Oil

Market Update & More (3/15/2020)

Posted by

0

Q. How about that stock market rally on Friday? It has to mean Thursday was the bottom right and this was that quick turn you’ve talked about before?

A. Honestly, I doubt it. And I don’t mean that stocks are going to immediately just give that all back, though they certainly could. What I mean is that the stock market is constantly adjusting to price in all known current information and all opinions of those who are invested in it. If the average investor thinks that prices for a company, sector, asset class, country, index, or the market as a whole are too high, then that average investor will be buying less at the current price than selling. That makes prices fall, sometimes rapidly, to a lower point where equilibrium is established again. The reverse of course is true as well. If the average investor, known all they know, thinks prices are too low, then there will be more buying than selling at the current price, thereby pushing prices up. Right now, markets are getting lots of new information daily, sometimes minute-ly (don’t think that’s a word, but let’s go with it anyway). Opinions form, sometimes overreacting, sometimes underreacting, though we never know when that’s the case. Friday’s snap back from Thursday’s ~10% move down is more shifting opinions, more new information, and more projecting the future beyond covid-19 and an oil price war. The odds are good that the market is still fairly priced and if it’s not, we don’t know whether it’s overpriced (near term shock will be worse than expected, recovery longer, long-term impacts) or underpriced (near term shock will be better than expected, recovery shorter, few/no long-term impacts). The key part of that last sentence is “than expected”. We can’t simply read the news, say that covid-19 cases and deaths increased, and think that would cause stocks to lose value. What causes stocks to lose value is when things are worse “than expected”, in aggregate, and that worse than expected result is validly projected into the long-term future. No one can tell you when the stock market is going to bottom or has bottomed, just like they can’t tell you when it is going to top-out or has topped-out. It would be much wiser to say that the best guess is that the market is fairly priced, is most likely to produce average returns from here, but that the likelihood of a wild swing in one direction or the other remains.

Q. Well, that’s disappointing. Everything’s so depressing right now… can you give me a few positives as a result of what’s happening?

A. Absolutely.

  1. Long-term interest rates are extremely low. That’s not just great for refinancing personal debt (e.g. mortgages), but it also means something important about asset prices. A company’s value today is determined by a projection of its future profits, but typically the short-term profits are weighted much higher than long-term profits because of the interest rate you can earn on those profits each year as they’re collected. If interest rates are high, say 10%, you’d rather have a dividend right now and reinvest it at 10% than get it five years from now. That makes the short-term much important relative to the long-term in determining current value. When interest rates are as low as they are now, the value of the next year’s profits is a much smaller portion of a company’s total value. This is extremely important in the sort of scenario we’re living in now where the disruption to profits seems temporary. Losing year one of profits with minimal/no impact on years 2 thru infinity should not change current value by that much, at least not in aggregate (individual company’s might have debt which forces them out of business if they can’t make payments, but then another company that survives takes their revenue going forward). Warren Buffett invested in an airline yesterday. I suspect, he’s using this kind logic in buying the worst possible investment for news flow (ex-cruise lines), at exactly the worst possible time looking at near term profits.
  2. Gas prices will likely be in the ~$1.50 range nationwide in the next couple of weeks. Most people aren’t doing a lot of commuting / traveling right now, but when they do, those cheaper prices at the pump add up to more money in consumer pockets.
  3. More on interest rates… I don’t know if we’ll do this, but the country has an opportunity to extend the maturity of short-term debt to the very long-term without paying much higher (and sometimes even lower) interest rates. Some countries have 50-year and 100-year bonds. For some reason, we don’t go beyond 30. If we could refinance our national debt at low, fixed, long-term rates, it will give some leeway to fixing our fiscal issues.
  4. We’re going to be able to refill the strategic petroleum reserve for the US at prices that seemed unimaginable 10 years ago. The next time there is an oil supply shock, we’ll be much better positioned as a result. (Aside: shouldn’t we also have a strategic medical supply reserve? *sigh*).
  5. For those who are still adding to their portfolios, which are generally the ones that will take the biggest hit from stocks falling in value since retirees don’t have all their money in stocks, the opportunity is substantial. I don’t mean that stocks are a fantastic opportunity now and they should pour money in at current prices. But, investing steadily through the rollercoaster will get you to a higher ending portfolio value than investing the same way in a market that just moves steadily upward. See https://blog.perpetualwealthadvisors.com/2013/06/20/the-value-of-volatility/ for examples.
  6. The worldwide fiscal and monetary response to our current challenges is going to be enormous. This has some long-long-term consequences, but for the medium term, it can’t be anything but a positive. The last decade has also made it much more commonplace and acceptable for the Federal Reserve to pump money into the economy to replace a lower velocity of money due to forced deleveraging. Quantitative Easing (QE) takes a lot of credit for keeping us out of Great Depression II following the financial crisis. There’s a fair chance an even stronger response could come this time if things get dire. Did you know that Japan’s equivalent of the Federal Reserve purchases equity ETFs (i.e. stocks)? Our Fed doesn’t have that mandate from Congress, but I wonder what happens when a national emergency is declared and the president has broader executive order powers? Hmmm…

Q. I feel a little better. Still though, from a financial standpoint, there are tons of people on CNBC and other stations saying they don’t want to be in stocks right now and haven’t been in stocks while this was happening. What do they know that we don’t know?

A. There are lot of doomsayers out in the press right now, taking victory laps because the market is down, even though many haven’t been bullish since before the great financial crisis. Maybe some of you reading this fall into that camp internally as well, feeling like you knew this was going to happen, but thinking back, you’ve felt that for so long that if you had acted at that point, you would have missed out on much more growth than you have lost in the last month. Still others may have nailed their “top” call at exactly the right moment. Surely you will be hearing from them at times like this. There are a lot of people in the world making predictions though and if you frequently make bold ones, you’re bound to be correct and may even find yourself on TV celebrating it. CNBC presents cheerleaders when markets are doing well, calling on people to buy hand-over-fist and perma-bears proclaiming the end of the financial world during a crisis. It’s what gets ratings. It’s also the people who are willing to come on their shows since they’ve been recently correct. It’s not hard to find people who are correct, even several times in a row… If you flip 10,000 coins 10 times, odds are that about 10 of them will come up heads every time. It doesn’t mean the coin has an advantage over the other coins. It means you’re not hearing from the other 9,990.

Q. How do you stay calm about all this? Aren’t you worried at all?

A. In all honesty I have my moments of personal freaking out at times like these, just like many of you that are reading this. Like the old Hair Club For Men commercials for those of you who remember them, I’m not only an advisor, I’m also a client. It’s ok to let yourself feel emotion. It’s just not ok to act on that emotion and do something that you planned specifically not to do exactly in a case like this. I know I signed up for riding a long, upward-sloping roller-coaster the first time I invested. I know with almost certainty that there will be dips of 50% on this ride, with the possibility of more from time to time. I know that it won’t look upward sloping during those dips. I also know that investing in aggregate in the ingenuity of humans and the ever-rising productivity and technological growth of our society is the best way to build long-term wealth. It is the reason why the roller-coaster slopes upward over the long-term. I also know that money I may need in the short-term isn’t invested all in stocks and in matching that return/risk profile with my family’s goals, there’s really nothing to worry about over the short-term. I still worry because I’m human, but my plan gives me comfort. I also sometimes feel like I know what the stock market is going to do (especially in hindsight!!!). During the financial crisis, I convinced myself I knew it was going to happen (in truth, I knew real estate couldn’t rise 15% forever, but I had no idea the depths that we’d be going to in early ’09). I knew after the sharp rise in stocks in spring of ’09, that we were going to revisit those lows again (we didn’t). I knew that the Fiscal Cliff disaster was going to crash the market (it didn’t). I knew that the financial system was going to crack when Europe ex-Germany was inching closer and closer to defaulting on their government debt (it didn’t, and not only didn’t it, but that government debt turned out to be one of the best investments ever for those who bought at the brink of disaster). Now, I’ve had good internal calls as well over the years, but I remind myself frequently about that coin flipping that I mentioned above. In short, I give myself time to freak out, I moan and groan, I remind myself of the futility of market-timing, I pull myself together, and I get back to regularly scheduled life. If any of you, my clients, find yourself stuck between freaking out and getting back to regularly scheduled life, please call me. I’m also a client and I know what it feels like. It’s the reason I write these posts when times are tough. I’m talking to me as much as I am to you. And, I’m listening.

Market Update (3/11/2020)

Posted by

0

Continuing the new Q&A format…

Q. I heard the stock market is now down 20%+, so we’re officially in a bear market. That means stocks are going down, right?

A. No. It means stocks have gone down. There is no magic switch that flips when stocks go from down 19.99% to 20.00% that tells everyone that stocks will now fall for some time period. Rather a “bear market” is a description of the past, telling us that the value for a particular asset or index has fallen 20% from it’s high. It is like describing a losing streak when a sports team has lost several games in a row. It doesn’t tell you about the next game. By the way, while the most well-known indices just marked 20% down, other asset classes have been down more than 20% for much longer. The Russell 2000 (US small caps) is down more than 25% from its all-time high and the Russell 2000 Value (US value small caps) is down more than 30%. You’re just hearing about the “bear market” now because the Dow and S&P500 have joined in.

Q. Is this all due to the coronavirus (covid-19)?

A. No. Last weekend, disagreements among OPEC members and between OPEC and Russia led to the kickoff an oil price war. Oil prices, which were already down sharply from levels of a year ago, crashed on Monday to below $30 per barrel. While low oil prices means lower prices at the pump, lower energy costs for consumers, businesses, and energy importing countries in general, falling oil prices now hurt the US due to the abundance of oil we produce. Much of that oil is costlier to obtain than middle eastern oil and while we can do quite well (we’ve actually become a net exporter of oil in recent years) with prices in the $50+ range, down near $30 essentially puts our shale oil companies out of business. There are over 6M jobs in the US directly related to energy and due to the capital investment required to get new oil extraction started, most oil companies have a large amount of debt. Debt with little or no revenue spells bankruptcy. The surviving companies will gobble of the assets of those that fail, and will be well-positioned if there’s ever an oil boom again, but many jobs will be lost in aggregate and the holders of all the bad debt will take losses.

Q. Will the price war go on long-term?

A. No one knows. Saudi Arabia started the war with massive price cuts to try to increase demand for their oil after other OPEC countries and Russia would not agree to supply cuts to try to keep oil prices stable in the midst of falling demand as covid-19 slows down world economies. All sides remain open to talks and there is pain for Saudi Arabia with oil at these prices as well. So it is plausible they will reach an agreement that will return prices to previous levels and potentially cut supply. But the damage to US shale may already be done. As I noted above, it takes major capital investment to start the extraction process and knowing that Saudi Arabia can drop the price of oil at their whim may prevent that capital investments and/or the financing needed for it in the future, even if prices do rise from here. The energy sector of the stock market and the high-yield debt markets both immediately reflected the new reality on Monday will many stocks down near 50% that day alone. An agreement to cut global supply and thereby boost prices worldwide will obviously help on the margin, but job losses and defaults are likely no matter what and that will hurt the US economy somewhat.

Q. Speaking of hurting the US economy, things seem to be getting pretty bad with the coronavirus impact. How bad is this going to get?

A. Like I said in my last message, the fear of the fear of the unknown is the biggest issue. We still don’t have mass testing available in the US, so it’s hard to track places trending toward an outbreak level and take action to curb the spread. Until today, not much action was being taken nationwide. Now we’re seeing large cancellations and postponements including the suspension of the NBA season, travel restrictions from Europe, etc. Work must continue and critical services have to be maintained, but luxuries, hobbies, sports, and leisure travel really have to be restricted. This makes total sense.  With an incubation period of 5-14 days, we’re looking at the past right now, so taking immediate action to stop mass gatherings and travel is necessary, but will take a while to slow the spread. Meanwhile, the economy will suffer from the loss of all that activity. This is what the stock market sees and why it has fallen. Remember though that as the infection count rises (based on per capita cases from other countries, we’re likely in the 10-20k range already… just not counting them yet) , the death toll rises, the economic activity slows, and the news flow worsens, those are all items that the stock market already knows is coming. No one believes the US has 1100 cases of covid-19 infection right now. No one believes this is just going to miraculously go away tomorrow. The stock market is a realist and reflects the best guess at the future news from everyone who buys and sells. That’s why it’s impossible to know when stocks have bottomed. We’ll all see terrible news flow and suddenly the market’s participants in aggregate will begin to see past the pandemic and into the future. Stocks will turn well in advance of the worst times, just as they have in past crises. Because fear & despair usually cause the market to overshoot to the downside (as it did in 2009), when the market turns, it often turns quickly right as the news is hitting its worst.

Q. So you’re saying that selling into the downturn due to the news flow won’t work?

A. I’m saying that selling at any time guessing that the market is going down short-term vs. going up short-term is about a 50/50 bet. Even if you get it right though and sell at the right time, you then have to win another 50/50 bet in the right time to reinvest. Many learned that lesson the hard way selling toward the bottom of the financial crisis in early 2009 and then waited for the news flow to turn to want to buy back in, but by then the market had already moved up past where they sold. We want to avoid that whipsaw and instead do the reverse. Use your target asset allocation (the one that reflects your goals and risk tolerance) as a literal target for your portfolio. As I’ve said previously, that means that if stocks fall, we sell bonds and buy stocks to rebalance back to the target percentages. When stocks rise, as they did strongly in 2019, we did the reverse, selling stocks and buying bonds. There is no guessing or betting or predicting involved. It’s systematic and emotionless.

Q. Ok, so long-term, odds favor a return to recent highs?

A. Of course, though we never know how long that will take. It’s already a distant memory for most, but in Q4 2018, the S&P 500 fell nearly 20% with small caps and international stocks down even more. Over the course of the last 7 days of 2018 and Q1 of 2019, the S&P had recovered almost all of its Q4 losses. By the end of 2019, the S&P 500 was up 30%+ for the year. Other times, 20% losses have been just the beginning of a much bigger, longer slide. We never know the depth of a pullback or the length of time to return to recent highs in advance. But, unless there is a major decline in world population (and even the worst estimates of covid-19 come nowhere near projecting such a thing), then when this is behind us, the world will return to normal, as it always has after a traumatic event. There will be bankruptcies, there will be defaults, and there will be financial dislocations for a while. But ultimately, if there is the same number of people and the same aggregate demand for goods and services, the same technology, the same capacity, the same real assets (even if financial assets are worth less temporarily), how would we not get back to business as usual? That’s what the stock market will eventually see ahead of the turn in the news flow.

Q. Should I then be investing some of my cash emergency fund to take advantage of the temporary lower prices?

A. Absolutely not. An emergency fund is there for emergencies and especially in uncertain times, emergencies like a job loss, medical need, family need, etc. could come up at any time. We never advocate investing the cash that you’ve set aside for emergencies due to the recent movement of financial markets.

Q. What about taking on leverage (loans) via a home equity line of credit and investing that to try to catch the rebound?

A. We don’t recommend investing on leverage whether via a margin loan, a HELOC, or leveraged investment products. Again, we don’t know how long this will last or how deep the downturn will go. If you have $100k and borrow $100k to invest $200k in total into stocks and stocks fall 50%, you have lost all of your $100k. There is no coming back from a 100% loss. Even 1000% returns don’t increase a zero-balance portfolio.

Q. Any other general words of advice for times like this?

A. First off, do what you need to do to keep yourself and your family safe especially if any of you are in poor health or are elderly. You have to stay tuned to the news in some way to know what’s developing and what’s required of you as policies change. Try to tune out the financial part of it as much as possible. Think of all the times your financial advisor has told you that at some point, stocks will again lose 50% of their value. I’m not saying that will happen now, but you, your portfolio, and your plan were then, and are now, prepared for it to happen.  Put the energy you’d spend worrying about it toward better uses in your health, your job, and your family, as much as possible.

Market Update 10/15/2014

Posted by

0

I don’t have a crystal ball and can’t tell you where the market is going, but I can tell you why I think it has fallen recently. Here are my top pain points in reverse order of concern/impact over the short-term (#6 having the biggest impact in my opinion):

1) Geopolitical Tensions / Civil Unrest – press on these has eased recently just because there seems to be worse news in other areas to take the headlines, but they’re still very present. Middle East, Russia / Ukraine, Hong Kong… all these sorts of issues threaten global economic growth through lower productivity and inefficient use of resources. Protests, sanctions, wars, fear, and loss of life around the world that seems like it will be ongoing indefinitely.

2) Central Banks – the US Federal Reserve is ending Quantitative Easing (QE), their bond buying program that essentially amounted to printing money to purchase treasury bonds (finance government debt spending) and mortgage backed securities (finance home purchases). Many worry that the end of QE and the ultimate beginning of an interest-rate hike cycle will put the brakes on a recovering US economy. So far, long-term treasury rates and mortgage rates have stayed low despite the Fed pulling back on QE as a potential economic slowdown tends to lower rates on its own. Other major economies of the world are also moving in the opposite direction, embarking on further monetary stimulus programs as the US pulls back. This forces their rates lower and acts as competition for US rates, dragging them lower as well. 10-year government bonds in Germany are paying less than 0.7% right now. US ending monetary stimulus while Europe and Japan extend stimulus tends to push the US Dollar up vs. the Euro and the Yen, making our exports less competitive which can also act to slow down the US economy. As one of very few sources of global economic recovery for the last few years, a lot is riding on continued US growth and the end of QE combined with a stronger dollar jeopardize that.

3) Europe – the majority of the continent’s economy is still a disaster and there aren’t any signs of improvements. Many suspect a QE-like program launching in Europe soon, but the legalities of such a program in a common currency with so many different jurisdictions involved make it difficult to pull off. There’s also no way of knowing how it effective it would even be given how low interest rates in the Euro zone already are. Additionally, some concerns from a few years ago are roaring back. Greece wants to end its participation in its bailout program, but doing so means it won’t be able to borrow at the low euro-zone rates, and potentially means it will need to exit the Euro completely which threatens the stability of the currency as a whole. If Greece reverts to its issues of a few years back, Portugal, Spain, and Italy (maybe even France) can’t be far behind.

4) Oil – the price of oil has been plunging in the past few weeks. While this is good for global economic growth in general (lower prices at the pump, lower heating oil this winter, lower costs for airlines, etc.), a portion of the US recovery has been led by the energy sector and our progression toward oil independence from the Middle East though domestic production and Canadian imports. It appears that OPEC is putting on a sort-of price war now with the US, keeping their production high despite falling prices because their drilling costs are lower than our more complex ways of extracting oil (oil sands, fracking, etc.). If they can push the price down for long enough, they may be able to force a reduction in US / Canadian production and maybe even put some US / Canadian companies out of business which will ultimately push prices back up with a larger share of oil production coming from the Middle East again. As energy prices dramatically fall, hedge funds that are dedicated toward energy investments, sometimes in a leveraged way, are forced to liquidate which causes further drops in energy prices and ultimately in other assets as well. Forced selling begets forced selling and the price of everything tends to fall in a whoosh until leverage is managed, markets clear, and price stability resumes. If oil continues to fall, it’s likely the rest of the market will fall with it until oil stabilizes. The good news is that once the forced selling is done, we’ll be left with lower energy prices overall and as long as the US / Canadian producers survive, that will be a stimulus to the economy in additional discretionary money in the pockets of consumers.

5) Ebola – this is one of those very low probability of extreme catastrophe events that makes it very hard for financial markets to price risk. When markets can’t price risk, then tend to avoid it, and that means short-term traders selling just about everything other than the safest assets (treasuries). Ebola has been around for a long time and there have been other outbreaks. There will be other outbreaks after this as well, since it is carried by animals that can transmit the virus to humans, without illness by the animals. If contained, as it has been in the past, it will come and go again as any other flare up of disease (remember SARS?). If not controlled, given a 70% mortality rate with the latest outbreak, it threatens large sections of the population. The concept of confident long-term market growth is based on population growth and productivity increases over time. If a disease eliminates substantial portions of the population, that premise fails and even over the long-term, economies will shrink and equity markets will shrink with them. Even if the most likely scenario happens (a minor breakout with no epidemic-like results), fear of the disease can temporarily cause fear of being out in public, traveling, shopping, etc. Each time more negative ebola news comes out, stock markets take another leg down. With a 10-14 day incubation period, It could take several weeks to see that the breakout is controlled before some confidence is restored. As I write this, details have emerged about a 2nd healthcare worker in Dallas having ebola and having flown on a commercial jet the night before her symptoms began. Sure enough the market fell to new lows shortly after the news. The US CDC needs to instill confidence soon or ebola will take the economy down in the short-term (best case) and could take it down in the long-term if it truly does become an epidemic. Again, very low probability of extreme catastrophe, but until it’s a zero probability, it will have an impact in financial markets.

6) Fear / Self-Fulfillment – Fear of all of the above having a negative impact on the economy causes markets to fall which causes confidence to fall which causes spending to drop and layoffs to begin, which causes the economy to contract. It can be self-fulfilling and can happen very quickly. The more the stock market falls and the longer the fall drags on due to fear of a recession, the higher the potential that the recession occurs as a result. This is the biggest concern for the stock market short-term. This correction, so far, has happened quickly and hasn’t taken market levels to a point that the fall will impact the economy. That doesn’t stop the market from starting to worry about though.

Remember, markets tend to climb the wall of worry. As long as there are reasons to worry, there’s room for the market to go up. New worries will push it down temporarily (no one was talking about ebola a year ago), but the lower prices go, the better the price you get if you’re using a consistent plan of buying over time. This is why people are so successful with 401ks. Volatility creates wealth for those who don’t fear it (see https://blog.perpetualwealthadvisors.com/2013/06/20/the-value-of-volatility/). While we can’t control the aggregate market going through a fear-cycle, I hope that understanding the reasons that cause the fear helps you avoid it.