MONEY stocks

What the Republican Majority Means for the Market

Senate at US Capitol
AA World Travel Library—Alamy

Will the Republican victory in the Senate lead to more legislation or gridlock? As far as Wall Street is concerned, that doesn't matter as the markets are about to enter their most fruitful months.

With most of the votes counted in the mid-term elections, Republicans picked up at least seven seats in the Senate last night, giving the GOP control of both houses of Congress for the first time in a decade.

The GOP’s majority in the Senate could still widen, depending on the count in Alaska and a December run-off in Louisiana, where neither Democratic incumbent Mary Landrieu nor Republican challenger Bill Cassidy won 50% of the popular vote in a three-person race.

Are the Republicans now in position to set a new economic agenda into motion? Or will the final two years of President Obama’s term be characterized by more of the gridlock that has largely stifled serious policy discussions in recent years?

As far as Wall Street is concerned, it doesn’t really matter. Here’s why.

1. We are about to enter the third year of the Obama administration. And third years are hands-down the best years in the stock market.

In fact, since 1926, the S&P 500 has gained nearly 17% on average in Year 3 of presidential terms, according to the investment research firm the Leuthold Group. The next-best years for stocks are presidential election years, when equities have gained 9.8% on average.

Jeffrey Hirsch, editor-in-chief of the Stock Trader’s Almanac, adds that the Dow Jones industrial average has not suffered a third-year loss since 1939.

What accounts for the sizzling performance? Part of it has to do with the fact that the third year of an administration also tends to see the best growth in gross domestic product. Market strategists surmise that the party in power in the White House has a vested interest in stimulating the economy—and the markets—as much as it can in the year before it faces re-election.

2. Stocks surge sharply in the immediate aftermath of midterm elections.

Researchers at Leuthold discovered that stocks have risen at an annualized rate of nearly 25% (including dividends) in the period that runs from the midterm elections in November to April of the following year.

Sam Stovall, U.S. equity strategist for S&P Capital IQ, notes that “we are entering the strongest six-month period for the markets in the entire four-year presidential cycle.”

He points out that this stretch coincides with two positive forces for stocks. The first is the presidential cycle. But just as important is the normal seasonal tailwind that equities enjoy from November to April, historically the best stretch for Wall Street in most years as investors emerge from the summer doldrums.

3. Washington gridlock doesn’t stall markets.

Stovall broke down election year performance even further. He went back to 1901 and examined how stocks performed in years where there’s been a split Congress—that is, the House is controlled by one party and the Senate by another, as was the case heading into this election.

He also looked at years in which a president of one party has to work with a unified Congress controlled by the opposition, which is what we’ll have starting in 2015.

In years where a president works with a split Congress, the S&P 500 has risen around 6% on average (not counting dividends), which is slightly below the long-term average of around 7% (again, not counting dividends). However, in years where a president must work with a unified Congress controlled by the opposition party, the average return for stocks is 6.2%.

It’s even better when a Democratic president must work with a Republican-led House and Republican-led Senate, like we’ll have next year. In those instances, the S&P 500 has risen 8.6% annually.

“Whether it’s gridlock or unlock,” notes Jack Ablin, chief investment officer for BMO Private Bank, “stock market history suggests the combination of a Republican-controlled Congress and a Democratic president is the most profitable politically.”

MONEY tech stocks

Twitter Becomes Latest Victim of October’s Mini Tech Wreck

Twitter logo on iPad
Chris Batson—Alamy

Twitter joins a long list of tech heavyweights including, Google, Netflix, and Yelp that failed to beat Wall Street estimates — and whose stock got clocked.

In case you haven’t noticed, this has been a miserable month for tech — especially for those companies that couldn’t find a way to beat Wall Street’s expectations.

Just ask Twitter. The social media darling did pretty much everything that analysts has asked. The company more than doubled its quarterly revenues, posting sales of $361 million. Twitter turned an actual profit, albeit a mere penny a share. But that was what Wall Street analysts had been expecting.

Meanwhile, the company reported that the number of active users grew 23%; timeline views (Twitter’s equivalent of website page views) increased 80%; and ad revenues from those page views increased 83%. Still, as UBS analyst Eric Sheridan told USA Today, the results lacked “upside surprise.”

The result: Investors pummeled the stock, which lost more than 10% of its value in after-hours trading Monday.

TWTR Price Chart

TWTR Price data by YCharts

Twitter wasn’t the only technology company to be taken out to the woodshed.

Last Thursday, did what it usually does — the e-commerce giant reported robust sales growth, but couldn’t manage to turn a profit amid its massive build out. Investors weren’t in a forgiving mood, shaving more than 8% off the stock’s price:

AMZN Price Chart

AMZN Price data by YCharts

The day before that, Yelp reported decent results, but the review site warned investors that fourth quarter sales would fall short of expectations. The result: Investors erased nearly a fifth of the value of the social media company:

YELP Chart

YELP data by YCharts

The week before that, Google reported strong profits, but said that the amount of money it is making per ad is falling. That was enough to knock the stock down.


GOOGL data by YCharts

And the day before that, Netflix announced it attracted far fewer new U.S. members for its streaming video service than was previously estimated. That was enough to erase more than a fifth of the company’s market value:

NFLX Chart

NFLX data by YCharts

MONEY currencies

Making the Most of a Mighty Dollar

Man flexing arm with $ tattoo on it
Claire Benoist—Prop Styling by Brian Byrne for Set In Ice; Tattoo Design by Andy Perez

The buck is back. Here's how to make the most of a stronger currency—and avoid the costs.

After getting pushed around for much of the 2000s, the once-wimpy buck is fighting back. The dollar has gained nearly 20% over the past 3½ years, compared with an index of global currencies. It’s now at multiyear highs against the euro and yen.

This is good news because it represents a global vote of confidence in our economy. Investors worldwide snap up bucks when they want to buy things denominated in our currency—including U.S. bonds, stocks, and other assets. The dollar’s current rally got going in 2011 and 2012, as the U.S. economy fitfully grew while Europe and Japan slipped into double-dip recessions. That has made America look like a better relative investment, says Brian McMahon, chief investment officer at Thornburg Investment Management.

And as our recovery gains strength, interest rates should nudge higher, making bonds more attractive to yield-seeking overseas investors. So the dollar could keep bulking up from here.

Dollar rallies have historically corresponded to a strong stock market, but “in any shift in a currency, there are going to be winners and losers,” says Liz Ann Sonders, chief investment strategist for Charles Schwab. You probably have some of both in your portfolio. So here’s a rundown of how things are likely to play out, asset by asset:


Bet on the American consumer … In part, the dollar boom is a reflection of the same trends that are benefiting any stock that’s sensitive to an improving domestic economy. GDP grew at an impressive rate
of 4.6% in the second quarter.

Yet the dollar isn’t just a mirror of U.S. strength. Its rise will also help lift some parts of the -economy. “The big winner is the U.S. consumer,” says Mark Freeman, chief investment officer for Westwood Holdings Group. One reason: A rise in the dollar tends to correspond to a drop in oil and other commodity prices. Since April 2011, the price of a barrel of crude oil has fallen by around 25%. Lower costs for energy leave consumers with more money to spend on other things.

Transportation stocks, including rail, freight, and airlines, benefit both from lower fuel costs and from consumer demand—more buying means more stuff is being shipped. A simple way to get exposure to the biggest names in these groups is through an index fund like iShares Transportation Average ETF.

… But not on U.S manufacturers. You can make room for a transportation-oriented ETF by lightening up on your exposure to U.S.-based multinationals.

For years, when the U.S. economy was sluggish, it made sense to bet on firms, such as Procter & Gamble THE PROCTER & GAMBLE CO. PG -0.1486% , that sell a lot to fast-growing markets abroad.


But a strong dollar will make it harder for such companies to compete with foreign rivals outside the U.S.  This is why large exporters such as Ford FORD MOTOR CO. F -0.5421% and tobacco giant Philip Morris International PHILIP MORRIS INTERNATIONAL INC. PM 0.3314% have cut expectations for profits this year. Industrial companies were once expected to grow earnings 24% in the third quarter. Now the forecast is 8% growth, according to S&P Capital IQ.

Be careful with dividends. In recent years, with interest rates very low, investors have turned to high-dividend-paying stocks to boost their income. So those stocks have boomed. But the rising dollar is signaling a steady shift to higher rates, says Freeman of Westwood Holdings.

Here’s why: Although U.S. bond yields remain low, they are significantly higher than what investors are now getting in many overseas markets. (Ten-year German bonds pay 0.9%, vs. 2.4% for Treasuries.) And the recent momentum in the dollar suggests traders expect U.S. bond yields to stay attractive—a reasonable bet given that the Federal Reserve is signaling that it will start gradually raising rates in 2015.

Better bond yields will be bad news for some high-income stocks, since many investors will switch from stocks that are attractive mainly because of their dividend checks. Income investors should go beyond just grabbing the highest yields and shift to companies that can also increase their payout steadily.

Susan Kempler, a portfolio manager at TIAA-CREF, points to Apple APPLE INC. AAPL 0.9269% , which yields just 1.8% but sits on more than $160 billion in excess cash. Such companies can be found in T. Rowe Price Dividend Growth Fund, which has beaten nearly 80% of its peers over the past decade.


Don’t give up …International investing tends to grow in popularity when the dollar sinks. That’s because when the buck loses value, Americans can make money on international stocks simply on the currency exchange. When the dollar rises, on the other hand, that’s a drag on returns.

So Americans’ attraction to foreign investing is likely to cool, says Scott Clemons, chief investment strategist at Brown Brothers Harriman. Yet this is precisely why you shouldn’t turn your back on international equities now.

For one thing, valuations abroad, especially for European shares, are low. Doug Ramsey, chief investment officer for the Leuthold Group, notes that U.S. stocks have historically been cheap—as measured by price relative to past earnings—compared with global shares. Recently, though, U.S. stocks have jumped to a 20% premium. On valuations alone, he says, “foreign equities should produce total returns of about two percentage points annualized above the U.S. over a seven-to-10-year horizon.”

You can gain European exposure through a broad-based fund that invests globally (so you’re still diversified) but with big positions in Europe. An example is Oakmark International, which is on our MONEY 50 recommended list of funds. The fund keeps more than 75% of its assets in European equities.

… But tread lightly in the emerging markets. As the dollar strengthens, expect rockiness in emerging markets as global investors reassess their portfolios.

Once rates start to climb in the U.S., says Kate Warne, investment strategist for Edward Jones, investors will shift to a more conservative mode, since they won’t have to take as much risk to earn a return. Many are likely to pull money away from emerging-markets investments. Warne says her company recommends that investors keep only 5% of their total portfolio in emerging-markets equities.



Don’t assume the worst …
One cause of the strong dollar—-expected rising rates—may have bond investors shivering. When rates rise, the value of older bonds in your fixed-income funds will fall, reducing your total return.

But take a breath. A gradual rise wouldn’t be a catastrophe if you hold conservative short- and intermediate-term bond funds. Meanwhile, a strong dollar also brings some good news for fixed-income investors. Inflation, a major enemy to bond investors, is held in check by the rising dollar, thanks to lower commodity prices.

… But hedge your foreign exposure. As with stocks, American investors have used foreign bonds as a way to profit from a weak dollar. Indeed, the currency effect added about two percentage points to foreign bond fund total returns since 1985, according to the Vanguard fund group. But a strengthening dollar going forward would mean the currency trade hurts, not helps.

You can still maintain foreign fixed-income exposure for diversification, but in a way that hedges your bets. A few funds lessen the impact of currency shifts by essentially buying dollars in the open market every time they buy
a foreign bond. One solid option is
Vanguard Total International Bond Index, which charges just 0.23% of assets a year. Sometimes you are better off playing just the investment and not the currency it’s wrapped in.

MONEY stocks

Could Another Sell-Off Be Lurking This Week?

Traders work on the floor of the New York Stock Exchange October 15, 2014.
Brendan McDermid—Reuters

Last week's tumultuous week in the stock market sets the stage for yet more nervousness and hand-wringing as a fresh set of earnings and economic data are due to be released.

When Wall Street opens for business on Monday morning, will bad news about the global economy be bad news for stocks?

That was the case for most of last week, when the equity market was hit with a frightening sell-off that reminded investors of the bad old days of the financial crisis.

^INDU Chart

^INDU data by YCharts

Or will bad news turn out to be good news for the market, as was the case on Friday, when the Dow Jones industrial average soared more than 260 points?

^INDU Chart

^INDU data by YCharts

Friday’s dramatic rebound in stock prices reflected two forces that are likely to move the market in the coming days.

Keep an Eye on the Fed

At the end of this month, the Federal Reserve is slated to end its stimulative bond-buying program known as quantitative easing.

Investors are naturally nervous about this development, as quantitive easing, or QE, has been credited for the strength and length of what is now a five-and-a-half-year-old bull market. As many market observers have noted, Wall Street is about to lose a major psychological crutch.

Remember that when the Fed ended its prior two rounds of quantitative easing — in 2010 and 2011 — stocks sold off fairly quickly:

After QE round 1, which ended March 31, 2010:
^SPX Chart

^SPX data by YCharts

After QE round 2, which ended on June 30, 2011:
^SPX Chart

^SPX data by YCharts

But late last week, when the market was in the throes of a selloff, St. Louis Fed president James Bullard said in a Bloomberg TV interview that “we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December.”

In other words, a member of the Federal Open Market Committee that sets the nation’s interest rate policy is openly mulling whether the Fed should postpone ending QE in light of recent market volatility.

Bullard’s remarks on Thursday were enough to give the markets a lift in the last two days of the week. And if there are more signs of a major global economic slowdown, including a possible recession in Europe and Japan, then the Fed may have to think twice about how — and how soon — it ends its stimulus efforts.

This week, investors will want to see if more members of the FOMC sound similar conciliatory notes of extending QE. So far, no one else has. Boston Fed president Eric Rosengren, a major defender of QE, said on Friday that he does not expect the Fed to extend the program at this juncture.

What else should investors look for?

  • Wednesday’s inflation report from the Department of Labor. If the global economic slowdown is starting to impact the U.S., we will start to see it in the form of lower prices for U.S. consumers.
  • Thursday’s report on the index of leading economic indicators from the Conference Board. The LEI is forward-looking barometer of economic trends, so if the global slowdown is likely to affect the U.S. in the coming months, this index should offer clues.

Keep an Eye on Earnings

Last week’s bloody selloff was peppered by major earnings disappointments on Wall Street. For instance, there was Netflix, which reported that subscriber growth wasn’t as strong as expected and saw its stock lose more than a quarter of its value on Wednesday. Google also disappointed Wall Street on earnings and revenue growth, as well as on paid clicks on ad links.

The idea is that if Wall Street is about to lose its QE crutch, it will have to fall back on the fundamentals — so corporate profit reports will have to look good.

On Friday, a slew of companies led by General Electric and Honeywell announced better-than-expected results, which helped drive stocks higher at the end of the week.

Yet the mood on Wall Street regarding earnings is somewhat pessimistic. The strengthening U.S. dollar, brought about by the global economic slowdown, is expected to crimp global profits for U.S. exporters.

This week, several high-profile earnings announcements are due to be released. Here are the major ones to look for:

  • On Monday, Apple is due to report its results after the closing bell. Everything Apple reports is news these days.
  • On Tuesday, Coca-Cola will reports its results before the market opens. No company is as exposed to the global economy as Coke is.
  • On Wednesday, Boeing is set to reveal its earnings before the market opens. The global slowdown is expected to hurt U.S. exporters, and Boeing could be a sign of how bad things have become.
  • On Thursday, will report after the bell. Amazon isn’t just a bellwether of the tech economy, it is now a key gauge of the health of the U.S. consumer.
MONEY stocks

If This Is the Start of a Bear Market, Blame Alibaba

There's a possibility that the recent selloff morphs into a real downturn — and Alibaba's gaudy IPO may have marked the market's top.

It’s impossible to say if the recent plunge in the market is the start of a full-on downturn, or if it’s just a bout of short-term angst.

But if this does turn out to be an an official bear market, defined as a sustained drop of 20% or more, you can blame the Chinese e-commerce giant Alibaba and its celebrated initial public offering on Sept. 19.

That’s what famed bond fund manager Jeffrey Gundlach told CNBC earlier this week. Indeed, since Alibaba went public about a month ago, the broad market has lost almost all of its gains since the start of the year. And Alibaba itself has lost nearly 10% of its value.

BABA Chart

BABA data by YCharts

But it’s also what history says.

Bull markets are born at a time of fear, but as they mature, greed sets in. And at the top of the market, investors try to get their mitts on one last pot of gold.

That’s why many of history’s biggest downturns coincided with celebrated IPOs that exemplified the themes of the prior bull market.

You’ll recall, for instance, that in the summer of 2007, just as the financial crisis was getting going — and just months before the start of the 2007-2009 bear market — the private equity and financial services firm Blackstone Group went public … and proceeded to get hammered.

^SPX Chart

^SPX data by YCharts

And before that, in April 2000, AT&T Wireless went public just days after the market peaked on March 24, 2000.

In Alibaba’s case, the company exemplified the hot themes that had been driving the five-and-a-half-year-old bull market. That is, exposure to technology, mobile, social media, and China.

But all of that may prove to have been too much of a good thing.

MONEY stocks

Here’s the Deeply Depressing News About This Market

A trader watches the screen at his terminal on the floor of the New York Stock Exchange in New York October 15, 2014.
Lucas Jackson—Reuters

Sadly, there may be no safe havens this time. Stock investors typically turn to dividend payers and "low-volatility" stocks in rocky times. But those investments have gotten pricey.

When the stock market gets choppy, as it is now—the Dow Jones industrial average plunged by triple digits again on Wednesday — equity investors tend to set sail for calmer waters.

Historically, that’s led them to a few sheltered corners of the market.

First, there are high-yielding stocks, where payouts to shareholders serve as a cushion when stock prices crater. Dividend-paying stocks don’t prevent losses altogether—this is the stock market after all—but during the 2008 financial crisis, for instance, when the S&P 500 S&P 500 INDEX SPX 0.0339% lost 37% of its value, the SPDR S&P 500 Dividend ETF SPDR SERIES TRUST DIVIDEND ETF SDY -0.0248% fell just 23%.

Investors also look for safety in so-called low-volatility stocks. These are shares of “steady Eddie” companies, often found in stable but slow-growing and boring businesses, that usually gain less than the broad market during upturns but lose less in downturns. Among the biggest holdings of the PowerShares S&P 500 Low Volatility ETF POWERSHARES ETF II S&P 500 LOW VOLATILITY PORT SPLV 0.1475% , for example, are Coca-Cola THE COCA COLA CO. KO 0% and Warren Buffett’s insurance and holding company Berkshire Hathaway .

History says that both dividend payers and low-volatility stocks not only provide ballast in turbulent times but actually outperform the broad market over the long run.

Normally, tilting your portfolio toward either of these types of stocks would make sense if you’re worried that the recent jump in volatility — as seen below in the CBOE VIX “fear” index — is a sign of worse things to come.

^VIX Chart

^VIX data by YCharts

Trouble is, nervous investors jumped the gun and bid up shares of dividend payers and “low-vol” investments before volatility actually manifested in the economy. Indeed, from 2009 to the start of this year, dividend investing proved to be one of the easiest ways to beat the market:

^SPX Chart

^SPX data by YCharts

In other words, these two conservative and time-tested ways to stay in stocks are now expensive on a relative basis. And recent history tells us that buying an overvalued stock is fraught with risk.

Take dividend payers. They typically sport lower price/earnings (P/E) ratios than the broad market because high-yielders tend not to grow that fast. (That’s why they return dividends to shareholders in the first place.) But these days the average P/E for stocks in the SPDR S&P 500 Dividend ETF is 18.3, based on projected future corporate earnings. By comparison, the average stock in the broad market trades at a P/E of 17.

Similarly, the average holding in the PowerShares S&P 500 Low Volatility ETF trades at a higher-than-average P/E ratio of 18.

The problem with these frothy prices is that they detract from the stability that these types of stocks normally provide. Feifei Li, head of research at Research Affiliates (a major proponent of low-volatility investing), published some thoughts last year about rising prices and valuations in the low vol space. Li noted:

Empirical evidence demonstrates that low volatility strategies offer higher-than-market returns and considerably lower risks… Not surprisingly, these desirable performance characteristics have attracted many players to the market … The fast pace of growth raises the question: Does the rapid flow into this space erode the strategy’s effectiveness in delivering attractive risk-adjusted returns? This is a legitimate concern.

Does this mean you should avoid low-vol stocks and dividend payers altogether? No, but it will take more work to find the handful of examples of these types of stocks that are undervalued and attractively priced.

Hey, no one said avoiding a downturn — while remaining in the stock market — would be easy.

MONEY stocks

Stocks Plunge Wednesday on Global Economic Fears

Spencer Platt—Getty Images

Volatility is back with vengeance, and it's being felt throughout the financial markets.

Updated: 4:30 pm

Volatility is back with a vengeance on Wall Street.

The Dow Jones industrial average plunged around 450 points on Wednesday afternoon before recovering to close at 175 points down, marking the sixth day in October that the stock market has suffered triple-digit losses. The Dow, which had been trading as high as 17,145 at the end of September, sank to below 15,900 before ending the day at 16,141.

^DJI Chart

^DJI data by YCharts

This capped off the worst three-day sell off for the broad market since 2011.

Small-company stocks — considered the market’s canary in the coal mine, since they’re more easily rattled by changes in the economy due to their size — sank around 1% on Wednesday and are in an official correction, defined as a 10% drop in value over an extended period. Micro-cap stocks, the tiniest sub-set of small stocks, also fell and they’re only a few percentage points off from an official bear market, or a 20% decline.


Wall Street is having flashbacks to the bad old days in the aftermath of the global financial panic, when there were real concerns that the global economy might slip back into a deflationary and recessionary spiral.

Right now, the big worry is that Europe and Japan will soon suffer their third recessions in the past six years. Policymakers in both countries are scrambling to find ways to jumpstart growth, yet their central banks are running out of ammunition.

Meanwhile China, once viewed as the engine driving global growth, has been slowing noticeably in recent quarters and can‘t find a way to reaccelerate, as it works through its own housing and financial crisis.

“While domestic growth is robust, slowing economies abroad have the potential to upset the recovery,” notes Jack Ablin, chief investment officer for BMO Private Bank.

Those global growth concerns are now being reflected in two troubling trends.

First, there’s the plunge in crude oil prices. While a barrel of crude oil traded above $100 a barrel as recently as this summer, prices fell to around $81 a barrel on Wednesday morning. Falling oil prices are often viewed as a good thing — since lower energy costs free up households and businesses to spend on other things. Yet the fact is, people aren’t necessarily spending that money on other things.

Michael Gapen, chief U.S. economist for Barclays Capital, noted that U.S. retail sales fell 0.3% in September. “The main downside surprise in this report,” he said, came in core retail sales — which strips out volatile food an energy prices — fell 0.2%. He said that was “against our expectation for a four-tenths rise.”

Moreover, the price of oil sometimes doesn’t cause good things so much as it reflects bad things already in the economy.

Right now, investors may be asking: “Is this the moment of truth when lower oil is signaling lower demand?” says Neal Dihora, an analyst with Morningstar.

Similarly, fears over the global economy tends to drive investors into slow-growing but safe assets, like Treasury bonds. And this morning, the yield on the 10-year Treasury fell below the 2% threshold for the first time since June 2013, a worrisome trend as MONEY’s Pat Regnier points out.

Even more troubling is the possibility that the market is telling us that the financial crisis may not be squarely in the rear view mirror.

BMO’s Ablin noted:

“Decades of debt accumulation touched off the 2008 financial crisis and critics argue that the solution, quantitative easing programs, simply shifted borrowing from the private sector to the public sector. The Fed’s primary lever since the Greenspan years, boosting asset prices and enticing borrowing by lowering interest rates, is no longer working now that short-term rates are effectively zero. Scarred by the financial meltdown and an underwater mortgage, households have had a change of heart and are now more interested in reducing debt.”

And as investors are keenly aware, reducing debt doesn’t help stimulate economic activity.

MONEY stocks

5 Ways To Tell If There’s More Trouble Ahead for Stocks

Is Monday's triple-digit loss the start of something worse — like a bear market? Here are five things to watch for in the coming days and weeks.

On Monday, the Dow Jones industrial average sank more than 223 points, marking the fifth straight day of triple-digit moves in the closely watched benchmark.

Technically, this is just a “pullback,” which is loosely defined as a drop of around 5%.

^SPX Chart

^SPX data by YCharts

The S&P 500 index has yet to reach a correction, or a 10% plunge. And the broad market is nowhere close to bear market territory, which is a sustained 20% decline in stock prices.

Still, as MONEY recently pointed out, this bull market is starting to show its age. So it’s hard not to wonder if a bear is lurking.

If you’re worried there are more troubled days ahead for equities, here are five things to watch for in the coming days and weeks:

1) Are companies reporting disappointing earnings results?

“I’d be listening to and watching third-quarter earnings reports,” says Liz Ann Sonders, chief investment strategist at the brokerage Charles Schwab.

Why? First, some companies face a new headwind in the form of the stronger dollar. While the strengthening U.S. currency is a sign of global confidence in the U.S. economy, it creates problems for American businesses. A mighty dollar makes it harder for U.S. exporters to sell their goods competitively overseas, which could crimp corporate earnings growth.

Robert Landry, a portfolio manager for USAA, put it this way:

We’re paying attention to whether companies beat, meet or fall short of revenue and earnings estimates. According to FactSet, average sales growth for the S&P 500 is expected to be 3.6% year-over-year and profit growth at 4.6%. The latter number is roughly half of where expectations stood back in late June.

What’s more, many investors think the stock market — at least prior to this sell off — was getting ahead of itself this year. Indeed, the price/earnings ratio (a common measure used to gauge market valuations) for the S&P 500 index had shot up higher than 18, based on the past 12 months of profits. That’s compared to an historic average of around 15. To justify those higher-than-average P/E ratios, investors want to see higher-than-expected earnings growth rates. The volatility of recent days suggests a worry that the bar’s been set too high.

2) Are commodity prices sliding?

The selloff in blue chip stocks recently has “coincided with mounting evidence of a global economic slowdown,” says Edward Yardeni, president and chief investment strategist at Yardeni Research.

Indeed, the reason why the dollar has been strengthening in the first place is that while the U.S. economy has been improving, Europe and Japan are both perilously close to slipping back into recession — for the third time since the start of the global financial panic.

Yardeni adds that global slowdown fears have grown in recent days as industrial commodity prices, including crude oil, have dropped sharply. (This isn’t a big surprise: Slower-than-expected growth in Europe, China and Japan has led to weaker demand for things like steel, copper and oil.)

David Kelly, chief global strategist for J.P. Morgan Funds, notes that Europe is set to release industrial production figures for August this week, along with data on inflation trends. If there’s even a whiff of deflation in the Eurozone — led by tumbling commodity prices — expect another bout of handwringing on Wall Street.

3) Are small stocks getting mauled?
While investors typically pay more attention to large blue-chip stocks, shares of smaller companies can be a harbinger of things to come for the broad market. Why? Because of their size, tiny stocks tend to be more volatile in general and the underlying companies are more easily rattled by changes in the economy.

The bad news is, the market’s tiniest publicly traded companies are already in a correction, as measured by the Russell Micro-cap Index. And should they slide into an official bear — which could be just days away — things could get really dicey on Wall Street.

^RTM Chart

^RTM data by Charts

Sam Stovall, U.S. equity strategist for S&P Capital IQ, noted that there have been 10 calendar years that small stocks have declined in price since 1979. “Of those 10 times,” he said, nine of the S&P 500’s 10 annual returns were 3.5% or less, and six of the 10 years were negative.” What’s more, for all 10 observations, “the S&P 500 posted an average annual price decline of 4.6%,” he said.

4) How is the Nasdaq composite index holding up?

Another canary in the coalmine for the broad market, according to market observers, is the Nasdaq composite index. Relative to S&P 500 or the Dow, the Nasdaq tends to be made up of slightly smaller, faster-growing and economically sensitive companies. In fact, technology stocks still make up around 45% of the index.

This is why in years when stocks slip, the Nasdaq tends to skid further. This happened in 1994, 2000, 2001, 2002, and 2008.

So far this year, the Nasdaq is close to entering into a correction. Should the Nasdaq’s 8% loss expand to 10% or more, look for more volatility in the S&P and Dow.

^IXIC Chart

^IXIC data by Charts

5) Is China’s economy growing less than 7%?

Continuing worries about China have contributed to the recent sell off in stocks. China’s economy, which had been growing as fast as 9% in 2012, slowed to 7.5% in the second quarter. That figure is expected to fall even further, to 7.3% in the third quarter. Some economists, in fact, are bracing for 7% growth or below.

Why is this important?

Brian Jackson, China economist for IHS Global Insight, notes that China’s leaders “signaled somewhere between 7% and 7.2% as a ‘bottom line’ for growth to meet job creation needs; IHS estimates that 7.2% is necessary to generate the roughly 13 million jobs annually to satisfy new job market entrants.”

Should GDP growth slip below 7%, policymakers in China may have start thinking outside the box. And Wall Street hates the unexpected — especially when it comes to governments and economic policy.

MONEY stock market

7 Years Later, Is the Bear Stalking Again?

Grizzly Bear
Scott Markewitz—GalleryStock

While the start of the 2007-2009 bear market now seems a lifetime away, there are a number of similarities between this market and that one that makes it hard to forget.

Exactly seven years ago today, the stock market fell into the worst bear market this side of the Great Depression.

The crash, which unfolded from Oct. 9, 2007 to March 9, 2009, obliterated more than half of the total value of the U.S. stock market and threatened the very existence of iconic companies from General Motors to Merrill Lynch.

Of course, all of this seems like ancient history now that the stock market has fully recovered — and then some.

^SPX Chart

^SPX data by YCharts

After the fourth-longest bull market in history, the Dow Jones industrial average and the S&P 500 are both near all-time highs. The housing market is slowly but surely recovering. And the U.S. economy has recently been growing at an annual rate of 4.6%.

Sounds like a totally different scene than seven years ago, when the economy was about to slip into a recession, the housing market was melting down, and the global financial panic was at full tilt.

Yet if you start digging into the details, there are a number of glaring similarities between today’s market and where Wall Street was on this fateful day seven years ago.

The bull market is aging. The stock market rally was an older-than-average five years old on Oct. 9, 2007. On Oct. 9, 2014, the bull is an even-older-than-average five and a half years old.

The market is starting to look its age. One way to tell if a bull is losing steam is to see how many stocks are actually participating in the rally. In 2007, the percent of companies in the S&P 1500 total stock market index that were outperforming the broad market fell to a lower-than-average 35%. Today, it’s even lower at 30%.

The market is pricey. The price/earnings ratio for the S&P 500, based on projected corporate profits, stood at 15.2 on Oct. 9, 2007. Today, that P/E ratio is an even-higher-than-average 16.2.

The market is pricey, part 2. There’s another way to measure the market’s P/E, using 10 years of average profits. In October 2007, the S&P 500’s so-called Shiller P/E stood at 27. That marked one of only four sustained periods in history where this P/E ratio climbed and remained above 25. Today, the market’s Shiller P/E is at 26.

Since 1926, whenever this measure has exceeded 25, the average inflation-adjusted annual return for stocks has been a mere 0.5% over the subsequent decade. By contrast, the historic annual real return for stocks is closer to 7%.

Greed is back. Seven years ago, merger & acquisition activity in the U.S. hit a record high, as risk-taking returned to Wall Street. Today, M&A activity, based on the total number of deals, is on pace to be even higher.

Confidence is back. When company executives are confident that the market isn’t fully appreciating the strength of their business, they initiate stock buybacks of their company’s shares, on the theory that their own stock represents a good value. The Wall Street Journal recently reported that stock buybacks totaled $338 billion in the first half of this year. That marked the highest level of activity in any six-month period since 2007.

Risk-taking is back. You know investors are getting aggressive when they’re willing to use borrowed money to make their bets. The last times margin loan debt as a percentage of GDP exceeded 2.5% were in 2000 and 2007. Well, today, it’s back above this threshold.

Does this mean that the bull market is about to end? Not necessarily. These are signs of an aging bull, not necessarily precise predictors of when the market is about to turn. Still, after growing accustomed to seeing stocks go up and up and up for several years, it’s time to reflect on how scary the market can be when investors grow complacent.

MONEY Airline Stocks

Airline Stocks Are Sinking—and Ebola Is Only Partly to Blame

Dr. Tom Frieden, director of the Centers for Disease Control (CDC)
Assurances about Ebola safety from CDC Director Tom Frieden apparently fell on deaf ears on Wall Street. Tami Chappell—Reuters

Airline stocks got hammered this morning after the first official case of Ebola was confirmed in a Texas patient. But calm down: Investors have a long history of overreacting to deadly diseases.

Shares of major U.S. airlines descended about 4% Wednesday morning, and investors are blaming Ebola.

The CDC and Texas Health Department confirmed the first official diagnosis of Ebola in the U.S., in a man who had traveled to Dallas from Liberia.

CDC Director Tom Frieden was quick to point out that “there’s all the difference in the world between the U.S. and parts of Africa where Ebola is spreading. The United States has a strong health care system and public health professionals who will make sure this case does not threaten our communities.”

Those assurances apparently fell on deaf ears on Wall Street, where investors pushed the stocks of major carriers such as United Airlines UNITED CONTINENTAL HLDG. UAL 0.4444% , American Airlines AMERICAN AIRLINES GROUP INC AAL 2.1291% , and Delta DELTA AIR LINES INC. DAL 0.363% lower in early morning trading.

UAL Price Chart

UAL Price data by YCharts

Anytime diseases arise that could restrict air travel — in this case, to and from various parts of West Africa — airline shares are among the first to see a reaction.

Last year, for instance, global airline stocks took a tumble on worries of the spread of bird flu. Before that, in early 2009, the outbreak of swine flu pushed airline stocks to double-digit losses amid concern that the disease might curtail travel at a time when the economy was already faltering due to the global financial crisis. And before that, in 2003, the first signs of SARS drove airline stocks lower on fears that international travel — in particular to and from Asia — would be hurt.

In this case, though, even airlines that do not travel in West Africa — for instance, Southwest Airlines SOUTHWEST AIRLINES CO. LUV 1.4282% — have been hit.

LUV Price Chart

LUV Price data by YCharts

To be sure, Southwest is headquartered in Dallas, which is where the first U.S. Ebola case was reported. But the fact that an airline like Southwest is being affected makes Morningstar analyst Neal Dihora think that “this might be about something else.”

That something might have to do with oil prices. Oil prices have fallen recently to below $100 a barrel. This is generally good news for airline stocks, since that means a major input cost is headed lower, Dihora says.

But there comes a time in every oil cycle, he points out, where investors wonder if oil prices are headed lower for a reason — as in, is this a sign of further troubles for the global economy?

It’s too soon to say if that’s the case. Many observers are currently chalking up falling oil prices to the strengthening dollar.

But for the moment, it seems that this worry about the global economy is what’s really driving the sector — and the emotional reaction to Ebola only compounded the situation.

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