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The Heights and Depths of Stock Markets
On February 8, 2018, the S&P 500 erased its gain for the year, closed at a two-month low and is on track for its worst week since 2011. The Dow plunged more than 1,000 points for the second time in four days. This is against the backdrop of us experiencing the second longest bull run (period where stocks keep going up in value). A lot of investors have been predicting a fall in the stock market for the last several years. Each time they were proven wrong, they simply extended the time line. The thinking was that a bull run cannot last forever-and indeed it can’t. This time around, people were concerned that all the good news may cause the Fed to raise rates faster, therefore slowing down the stock market. Some investors believe that this is a correction, others feel it may be the start of a bear market. These remain to be seen. The question is: how does an investor figure out what drives the performance of various stock markets?
Effect of Liquidity
In the old days, students at university would learn all about how the stock market was affected by things like interest rates, inflation, company earnings, and oil prices to name a few. There is a reason these things were taught, because they were true at the time. But what the second longest bull run showed, is that many of these factors did not hold up this time around. So what was the main driver of the prolonged bull run? From all appearances, it was the easy money, i.e. the Quantitative Easing employed by the Fed reserve, starting in November 2008, where they purchased long-term Treasuries and mortgage-backed securities in an effort to stimulate the U.S. economy. This ended in 2014, but they kept the balance sheet at the same size. This was a very prolonged period of infusing cash in the economy which in turn pushed up asset prices. It therefore eclipsed the other variables or we can call them-the “usual suspects”.
Availability of substitutes
Investment managers, when building their portfolios, would typically look at the expected returns from all the various asset classes, including bonds, stocks, real estate, foreign exchange trading etc. The implication of this for the stock market is that if other assets, like bonds are giving better risk-adjusted returns, investors will tend to put a higher allocation of funds into bonds than stocks and vice-versa.
“A rising tide lifts all boats”
When you decide to invest in the stock market, you need to know whether you are in a bull run or a bear run (when stocks are going down in price). As the above expression suggests, most stocks will benefit, i.e. go up in prices when the stock market is going well. This is when many investors mistakenly think that they are more talented than they really are, because their stocks are performing well. Many times, it is simply a reflection of the general market.
The macro factors are very important when picking individual stocks, but the individual stock fundamentals are also critical. Is the P/E high or low relative to the market? That is, is it expensive or cheap? Are the prospects good? Is the management sound? However, be aware that in a strong bear market, even a good or great stock is also likely to get pummeled! You will hear many investment professionals telling you that you can’t fight against the market.
The performance of the economy is critical as well. Some stocks have a high correlation to the market, so when the market is doing well, they tend to outperform. This includes luxury stocks, which are usually the first to get hit when the economy goes south. This doesn’t tend to be the case for utility stocks for example, which are more resilient in market downturns.
It wouldn’t be possible to deal with all the factors affecting various stock markets in this article, but maybe the key thing here is to be aware that different factors will have larger impacts on prices at different times, i.e. it really is not a perfect science. We should be aware of the “textbook” factors, but they will sometimes have little to no bearing on the actual performance. Investing for the long term in stocks with good fundamentals never grows old though!
Yanique Leiba-Ebanks, CFA, FRM is the AVP, Pensions & Portfolio Investments at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: firstname.lastname@example.org
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