TIME Economy

Don’t Trust the Markets: A Correction Is Coming

stock-market-data-screen
Getty Images

The Fed, despite its recent pronouncements, will trigger a fall in stock prices later this year

Up until yesterday’s Fed meeting, America’s central bankers said they were going to be “patient” about the timing of an interest rate hike, which most experts believe will ultimately result in a significant stock market correction (see my recent column about why). So why did that make markets go up so dramatically yesterday?

Because everything else about the Fed’s communication said “we’re going to be more patient than ever” about when and how to raise rates. The central bank downgraded its forecast on the US economic recovery, saying that the pace of the recovery had “moderated somewhat,” in large part because of the strong dollar.

Why is the dollar strong? Mainly because everyone knows that the easy money monetary policy in the US is coming to an end. (QE is over, and most economists are now predicting a rate hike by September.) Meanwhile, pretty much every other central bank is now easing monetary policy—witness the ECB’s new money dump, which has sent European markets soaring.

What does all this tell us? That markets and the real economy are disconnected in a way that is terrifying. Central banks are, as chief economic advisor to Allianz and former PIMCO CEO Mohamed El-Erian put it to me recently, “the only game in town.” Every time the Fed says it will keep rates low a little longer, the market party goes on. All that means is that there will be more pain, eventually, when the punch bowl gets pulled away.

MONEY stocks

Probability That Stocks Will Rise This Year: 90%

barometer
iStock

After a furious rally on Thursday, stocks are now up after the first five trading days of January—a time-tested signal the market could be in store for another positive year.

Maybe this will be a decent year for stocks after all.

After the Dow Jones industrial average lost around 500 points in the first three trading days of the year, it sure looked as if 2015 was getting off to a lousy start. But for the past two days, the Dow posted back-to-back triple digits gains. Yesterday alone, the Dow soared more than 300 points as investors calmed down about troubles in the global economy.

The result: The Dow is up 0.44%, while the Standard & Poor’s 500 index has gained 0.15% so far this year.

^SPX Chart

^SPX data by YCharts

What’s the big deal?

The first five trading days of the year — known as the January Barometer — offer a surprisingly good clue for how stocks are likely to perform for the full year.

Historically, when stocks rise after the first five sessions of a year, equities wind up posting gains for the full year nearly 90% of the time, according to the Stock Trader’s Almanac, which has been tracking this and other market barometers for years.

More recently, the correlation has grown even stronger. In a Fidelity article about the January Barometer published last year, Fidelity technical analyst Jeffrey Todd pointed out that “the January barometer has held true 37 of the 39 times since 1950 when January experienced market gains.”

Even so, isn’t this wishful thinking in 2015?

After all, the global economy seems to have hit the skids, as evidenced by the recent drop in oil prices. In fact, Japan is in recession, Europe is in deflation, and China is decelerating faster than folks expected.

Yet the U.S. remains the one economic force in the world that’s holding its own.

And if softness in the global economy keeps the Federal Reserve from raising interest rates until late this year — or even until 2016, as Charles Evans, president of the Federal Reserve Bank of Chicago, thinks it should — that could be just enough good news to keep Wall Street happy in 2015.

TIME stocks

Stock Rebound Continues as Dow Turns Positive for 2015

Traders work on the floor of the New York Stock Exchange.
Andrew Burton—Getty Images Traders work on the floor of the New York Stock Exchange.

After a rough start to the year, the stock market has rebounded for two straight days

The U.S. stock market continued its sharp rebound Thursday following a second day of gains in Europe.

The Dow Jones Industrial Average was up more than 300 points at one point, or 2%, turning positive for the year. All 30 companies on the index were up in early trading, putting the Dow Jones on pace for its second straight day of gains after rising 213 points on Wednesday. Meanwhile, the S&P 500 and Nasdaq composite also continued their own surges one day after they each halted five-day losing streaks. The S&P 500 was recently up 30 points, or 1.5% and the Nasdaq gained 75 points, or 1.6%.

While the euro continues to lose value against the U.S. dollar, European markets surged again on Thursday as pressure mounts for the European Central Bank to introduce new stimulus measures to invigorate the region’s economy. Both London’s FTSE 100 and Germany’s DAX jumped more than 2% in trading for the day as investors bet on the prospect of a government bond-buying program from the ECB.

The European gains provided a further boost to U.S. stocks, which were also bolstered by Wednesday’s minutes release from the mid-December meeting of the Federal Open Markets Committee (FOMC). The Fed gave no indication that it would change plans to be “patient” when it comes to interest rate hikes that are likely to come sometime later in 2015.

The latest market rally comes after a rough start to 2015 as stocks were dragged down by sinking oil prices and concerns over the European economy. The price of crude oil inched higher on Thursday, but prices still remain under $50 per barrel — a 5 and 1/2 year low.

This article originally appeared on Fortune.com

MONEY stocks

Why Main Street’s Gain Is Wall Street’s Pain

150106_HO_Lede
Carlo Allegri—Reuters via Corbis Trader Joseph Mastrolia works on the floor of the New York Stock Exchange while wearing 2015 novelty glasses on New Year's Eve, the last trading day of the year, in New York December 31, 2014.

Monday's 331-point drop in the Dow shows that the tables have turned on Wall Street.

Up until now, the bull market seemed to defy the everyday experience of many Americans: As Main Street households struggled through a recovery that repeatedly fell short of expectations, investors on Wall Street rejoiced.

That’s because the economy was growing fast enough to justify higher share prices, but not so fast that inflation was viewed as a real threat.

This year, though, the script seems to be flipped.

As Main Street Americans finally begin to see the economy improving, it’s the stock market that’s falling short, as evidenced by Monday’s 331-point drop in the Dow.

Monday’s dive was driven by two major economic trends that on the surface should be a boon for U.S. consumers. First, oil prices continued their sudden and surprising slide, driving prices at the pump down with them.

Brent Crude Oil Spot Price Chart

Brent Crude Oil Spot Price data by YCharts

At the same time, the U.S. dollar is now at a nine-year high against the struggling euro. That bolsters the purchasing power of Americans traveling abroad and U.S. consumers purchasing imported goods.

^DXY Chart

^DXY data by YCharts

Thanks to both trends, auto sales last year reached their highest level since before the global financial crisis.

Yet none of this is moving the dial on stock prices so far in 2015.

Some analysts think this could be a recurring trend throughout this year. “Expect a good year on Main Street but a more challenging environment for Wall Street,” says James Paulsen, chief investment strategist for Wells Capital Management.

Why?

Before, lukewarm news on the economic front bolstered the hope that the Federal Reserve would keep interest rates near zero for the foreseeable future. Now, some investors worry that the forces causing oil prices to fall and the dollar to rise — the weak global economy abroad — may be too much for the Fed to tackle even if rates stay low throughout this year.

Moreover, falling oil prices and the strengthening dollar may be giving the market false hope about low inflation.

“Some have argued that lower oil prices give the Fed more room to maneuver. This is a mistake,” says David Kelley, chief global strategist for J.P. Morgan Funds.

While it is true that lower energy prices are reducing inflation in the near term, “falling oil prices are also a big boost for consumers,” Kelly said. “Even if gasoline prices were gradually to move up to $2.75 a gallon by the end of this year from $2.39 at the end of last year, consumers would spend roughly $90 billion less on gasoline in 2015 than they did in the 12 months ended in June 2014.”

Not only is this a financial boost, “it is also a psychological positive with sharp increases seen in consumer confidence readings in the last few weeks,” Kelly said. “This should power an increase in consumer demand which should, in turn, boost prices in other areas.”

MONEY

The Only Chart You Need to See About Record Market Highs

Trader on NYSE Stock Market Floor
Spencer Platt—Getty Images

Media pundits love to make a big deal of new stock market peaks—but they are actually surprisingly common.

The stock market reached new record highs on Monday, with the Dow and S&P 500 indexes closing above 17,613 and 2038, respectively.

As usual, the occasion was cause for skeptics to raise concerns that we are in the midst of a market bubble.

But the headline numbers obscure a simple point: Record market highs are not unusual during a bull market—at all. As shown by the chart below, courtesy of my colleague Pat Regnier, record highs can occur again and again for years before the market tumbles.

Screen Shot 2014-11-11 at 10.36.40 AM
Source: http://ycharts.com/

That’s not to say that another market tumble is completely out of the question. After all, even at the lowest point of the October market slump, stock valuations were at or near historic highs.

But the simple fact of new nominal highs in the market’s major indexes is not by itself reason for concern. As investment adviser and blogger Josh Brown points out in the video below, the market has been hitting new highs about once a month on average over the past 65 years.

Read more on…

 

MONEY stocks

Should I Be Worried That Stocks Are at Near-Record Highs?

Ritholtz Wealth Management CEO Josh Brown, a.k.a. the Reformed Broker, explains how to look at the market's recent performance.

MONEY risk

The Crucial Investing Advice You Need Right Now

glass of water balanced on see-saw
Martin Barraud—Getty Images

When the stock market is near record highs, it's more important than ever to think about risk.

Don’t let history repeat itself.

You’ve heard that phrase before, likely as a warning to those who might be traveling down the same dangerous path as those before them. But it’s also currently the most important piece of advice I offer to clients.

Recently, I’ve been helping clients rebalance portfolios that have become stock-heavy due to the bull market that’s taken the S&P 500 up 194% since March 2009. With the bull now more than five years long and memories of the financial crisis starting to fade, I’m finding that investors aren’t exactly excited about reducing their stock allocations.

One of my duties as a financial adviser is to encourage my clients to rebalance their portfolios to the levels that we agreed made sense for them given their risk tolerance. In August, however, the S&P 500 topped 2,000 for the first time, giving investors a new boost of confidence.

And although seeing the market at new highs is exciting, let’s not forget that markets can go the other way too. On October 19, 1987, the Dow fell 22.6% in just one day. Applied to current levels, a 22.6% drop would be 3,801 points. During the financial crisis, from October 11, 2007 through March 6, 2009, stocks fell 57%, which would be 9,586 points today. I don’t expect anything that drastic to happen anytime soon, but investors need to remember that bear markets — declines of 20% or more — historically have occurred on average every four-and-a-half to five years.

So even though I’m a big believer in holding stocks for the long run, lately I’ve been making a point to show my clients how portfolios like theirs would’ve performed during previous bear markets, including the crash of 1987 and the financial crisis. I help them understand not just stocks’ growth potential but also the risks associated with achieving that growth.

At times like this I talk about risk for two reasons. First, focusing on risk prevents clients from being caught up in the moment and making choices that they may regret. Second, risk is still very much a reality. Investors are more optimistic these days, but this optimism allows them to be tempted to abandon their rebalancing strategies in order to maintain or increase their exposure to the aggressive side of their portfolios, which reduces the downside protection that rebalancing back to bonds and cash may offer.

No matter how the market performs, I reinforce investment discipline by coaching clients to stick with their investment plans. Past performance is not a guarantee of future returns, but a good way to cut the odds of repeating the history of buying high and later selling low is to rebalance in a disciplined way. For many investors, that could mean reducing stock exposure and adding to bonds — especially at times like this, when our impulse is to do just the opposite.

———-

David A. Schneider, CFP, is the principal of Schneider Wealth Strategies, a financial services firm based in New York City. Schneider has more than 25 years of experience in the wealth management industry and specializes in the planning needs of business owners, professionals, and affluent individuals. He is a registered representative of Cambridge Investment Research and an investment adviser representative of Cambridge Investment Research Advisors. Schneider is also a member of the Financial Planning Association.

Note: The S&P 500 and the Dow are stock market indices containing the stocks of American large-cap corporations. An index can’t be invested into directly. Asset allocation does not guarantee a profit or protection against loss.

MONEY Markets

The Dow Moved Triple Digits Today. Here’s What You Should Do.

Arrow cut out of piece of paper
Gregor Schuster—Getty Images

Nothing. You should do absolutely nothing. Here's why.

[Update: The DOW went up 216 points on Oct. 23.]

The Dow Jones Industrial Average has long been held up as the stock market index to follow. Now that the Dow Jones is at such a high level, even moves that are small on a percentage basis allow for attention-grabbing headlines like “Dow Jones Today Skyrockets Over 200 points!” or “Dow Jones Plummets 150 points!”

While these headlines lure in readers, they do nothing to make us better investors. Read on to see why the best investors ignore the daily movements of the DJIA.

Dow Jones today

Do you remember when the Dow jumped 220 points after tensions with Ukraine moderated? How about the 200-point drop after Chinese industrial production slowed, or the 180-point jump following the release of minutes from the secret early-March meeting of the Federal Reserve?

I doubt it.

And don’t get me started on early October. The Dow Jones Industrial average dropped 272 points on a Tuesday — its biggest drop of the year to that point. The next day, the Dow jumped 274 points — the Dow’s biggest gain of the year. Then, on Thursday, the Dow fell 334 points.

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The headlines would have you think the world is ending or that you won’t be able to retire because of these market dips. The stock market is one of the few places where, whenever things go on sale, no one wants to buy.

However, these moves only amounted to a 2% drop from the end of the previous week. To put that in an even bigger-picture perspective, the Dow is basically flat year to date.

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What you should do now?

Nothing. You don’t have to do anything. If your investment strategy changes based on one day’s market movements, you’re doing it wrong. Your focus should be to stick to your plan, constantly educate yourself, and invest for the long term. And if you don’t have a clear strategy, this is your wake-up call.

Research has shown that process is one of the biggest determinants of success in the market over the long term. While your process can yield good or bad results in the short term, those with a proven process do better than the average investor over the long term.

For total beginners, I would first suggest learning about how the market works and how you can do at least as well as the market through index investing. I highly recommend The Little Book of Common Sense Investing by John Bogle as a great place to start.

If you understand the basics of the market as well as index investing, check out The Motley Fool’s 13 Steps to Investing Foolishly, which will teach you the process The Motley Fool has used to consistently beat the markets over the long term.

Everyone can learn from this

For every investor, focusing too much on daily market movements is a mistake. Things happen for no discernible reason. Rather than wasting time wondering why the market is up or down by a percent or two, we should focus on business fundamentals and continue to search for quality stocks trading at bargain prices.

We also must keep calm and not make rash decisions based on short-term market moves. Research has shown that it is far better to focus on minimizing mistakes, rather than overreaching for greatness. As economist Eric Falkenstein wrote: “In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

And as Warren Buffett’s longtime business partner Charlie Munger said: “We try to profit more from always remembering the obvious than grasping the esoteric. It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

My Dow Jones Industrial Average prediction for today

The Dow Jones Industrial Average will continue to fluctuate. That’s a given, and we have no control over it. What you can control is your reactions to those fluctuations — and the best reaction is usually no reaction.

Dan Dzombak can be found on Twitter @DanDzombak, on his Facebook page DanDzombak, or on his blog where he writes about investing, happiness, life, and success in life. He has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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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, Amazon.com 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 Markets

Four Reasons Not to Worry About the Stock Market

Waterfall
Roine Magnusson—Getty Images

Take a deep breath and consider some historical context.

The funniest thing about markets is that all past crashes are viewed as an opportunity, but all current and future crashes are viewed as a risk.

For months, investors have been saying a pullback is inevitable, healthy, and should be welcomed. Now, it’s here, with the S&P 500 down about 10% from last month’s highs.

Enter the maniacs.

“Carnage.”

“Slaughter.”

“Chaos.”

Those are words I read in finance blogs this morning.

By my count, this is the 90th 10% correction the market has experienced since 1928. That’s about once every 11 months, on average. It’s been three years since the last 10% correction, but you would think something so normal wouldn’t be so shocking.

But losing money hurts more than it should, and more than you think it will. In his book Where Are the Customers’ Yachts?, Fred Schwed wrote:

There are certain things that cannot be adequately explained to a virgin either by words or pictures. Not can any description I might offer here ever approximate what it feels like to lose a chunk of money that you used to own.

That’s fair. One lesson I learned after 2008 is that it’s much easier to say you’ll be greedy when others are fearful than it is to actually do it.

Regardless, this is a critical time to pay attention as an investor. One of my favorite quotes is Napoleon’s definition of a military genius: “The man who can do the average thing when all those around him are going crazy.” It’s the same in investing. You don’t have to be a genius to do well in investing. You just have to not go crazy when everyone else is, like they are now.

Here are a few things to keep in mind to help you along.

Unless you’re impatient, innumerate, or an idiot, lower prices are your friend

You’re supposed to like market plunges because you can buy good companies at lower prices. Before long, those prices rise and you’ll be rewarded.

But you’ve heard that a thousand times.

There’s a more compelling reason to like market plunges even if stocks never recover.

The psuedoanonymous blogger Jesse Livermore asked a smart question this year: Would you rather stocks soared 200%, or fell 66% and stayed there forever? Literally, never recovering.

If you’re a long-term investor, the second option is actually more lucrative.

That’s because so much of the market’s long-term returns come from reinvesting dividends. When share prices fall, dividend yields rise, and the compounding effect of reinvesting dividends becomes more powerful. After 30 years, the plunge-and-no-recovery scenario beats out boom-and-normal-growth market by a quarter of a percentage point per year.

On that note, the S&P 500’s dividend yield rose from 1.71% in September to 1.82% this week. Whohoo!

Plunges are why stocks return more than other assets

Imagine if stocks weren’t volatile. Imagine they went up 8% a year, every year, with no volatility. Nice and stable.

What would happen in this world?

Nobody would own bonds or cash, which return about zero percent. Why would you if you could earn a steady, stable 8% return in stocks?

In this world, stock prices would surge until they offered a return closer to bonds and cash. If stocks really had no volatility, prices would rise until they yielded the same amount as FDIC-insured savings accounts.

But then — priced for perfection with no room for error — the first whiff of real-world realities like disappointing earnings, rising interest rates, recessions, terrorism, ebola, and political theater sends them plunging.

So, if stocks never crashed, prices would rise so high that a new crash was pretty much guaranteed. That’s why the whole history of the stock market is boom to bust, rinse, repeat. Volatility is the price you have to be willing to pay to earn higher returns than other assets.

They’re not indicative of the crowd

It’s easy to watch the market fall 500 points and think, “Wow, everyone is panicking. Everyone is selling. They know something I don’t.”

That’s not true at all.

Market prices reflect the last trade made. It shows the views of marginal buyers and marginal sellers — whoever was willing to buy at highest price and sell at the lowest price. The most recent price can represent one share traded, or 100,000 shares traded. Whatever it is, it doesn’t reflect the views of the vast majority of shareholders, who just sit there doing nothing.

Consider: The S&P fell almost 20% in the summer of 2011. That’s a big fall. But at Vanguard — one of the largest money managers, with more than $3 trillion — 98% of investors didn’t make a single change to their portfolios. “Ninety-eight percent took the long-term view,” wrote Vanguard’s Steve Utkus. “Those trading are a very small subset of investors.”

A lot of what moves day-to-day prices are computers playing pat-a-cake with themselves. You shouldn’t read into it for meaning.

They don’t tell you anything about the economy

It’s easy to look at plunging markets and think it’s foretelling something bad in the economy, like a recession.

But that’s not always the case.

As my friend Ben Carlson showed yesterday, there have been 13 corrections of 10% or more since World War II that were not followed by a recession. Stocks fell 35% in 1987 with no subsequent recession.

There is a huge disconnect between stocks and the economy. The correlation between GDP growth and subsequent five-year market returns is -0.06 — as in no correlation whatsoever, basically.

Vanguard once showed that rainfall — yes, rainfall — is a better predictor of future market returns than trend GDP growth, earnings growth, interest rates, or analyst forecasts. They all tell you effectively nothing about what stocks might do next.

So, breathe. Go to the beach. Hang out with your friends. Stop checking your portfolio. Life will go on.

For more on this topic:

Check back every Tuesday and Friday for Morgan Housel’s columns. Contact Morgan Housel at mhousel@fool.com. The Motley Fool has a disclosure policy.

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