This is my fourth take on how to worry in less than six months.
I wrote the first one in October when the Dow Jones Industrial Average had poked its head above 10,000 for the first time in a year (and the Standard & Poor’s 500 Stock Index was just about to kiss 1100.)
Now I’m posting on the topic just days after the Dow Industrials touched 10,000 again—but this time headed in the other direction. The Dow Jones Average closed at 9908 on February 8.
In October and November (when I reposted the original) the worry was that the stock market had gone up too far, too fast and was ready for a fall. In January and now in February the worry is that the long-feared decline has finally arrived. And it’s going to turn out to be a lot worse than the correction that everyone watching stocks go straight up from the March low had been waiting for. Or at least that’s the fear.
All this “how to worry” history tells you something about how tough the last four to five months have been on investors who have been through two bear markets in less than ten years now—and are justifiably now inclined to jump at every bit of news good or bad.
Jumping at every bit of news is actually not bad behavior. The lesson of the last decade is that investors can easily get too complacent.
What’s the saying? You’re not paranoid if they really are out to get you?
I just came back from an investment conference in Orlando where I heard a number of speakers—no names but you know who you are—proclaim that the 60% rally off the March bottom proves that Buy and Hold is alive and well. Well, frankly, I think all that remark proves is that complacency is alive and well even after two bear markets have left many Buy and Hold investors looking up at 0% for the decade.
No, being jumpier than a cat on Mott Street during the Lunar New Year isn’t a bad thing. Since the real world right now is full of contradictory trends that each seem to take control of the market for just a week or two at a time, all that being jumpy right now proves is that you’re paying attention.
That doesn’t mean, however, that you want to act every time a bit of news sends you twitching. The challenge now is to pay attention as you should—but to separate the real worries that you need to act on from the day to day flow of noise. If you act on every bit of noise that causes a moment’s worry, you’ll do a good job of turning your portfolio into a profit center for your on-line or wetware broker. But you won’t be doing your own returns any favor.
If you want a good example of exactly how twitchy the news is look at my three posts from February 10 on the Greek crisis. At 11:48 I posted “Just a euro bounce on rumors” http://jubakpicks.com/2010/02/09/just-a-euro-bounce/ . At 12:25 I posted “Euro rumors get more concrete” http://jubakpicks.com/2010/02/09/euro-rumors-get-more-concrete/ . And at 1 p.m. I posted “Euro rumors get less concrete” http://jubakpicks.com/2010/02/09/euro-rumors-get-less-concrete/ .
I hope everyone got the point that my increasingly silly headlines were supposed to convey: You shouldn’t act by buying and selling on every twitch in the rumor mill.
That still leaves us all with an important question: If some of this news is just noise (and not worth acting on) and some is important in the real world (and worth acting on), then how do we tell the difference?
And that’s where my “How to worry” list of what’s real world important to worry about and when comes in.
By listing the potential turning points in the stock market over the remainder of 2010, “How to worry” indicates what news might be worth acting on because it has a good chance of moving stock prices for more than a day or two or three because that news is part of a real long-term worry for the market.
The goal is to put together a list that tells you 1) what the chances are that something will go wrong, 2) how bad it might be if something did go wrong, and 3) when things might go wrong.
Here’s my current list of worries and the timetable they are running on.
- The leaders of the European Union will fumble about issuing empty promises to support Greece in its budget crisis before cobbling together a “solution” that makes bond holders just happy enough and removes the threat now hanging over European banks outside of Greece that are holding Greek sovereign and bank debt. I wrote about the crisis and its limits in two posts on February 8: http://jubakpicks.com/2010/02/08/reassuring-talk-isnt-ending-the-euro-crisis/ and http://jubakpicks.com/2010/02/08/the-euro-crisis-isnt-a-global-crisis-yet/. The most likely outcome, now that it’s clear to everyone exactly how reluctant (BIG TIME reluctant) the German government is to get into the guarantee business and dent the country’s AAA reputation for fiscal conservatism, is something that will turn a boiling crisis into a simmering problem. I don’t think this is going away anytime soon. “Fixing” Greece, whatever that means, will still leave the European Union with a list of problems that starts with Portugal and doesn’t end with Spain. But unless the Germans do something that is currently unimaginable and pull out of the Euro, this is a European crisis that in economic terms is limited to countries on the periphery of the European Union. In currency terms a continuing euro crisis will lead to a stronger U.S. dollar.
- China’s National People’s Congress begins on March 5. If China is going to officially change monetary policy or shift more spending to domestic consumption, it’s likely that the new policy will be announced as a result of this meeting. The big policy issues for China’s stock market this year all concern cheap money. March could see the government announce that it will raise interest rates. (China’s central bank generally tries everything else first and changes interest rates only as last resort. Hence the recent spate of increases in bank reserve requirements. An actual interest rate increase would be a signal of a real change in policy.) That would push down stock prices in general and push down the share prices of real estate developers and many industrial companies especially hard. The other big policy question is whether the government will do something to change its rather toothless system for setting lending targets for banks and institute a system that enforces more binding targets. That would also send China’s stocks tumbling. I think the odds are that the government won’t do anything very dramatic at this meeting. Officials won’t have final numbers on first quarter GDP growth and will still be studying how lending moratoriums enacted in late January have slowed growth. I’d expect an announcement of a loan target for the year –that banks will be free to ignore as usual—some more moves to equalize growth and to support the consumer economy—and promises to fight speculation, but I don’t think Beijing is yet ready to rock its own economic boat at this meeting. For more on why the command economy can’t always get what it wants (although it usually gets what it needs) see my post http://jubakpicks.com/2010/01/28/the-rout-in-global-stocks-is-a-tempest-in-the-teapot-of-chinas-command-economy/.
- Near the end of April investors will get the first official numbers on how fast the U.S. and Chinese economies grew in the first three months of the year. For the United States, the worry is that the data will show growth slowing significantly from the 5.7% growth recorded (according to first estimates) in the fourth quarter of 2009. Everybody expects that growth will slow as the recovery moves along and as the effects of the February 2009 stimulus package wear off, but too big a drop will reignite fears that the recovery hasn’t become self sustaining and that the United States could tumble back into a recession. Officials in Beijing will be studying the first quarter numbers to see if they stepped on the brakes too hard or too softly by restricting bank lending in January. A repeat of the fourth quarter’s 10.7% growth would be a disappointment since it would almost certainly mean that the government would have to restrict the money supply. (The odds of an interest rate increase would go up—and stocks would go down.) A number too far below 10.7% would indicate that the government had over-re-acted and signals a likely return to looser money. Investors, economists and government officials will all be looking at March data such as the February jobs numbers that the United States reports in the first week of March for clues on how GDP growth will go.
- By the time the Federal Reserve’s Open Market Committee meets on April 27 through 28, its members will know what the GDP numbers say about the first quarter, even if the public doesn’t. The April 28 second day policy statement might then include new language that will indicate an interest rate increase sooner rather than later. The next meeting—on June 23 through 23—is an even more likely candidate for a change in language. But any change won’t be a big change. Fed chairman Ben Bernanke’s testimony to the House Financial Services Committee last week made it clear that when the Fed finally does move, its first moves will be to raise the interest it pays to banks for money kept on deposit at Federal Reserve banks and perhaps a nudge in the short-term target rate of a quarter of a point. Any move will take a bit of wind out of the market’s sails but the big increases that investors fear are an issue for 2011 and not 2010.
- Central banks from India to Brazil are clearly thinking about raising interest rates in 2010. The Reserve Bank of India, for example, has done all the preparation for a rate increase. But these increases play out differently than in the United States. These increases, when they come, will be in economies that are growing so fast that inflation has become a real danger—and not, as in the United States in an economy growing so slowly that a tiny increase in interest rates could put the recovery at risk. Interest rate increases in Brazil or India or Australia or wherever will strengthen those currencies against the U.S. dollar. Once these rate increases start the currency market will be treated to a U.S. dollar that’s rising against the euro and the pound but falling against the real and the Australian dollar to the degree that U.S. interest rate increases lag rate increases in those economies.
- The U.S. banking system still isn’t out of the woods and in fact faces a need to raise new capital in the second half of 2010. Mortgage foreclosure filings climbed 15% in January from January 2009. And bank seizures of homes could rise to a record 3 million in 2010, according to RealtyTrac. Studies show that once the value of a house falls below what the owner owes on a mortgage the likelihood of foreclosure increase. More than 20% of U.S. home owners had negative equity in the fourth quarter of 2009, according to RealtyTrac. Much of the risk in the mortgage market has been shifted from bank balance sheets to taxpayers through Fannie Mae (FNM) and Freddie Mac (FRE). These wards of U.S. taxpayers will wind up holding the bag if foreclosures surge. But bank portfolios have their own big problems. Regional and local banks could blow up on problems with their commercial real estate loans. I wrote about this in a post on October 8 http://jubakpicks.com/2009/10/08/will-bad-commercial-real-estate-loans-set-off-banking-crisis-ii/. More than 800 banks in the United States have more than half their total loan portfolios committed to loans to local real-estate developers, builders, and businesses. Loan losses reported by the big regional banks for the fourth quarter have actually come down slightly but the improvement isn’t enough to make a trend especially if economic growth slows in the second half of the year.
- Earnings growth could be less than now expected. I think this is a danger more for the second half of 2010 than the first. As I wrote in my January 22 post http://jubakpicks.com/2010/01/22/2010-well-the-first-half-anyway-looks-good-for-stocks-despite-the-current-correction/ watch what happens as 2010 moves along. To see why look at the pattern that earnings growth makes as we come off the bottom of the Great Recession. In the first quarter of 2010 projections call for Standard & Poor’s 500 operating earnings of $17.12, up from $10.11 in the first quarter of 2009. That’s 69% earnings growth year to year. Second quarter 2010 operating earnings are projected at $18.59, up from $13.01 in the second quarter of 2009. That’s 43% earnings growth year to year. Third quarter 2010 earnings are projected at $19.92, up from $15.78 in the third quarter of 2009. That’s 26% earnings growth year to year. See the pattern here? As stocks move further and further away from the economic bottom in earnings at the end of 2008, year to year earnings growth slows because the year earlier quarter wasn’t quite so horrible. That makes spectacular earnings growth pretty easy to come by in the first half of 2010 and makes earnings growth in the second half of the year look increasingly ordinary. (Especially if stocks have kept moving up in price quarter by quarter.) So the odds that stocks will deliver the earnings needed to justify higher share prices look pretty good in the first half of 2010 and then decline as the second half progresses.
- Slowing economic growth remains the big worry in 2010. It’s the one worry, that if worry turned into reality, could make all of the other seven worries in this list much, much worse. And it’s the only one that could work to combine some of these discrete worries into a much bigger crisis—again. Unfortunately, I can’t discount—although I think it’s unlikely–the possibility that the world’s developed economies, including the United States will lead the globe back into a painful slowdown at the end of 2010 and in early 2011. The European Union could very well still be wallowing in crisis then. The effects of the U.S. stimulus package will be wearing off and with the U.S. Senate unable to pass any legislation at all the United States could go into the second half of 2010 without a budget for fiscal 2011, let alone a second jobs bill. (The United Kingdom could still be trying to cobble together a government after a dead heat election in May.) Doesn’t have to happen mind you. But the possibility is real.
So what does my list of worries tell you? Four things I think.
First, that 2010 is going to be one tough year for investors to make a buck. Volatility will be high. Trends won’t last long. Emotions will drive the crowd from euphoria to panic in a matter of days. It will be a time to take profits when you have them, to control losses, and to not fall in love with any stock or sector.
Second, that developing markets look like a better bet for 2010 than do the developed markets of the Europe, Japan, and the United States. Economic growth will be higher. Debt overhangs are lower. And political problems seem more manageable. Developing economies won’t grow like gangbusters if developed economies falter but they will do better by investors especially if they buy in on a dip at relatively reasonable valuations.
Third, that the weeks from now through April will be incredibly volatile as investors ping pong from one crisis and uncertainty to another. But the real danger in this period is relatively low. China isn’t going to kill its economic growth. The Federal Reserve isn’t going to raise interest rates by two percentage points. The real danger remains in the second half of the year when developed economies stand a real chance at slipping back toward, if not into, recession.
And fourth, that the end of the dollar carry trade, which had been crucial to the rally in commodity prices and commodity currencies in 2009 isn’t on my list any more. Borrowing a cheap and falling U.S. dollar in order to invest in commodities or stocks in emerging markets or whatever isn’t that attractive e anymore mostly because the dollar has rallied and could continue to do so for a while. But the Japanese yen looks more than capable of picking up the slack. So I’m not especially worried any longer about the effect of an end to the dollar carry trade on commodity prices.
Looking at this list, investors certainly can’t relax in the first half of 2010. But it’s the second half of the year that I’m really worried about.
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