US Stock Markets Surprisingly Steady - First Quarter Review
Surprisingly steady! How can we say that? Because compared to the price swings of the last six years, the recent 3.9% decline in US Stocks (from a record set April 2) barely registers relative to the powerful uptrend since mid 2011. Volatility (the Fear Index) rose to 17 from the recent average around 14, but is nowhere close to 21.4 set back in January when stocks fell 5.8% from that high. Just think back to 2008-9, when swings of 3-6% were a daily occurrence and volatility soared to 81! On March 31st, US Stocks were up 1.7% YTD; at present, stocks are down 2.9% on the year. We're not concerned because we're reasonably confident based on fundamentals that stocks will close out 2014 with gains.
What we care about: Revenues, earnings, cash on balance sheets, and interest rates
Revenues & earnings for S&P 500 companies set new records for Q4 2013. Both should grow modestly in Q1, accelerate into the end of the year. Companies have record levels of cash on hand. Apple alone has $159 billion, while the top 50 companies hold $1.04 trillion! Interest rates as jumped sharply last from around 1.8% last June, peaked at 3% by year end, settled back to 2.6% recently (all quotes the US Ten Year Treasury.) Add those factors together, and US stocks are fairly to slightly over-valued. No need to make panic sales of stock in this environment. We reduced US stock positions in December and January, added to bonds and emerging market stocks, and are now sitting on our hands.
The next financial crisis!
The Economist recently published a time line of 13 economic crises dating back to 1720, with a detailed history of the 5 most significant. Crises since 1970 come once every 5-10 years. There's no evidence that we learned much from the 2008-9 crisis, which means that another crisis will probably occur by 2018. However sensible investors who don't use margin come out ahead after every crisis - stocks become undervalued temporarily, and rebound as soon as the crisis passes. If you're not forced to buy margin calls to sell, you just wait. The "smarty-pants investors," usually hedge funds, bankers, and clients thereof, commonly get their eyeballs ripped out because margin calls force those investors to sell at the worst possible prices.
We keep tabs on the amount of leverage in the system (currently low), how aggressively financial institutions push back against regulations (banks at present are tightly leashed) and whether investors are chasing fads (a modest boom in Web 2.0 stocks seems to be fizzling.) The present period is freakishly free of risks that would unbalance the system. We will let you know if our perception changes.
Recent headlines that have no effect on our investment strategy
Emerging Markets - Investors panicked, ripping $41 billion out of emerging market funds in Q1. We generally maintain an exposure of 5% to the stock markets of China, India, Brazil, Korea. We used this pullback to ADD to our positions in that sector.
Russia, Ukraine & Crimea - A second rate country seized some beach resorts from a third rate country. Pundit commentators wet their pants, howling that the US must "do something" to hold back Russian aggression. In fact, this episode shows Russia's weakness relative to the United States, still the world leader in invading other countries (Iraq, Afghanistan, Panama, Grenada, drone strikes worldwide.) The Russian Navy is mothballed. Russia still has nuclear tipped missiles but who knows how reliable? The chance that Ukraine might join NATO is as frightening to Putin as Canada joining the Warsaw Pact would frighten the US. The biggest problem that Russia has right now is demographic. Given high mortality, low birth and high immigration rates, it is possible that there will be 40% fewer Russians by 2100. Russian stocks fell 18% in March (a loss of $1.2 trillion,) recovering half those losses in recent days (still down $600 billion YTD.)
The mystery of Malaysian Airlines FL 370 - We can find a missing iPhone with a few clicks of a mouse, so how is it possible that we can't find an entire airplane. Accidents never happen unfortunately because of just one failure. Many theories, some complete ridiculous (black holes, alien abduction) have been proposed. The scenario that seems the most likely is that a fire, possible triggered in a cargo of lithium batteries, slowly spread through the plane, shorting out initially the transponder, later the radio and navigation equipment. The crew became aware of the problem just after the handoff from Malaysian to Vietnamese air traffic control - by then the radio was out of service. The crew tried to reverse course back to their home airport, but in the dark failed to calculate the reciprocal heading correctly and instead headed southwest out over the ocean. The crew may or may not have been in command of the aircraft when the fuel was exhausted, and the plane crashed into the water. It is surprising that NOTHING associated with the plane has turned up, but debris may be scattered across thousands of square miles of ocean. Eventually something will turn up. Litter from the Japanese Tsunami of March 2011 still shows up on the shores of the Pacific Northwest three years later.
With 0.0% of precincts reporting, CNN declares Hillary Clinton CNN the next president of the United States. Really? We haven't even gotten through the 2014 mid-term elections yet, yet campaigns (and the media circus that lives for campaigns) are already gearing up for 2016. For 2014, it seems likely that Republicans will retain the house and majority of state governorships. There is a 50/50 chance that Republicans take control of the Senate. Regardless of that outcome, we don't expect any significant legislation out of Washington in the next 2 ½ years.