This is from Mitch Zacks, Senior Portfolio Manager at Zacks Investment Management. I’ve done a lot of cutting and snipping. In connection with a previous post I asked Zacks Investment Management if I could post an occasional letter from Mitch Zacks on a MF board and they said it was okay as long as it was occasional, that I gave him full attribution, and a link to their site.
The US stock market as measured by the S&P 500 has had a tremendous run over the last twelve months. Pundits and analysts have been calling for a correction, meaning a steep quick sell-off, followed by a rebound back to pre-correction levels. However, a correction has not materialized… There is a psychological feeling among market participants that the market has gone up too far, too fast. This… itch needs to be scratched and as a result, some selling would be natural and ultimately healthy for the market in the long-run.
This past week the market was looking for a reason to sell-off and the currency issues among the emerging markets provided the spark. Emerging market currencies have been under pressure for some time, partly as a result of the effectiveness of the monetary stimulus of the US Federal Reserve. The monetary policy of the Fed has strengthened the U.S. economy and therefore reduced the relative attractiveness of emerging markets. Who wants to buy (stock of) a company in Argentina… when the U.S. economy is beginning to accelerate…?
This past week, Asian stocks ended lower after a preliminary reading of Chinese manufacturing activity fell to a six-month low… the (Chinese) Purchasing Manager Index … for January came in at 49.6… Anything below 50 indicates contraction. While the reading was not good, it by no means was out of the realm of expectations…
Currencies in emerging markets have been going through a devaluation period and as a result all assets in these countries are worth less, including stocks. The market reacted to the currency problems in the emerging markets by engaging in a traditional “Risk-Off” trade. Stocks in sectors that are economically sensitive and finance companies that may hold international assets were sold. Conversely, more defensive sectors, such as healthcare and consumer staples performed relatively better.
Confidence amongst investors is quickly eroding in emerging markets… There is now a chance that emerging markets are beginning to pose a threat to global GDP growth. The reasoning is that the emerging markets have traditionally been seen as the GDP growth engine of the world. If the emerging markets falter the concern is that Global GDP growth will come down. U.S. multinationals are very dependent on global growth to meet earnings numbers, and a slowdown globally would be a negative for corporate earnings and stock prices.
While the potential for a slowdown in emerging markets causing the earnings of U.S. multinationals to decline is real, the fear is likely overblown. At the end of the day, the market was looking for a reason to sell-off after its run-up. The emerging market problems are more of an excuse than anything else…
The Good News
While the currency devaluation of the emerging markets is bad news for the global economy, I do not believe it is a game changer. The global economic expansion continues to move along at a healthy clip. In the U.S., third quarter GDP growth came in at an annualized rate of 4.1%. While I don’t expect growth to remain at that rate, leading economic indicators are telling me we should see continued GDP growth in 2014 and 2015.
The International Monetary Fund predicted (the advantage in) the growth of emerging markets over developed economies will shrink this year to the smallest since 2001. However, the IMF kept its expansion forecast at 5.1% and raised the outlook for advanced economies to 2.2% from 2%… The data points to the fact that the global economic recovery continues. The run-up in the market due to increases in P/E multiples was not irrational; it was in anticipation of the current global recovery. As I have indicated several times before, 2014 is not going to be anywhere near as good as 2013 but an estimate for the S&P 500 to generate total returns including reinvested dividends of 6-7% for the year is very reasonable.
I, and many others, have been awaiting a correction for some time now… The chance however of any correction in the current economic environment causing a bear market is not high.
Growth in developed countries will most likely continue, which in turn should help increase earnings and eventually employment. From there, consumer spending should accelerate even faster and consumer spending is two-thirds of GDP. Also, as QE tapering continues, the yield curve should steepen giving banks more incentive to lend which should help small businesses grow and once again help the unemployment number come down.
Putting it all together, I believe the sell-off could very well continue in the short-term and cause the long-overdue correction. But the probability of emerging markets derailing the global economic expansion is quite low. Nothing happening right now with the stock market is abnormal. Investors have been looking for a reason to sell, they found one and sold.
Things have been so good for so long in the stock market, investors began to forget that risk is inherent in investing… This is all part of the wall of worry that bull markets love to climb. The important thing to remember is that investors with a sufficiently long time horizon of at least 5-10 years or more should not react to practically any sell-off.
It is almost impossible to predict the future but I can tell you based on what has happened in the U.S. over the past century that several years from now the earnings of publicly traded corporations should be, in aggregate, substantially higher than they are currently. As long as the P/E multiple does not compress dramatically, which is reasonable given (that) valuations are not currently excessive, the market will continue to head up over time. You buy the dips.