Stock Market Comments

Earnings Forecasts and You

January 10, 2019 by Thomas Mullooly

Earnings forecasts are a risky tool in our bag. There was a story in Bloomberg this morning (January 10, 2019) discussing how “profit forecasts are being cut like it’s 2009”

I have a few thoughts on earnings forecasts, and then we will get to where this affects me and you.

1. Companies have to determine whether their business is slowing or growing. Only then will that information get shared with analysts. Profit forecasts/earnings estimates will always be late.

2. Many companies began scaling back their earnings projections during the third and fourth quarter last year (2018) because there is no clarity regarding trade and potential tariffs. These firms have no visibility, so they must be cautious. Slowing growth in China, dropping prices of oil, uncertainty in Europe: all nothing new and each were the primary figures to blame behind market swoons in 2011 and also 2015-16.

This leads to what some have called an “earnings slowdown.” Is it a recession? No.

Profit forecasts at mid 2016 (heading in to 2017), were showing double-digit earnings increases into 2018. This is one reason why the market went up steadily throughout 2017 – in anticipation of good earnings in 2018.

The earnings forecasts now still show good growth for the S&P 500 – showing earnings gains of over 8%. Again, it’s only a forecast. But the forecast is less than the earnings growth seen in the previous twelve months. The market needed to “ratchet things down” to bring valuations more in line with expectations.

3. What if a “trade war” vanishes? What is “Tariff Man” decides tariffs are bad for business? What will happen to earnings forecast then? What will happen to the market?

Unfortunately, the market tends to “re-price” itself pretty quickly. We remind clients the market climbs the stairs on the way up, but takes the elevator on the way down. Compared to a climbing market, market drops are usually swifter and can be painful to watch.

Now, this is where you and me step into the picture:
We don’t like writing about earnings forecasts very much, because we find them to be flimsy and often subject to change too often. They’re unreliable.

The main thing to do during market drops is not to lose your head, not let emotions take control. It’s easier said than done. We had a 29 year old last week ask me what “we were doing to hurry up and get defensive?” I reminded him this is money he is setting aside for retirement – a point in his life that is easily thirty years away (or longer).

I also reminded him he should be begging to buy more things on sale.

Portfolio Fire — “this is not your portfolio”

Seeing 600 point and 800 point drops can turn normal folks crazy. In the right circumstances (for someone with the right temperament), I let them know “if the market continues to drop 600 points per day, the Dow Jones will be at zero in 38 days” (some time in March). It’s not a trend that continues forever.

Market drops can be like a forest fire. These fires need lots of dry kindling, along with oxygen to sustain and grow. The hardest thing to do is step aside and let the market do its’ thing. Don’t feed the frenzy.

The biggest issue we see (from our side of the desk), is clients who are “betting the rent” with the market. Essentially, they are playing with money they truly cannot afford to lose. Those folks, those assets should never have been in the market to begin with. Fortunately, we do not have many that “roll the dice” that way, and we are quick to dismiss folks who we discover have been betting the rent. We are just not a good match for them.

We discuss financial planning all the time with our clients. It’s a shame that some clients take the financial planning process seriously, some do not. One big reason behind these exercises is it can help US (as your adviser) determine the proper amount of risk a client ought to be taking.

Sadly, we hear from a small number of folks only when (in their minds) their house is on fire.

January 30, 2018 Market Comment

January 30, 2018 by Thomas Mullooly

As I’m writing this post, the Dow Jones is down 300 points. Yesterday, January 29th, the Dow was down 177 points. Let’s keep this all in perspective.

Our friends at Dorsey Wright & Associates remind us the market typically generates a 5% pullback between three and four times a year on average, and the market also averages one 10% pullback per year, over now nearly 100 years, dating back to the 1920’s.

The Dow Jones has not seen a 1% drop in 111 days, one of the longest runs in history. We have been spoiled, as investors, because the market has not had a 5% or greater drop since the middle of 2016, now eighteen months ago. Even a 500 point drop (between yesterday and this morning) adds up to roughly a 2% drop.

Additionally, Tim has been reporting (most of January) in our daily meetings how over-bought the markets are right now. Historically (and in my memory), it’s hard to recall seeing a market get this skewed to the over-bought side. We have plenty of clients looking to get more aggressive, which is another (personal) indicator of this over-bought condition.

I say “clients getting more aggressive” is a personal indicator of mine, because I know the opposite to also be true: when markets are over-sold and there are bargains galore, no one wants to take the risk of buying. That’s when individuals (in general) want to “get conservative.”

So, how does an “over-bought” condition get resolved? Two ways:

The market can simply go down.
The market can “stall” and trade in place over a period of a few weeks.

Markets reach over-bought and over-sold levels many times, and markets correct themselves without folks even being aware of the underlying conditions. Again, Dorsey Wright has made good use of “bell curves” to help show neanderthals like me what over-bought and over-sold conditions look like. If some pictures are worth a thousand words, than this image below may be worth a million:

Jan 30 2018 Distribution Curve — “click to embiggen”

Believe it or not, this actually IS a bell-curve. It does not LOOK like a normally-distributed curve, does it? See how nearly everything is skewed WAY to the right? The right side is the “over-bought” side of the market.

And while you may not understand the symbols in the image, just look at the overall position of the symbols. Way over-bought, skewed far to the right side of the bell curve.

What is NOT over-bought? What is not over-bought (and in this case, over-sold) are areas like DX/Y (the US Dollar), and bond investments (IEF, AGG, SHY, LQD).

Now, by comparison, I have taken the exact same image and (very crudely) hand-drawn in where the actual bell-curve lies on this screen. Is it clearer now? Everything skewed FAR to the right side (the over-bought side). This is a market that needs to work off the over-bought condition. And, as written earlier, markets do NOT need to go straight down for that to happen. Markets can simply “jog in place” for a few weeks (or even a few months) to work that over-bought condition off.

edited Jan 30, 2018 Distribution — “click to embiggen”

And the area highlighted in yellow?
The area I have highlighted in yellow indicates the “normal” area of the bell curve. Nearly two-thirds of the time, the markets will “live” in this area (the fattest part of the curve). This is what a normal distribution curve OUGHT to look like.

Many thanks to our friends at Dorsey Wright & Associates for these images included in the post. The current market is over-bought. Again, there are two main ways to relieve an over-bought condition. First, the market can simply go down. Second, the market can stall for a period or weeks and months, and work off an over-bought condition that way.

What we missed in 2017 was volatility. We had one of the “quietest” years in recent history: very few big sustained drops, and not a single 5% drop at all in the calendar year. It’s normal to expect some volatility, and I suspect we will see our friend volatility return to the markets in 2018.

OK, one last bell curve for you (below), just to show the difference.
Below is a bell curve from October 1, 2008, nearly ten years ago.

Oct 01 2008 Distribution — “click to embiggen”

Quite a different look, would you agree? Nearly all asset classes were skewed to the LEFT, indicating nearly everything was becoming very oversold. On the prior day (September 30, 2008), Congress had declined to approve the $700 billion TARP bailout package, and (after the news) the Dow Jones slid 777 points that day. Incidentally, for those keeping score at home, the Dow Jones closed at 10, 365 that day nearly ten years ago.