The amount of switches, twists and turns over the past quarter is enough to make anyone's head spin!
The news over the past quarter provided plenty of reasons for stocks to sell-off: the Fed sent mixed messages on tapering their QE (Quantitative Easing) program, a U.S. entanglement in the Middle East appeared likely, and earnings growth was subdued...
...but then "the taper" was postponed, immediate conflict in Syria was avoided, and investors appeared to focus on the potential for faster earnings growth ahead. The stock market price action reflected this yo-yo'ing, and looks like a rudderless ship (see chart below.)
The markets have shown considerable resilience over these past weeks. What are the likes of Warren Buffett and Carl Icahn saying about the current market environment? Please read on.
To most everyone's surprise, the S&P 500 made up for a weak August, with decent September gains.
- Stocks While the government shutdown triggered the S&P 500’s longest losing streak of the year in late September, the S&P 500 ended the quarter less than 3% from its September 18 record high of 1725, up just over 4.5%.
- Bonds "Taper talk" was particularly detrimental for Treasury bonds. The Barclay’s Long-Term Treasury Bond Index was down nearly 2 ¼% for the quarter, and has slumped 9.9% YTD, for its worst first nine months since 1987.
- Commodities The only asset class year-to-date worse than Treasury bonds has been gold, at -20.9%. The yellow metal had rebounded in July and August, but was the worst asset class in September, down 3 ¾%.
What About Q4..."The Oracle of Omaha?"
In 1999, the Oracle of Omaha, AKA Warren Buffett, said that we should be looking forward through the windshield, in the direction of interest rates, profits, and valuation levels, not through the rear-view mirror of past performance. Buffett warned that the stock market over the next 17 years “will not perform anything like it performed in the past 17 years." As we all know, Buffett's comments turned out to be quite prescient.
Market price levels have returned to, and in the case of the Dow Jones Industrial Average and the S&P 500, even exceeded levels seen in 2000. If we take a page out of Buffet’s book, how does the market look from his filter of valuation, interest rate and profit perspective?
- Valuations are a bit stretched right now, with Price-to-Earnings (P/E) ratio currently around 22, illustrating the market, as a whole, is a bit expensive. As you can see, ratios haven't quite reached levels seen in 2005 - 2007, nor are they at levels anywhere near 200o. However, in the last few weeks, Buffett, Icahn, and Stanley Druckenmiller, all investing titans, have stated concerns that the market is "fully valued." The chart below certainly supports their view.
- Profits Third quarter corporate earnings announcements kick off in earnest next week with Alcoa reporting on October 8. S&P 500 companies are expected to report a 4.7% year-over-year earnings gain for the quarter, continuing a trend of slow growth. Investors should be aware, however, that rising interest rates will squeeze profit margins, and as a result, could result in swings in earnings in the future. And depending on its length, the government shut-down won’t help corporate profits either.
- Interest Rates Discussions of QE tapering have been tabled for now. With the government shut-down, some are suggesting that tapering will be postponed even longer. One indicator of future policy will be who Obama appoints as the next Federal Reserve Chair. The most probable pick is Janet Yellen, whose past actions have indicated a dovish stance (maintaining an accommodative policy position), and as such, bullish for the markets.
As you all know, we tend to favor assessing various markets from a technical perspective, focusing on price trends, relative price strength, and momentum. Market price action and trends can persist long after fundamentals tell the logical person it's time to sell. All you need to do is look at the chart above for an example of this phenomenon - one could have made the argument to sell the S&P 500 in 1997, if looking at valuation alone.
From the technical lens, trend evidence continues to lean bullish. And as the saying goes, "Don't fight the tape (meaning the current price trend) or the Fed (meaning, a Fed that is stimulating the economy through lower interest rates and quantitative easing is bullish for stocks)."
So, our indicators are generally consistent with Buffet's view that there is not much upside - for now- and that we are due for a breather.
Will the shenanigans in Congress result in this breather? The closer we get to October 17 without a budget, the more likely a continued sell-off - and the sharper the likely sell-off. However, assuming Congress can make some decisions - about the budget and the debt ceiling - we think that even a minor pull back will likely be enough to relieve some of the market frothiness, and propel the markets higher into year-end.
If Congress doesn't come to consensus...well, that's likely a different story.
Live well. Invest well.
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