Visit a steel mill and you’ll hear this admonition from experienced metalworkers: Keep your head on a swivel. Danger, hot and heavy, can arrive from any direction.
That’s not a bad way to view investing these days. After a dismal start that initially drained 9% from the S&P 500 in January, stocks rallied in early March. The S&P is down just 1.37%, and oil bounced up to about $40 a barrel. The U.S. economy appears docile: Unemployment is a tolerable 4.9%; inflation remains tame, leaving the Federal Reserve less likely to raise interest rates this month. GDP growth is bumping along at 2%, the new normal.
But you’d better be ready to duck. There’s a well-documented tendency–called recency bias–for investors to think the future will resemble the recent past. They also pay too much attention to their home market. “If you look at the U.S. in isolation, you will miss the bigger picture,” says Andrew Cullen, a director at Asianomics, a research firm. “The rest of the world isn’t cooperating.”
First, consider that the World Bank has lowered its global growth forecast from 3.3% to 2.9%. Then there’s China, where the government’s 7% growth target doesn’t seem feasible to some analysts. “Chinese year-over-year imports and exports are negative. Explain to me how China’s growing at 7%?” said Jeffrey Gundlach, CEO of investment firm DoubleLine Funds, in a recent webcast. China is importing less raw material, which weighs further on beaten-down commodity prices and on commodity-dependent economies like Australia and Canada. At the same time, two of its big customers, the euro zone and Japan, keep expanding quantitative easing to stimulate their anemic economies. That’s why some German and Japanese bonds carry negative interest rates. The result: an undeclared currency war in which Europe’s purchasing power parity relative to China has declined some 20% over the past two years.
Global trade overall is lagging–you can see it in the distressed charter rates for cargo ships. “If you are a U.S. company with direct international exposure, your top-line revenue has to be challenged,” says Cullen. When the top drops, the bottom line usually follows. Increasing wage pressure in the U.S. (a by-product of lower unemployment) could ding profits even more. And since stock prices are pegged to future earnings, that’s hardly a positive for the market. Since World War II, Cullen’s research finds, a sequential quarterly decline in corporate revenues has generally led to a bear market in stocks.
Even the good news has a hollow ring. While Americans have enjoyed cheap energy and Detroit is selling tons of SUVs, domestic oil and gas companies are reaching a breaking point. They’ve borrowed large amounts of money, debt that sits on the balance sheet of banks like Bank of America. It’s no coincidence that BofA’s stock is down 19% since the beginning of the year. There could be a gusher of energy bankruptcies unless oil prices rise significantly, yet crude inventories are vast because Saudi Arabia, Iran, Russia, Brazil and Venezuela keep pumping to maintain their own economies.
Despite the cushion of a U.S. economy that relies heavily on consumer spending–not exports–the stock market will be hard-pressed to avoid the collateral damage, according to Gundlach. He says the risk-reward ratio is 10 to 1, “which is incredibly unfavorable.” Nor can the Fed be of much help. It already has $2.3 trillion in excess deposits–money no one wants to borrow. That’s true of central banks worldwide.
Don’t feel down if you find all this hard to digest. “I consult with the second largest hedge fund, and we have 50 Ph.D.s who try to figure this out all the time,” notes Tobias Moskowitz, an expert on market returns at the University of Chicago’s Booth School of Business. The scorecard says that in the past two years, the brainiacs have blown it; the average managed fund underperformed the average Jane who kept her money in a diversified portfolio including cash.
You can’t avoid all the dangers that lurk in the global economy, but you can minimize their impact. Timing any market remains a fool’s game. Another mistake, says Moskowitz, is that when stocks fall, many investors try to regain some sense of control by selling. That’s a bad idea because it keeps them from benefiting from the rebound that will eventually follow, as happened after the Great Recession. “These are things you really can’t do anything about,” he says. “It sounds defeatist and pessimistic, but doing something might be the worst thing.” T. Rowe Price notes that less than 2% of its 401(k)-plan participants made any moves during the January rout. The safest move, in other words, may be no move at all.
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