began to move higher. This was largely in spite of policy rather than a result of it as businesses figured out the new landscape, adjusted and moved forward. The point is that what appeared to be obvious (bad approaches would cause more and deeper problems) ended up missing new developments (businesses adapting and figuring out how to progress).
Within the context that history doesn’t repeat itself but does often rhyme, the 2014 stock market has some similar underlying characteristics that force us to look beyond the obvious. Right now everyone knows the stock market is at all-time highs. However, this clear fact has an element of distortion. First the Dow and S&P 500 both began at record levels so any move higher, no matter how small, results in a new record. This nugget seems to be overlooked by journalists as they report on the daily stock market action. To be sure, a “record stock market close” is much more interesting than reporting that the Dow inched higher by 10 points. However, a casual follower could easily be misled by this omission.
2014’s advance, in addition to being shallower than perceived, has also been narrow. The 6-month chart below show both points (Please note this chart includes July. Also, the color code is as follows Dow – blue, S&P 500 – red, Nasdaq composite – purple, and the Russell 2000 – green). As you can see, the S&P 500 has had the smoothest journey this year and especially in the second quarter. Further, despite the media’s portrayal, the majority of the market has made little progress above the March highs.
The chart points out another important development – a substantial divergence between the large cap and small cap of the market. From the beginning of April, the Nasdaq and Russell gave back all of 2014’s gains and then some by mid-May. While they rallied along with the rest of the market throughout July, their 2014 performance has lagged the S&P 500. This divergence grew materially in July as you can see.
Of course, the deviation in the averages can also be seen in the major averages’ quarterly and year to date numbers. Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
2nd Qtr 2014 [i]
Dow Jones Industrial Average +2.24% +1.5%
S&P 500 +4.69% +6.1%
Nasdaq Composite +4.98 +5.5%
Russell 2000 +1.70 +2.5%
For Kildare Asset Management clients, accounts averaged an increase of 4.7% in the second quarter while the weighted average increase of all Kildare Asset Managed accounts was 5.22%.
The year-to-date performance for 2014 was an average increase of 14.54% and a weighted average increase of 14.36%. These numbers are after all expenses.
While there are few steadfast investing rules, divergences can be a significant indicator of future price action. There has not been this type of separation among the major averages in recent years and certainly nothing came close during 2013’s rally. This type of movement (the broader averages weaker than the larger, narrower ones) might be an indication of upcoming turbulence. Of course, there are past examples where this type of divergence is resolved with the broader market regaining strength and closing the price gap (weaker averages catching up). Nevertheless, it is something to monitor.
The markets are flashing other red flags. The cumulative advance-decline ratio (the summation of the number of issues advancing and declining) has weakened. Further as the market regained record territory at the end of June the number of stocks trading at new 52-week highs was not as great as the number when the April highs were achieved. This means fewer issues were leading the charge.
While this deterioration must be watched, there is no arguing that this has been a remarkable rally. As measured by the S&P 500, we have gained 193.5% during the past 1,942 calendar days which ranks fourth in strength and duration. Interestingly, this move will have to continue through early May 2015 in order to overtake the third longest rally which started in October 1974 and ended in November 1980 (2,248 days). In terms of strength, third place belongs to the 1980’s (August 1982 through August 1987) with a 228.8% gain. For those interested, the same two bull markets capture first and second in both longevity as well as percentage gain. Second place transpired from June 1949 and ended August 1956 (2,607 days) and rose 267.1%. As some might guess, the greatest rally began in December 1987 and ended when the tech bubble burst in March 2000 (4,494 calendar days). During this stretch, the S&P 500 rose an amazing 582.1%.
While it would be quite enjoyable for the current rally to continue to gain on these other historic moves, we must consider the possibility that it falls short. To that end, I continue manage your account with risk control being a high priority. As you know, this involves using part of the portfolio in a combination of hedges and cash balances. Further, I remain diligent in looking for opportunities that present favorable risk vs. return situations.
Looking forward I think the markets will face some obstacles. Current conditions offer many sources of possible causes – geo-political conflicts, the end of QE, inflation, etc. Any of these developments could worsen to a point that they impact the stock market and the economy. This market setup reminds me of a quote from global hedge fund manager Paul Tudor Jones. Mr. Jones is quoted as saying “I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have.”[ii] Indeed this will be our priority.
Thank you for your continued trust and business. Please contact myself or Connie with any questions or comments.
[i] The Wall Street Journal, July, 1 2014
[ii] Raymond James Equity Research, July 23, 2014
Jeffrey J. Kerr, CFA
Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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.