Market volatility in recent months has a lot of investors focus all over the place on anything and everything including the Federal Reserve’s next moves, corporate earnings, the Chinese economy, the global economy, oil prices, recession concerns, and even the rather unusual election cycle in the U.S.
With so much volatility investors are also questioning what drives the markets and what drives them to invest in the markets. Why is it that we do invest our money in the market? The simplest answer, the obvious answer, looking past specific goals such as retirement or education funding is that we are looking to make money or generate income through those investments with capital gains and dividends. A long term diversified portfolio invested in the stock market has historically offered better returns than other investment options.
Investors are looking to make money, they're looking to protect wealth, and with all the market ups and downs they're wondering how exactly stocks are priced.
How indeed?
This may come as a surprise to some but there is an immense amount of research into how stocks are priced. Of course there is, everyone wants the magic bullet. The answer as to how prices are determined is both simple and immeasurably complex. The short version of price determination is simply that prices are a gauge of market sentiment. That gauge however is from a combination of all available market information, including individual company earnings, rules and regulations, and how the consumer or investor feels about the stock.
Stock price is what we say it is, it is a combination of what all investors say it is. Simply put the price is what we are willing to buy a stock at, or sell. Ultimately what this means for the individual investor is that timing the market exactly is akin to reading tea leaves. Take heed future day traders, the market doesn't here your screams.
Getting back to recent volatility and what is driving the swings, let's take a look at some concerns that have been a driving force in the change in market sentiment, namely, China, oil, and fears of recession. The headlines, also driving market sentiment in some Schrodinger's cat type of scenario, while having a point are also often unnecessarily caustic. "The old news adage, "If it bleeds, it leads," applies to sensational financial articles, too."
China did, and still does, have some economic hurdle to face, however its currency has seen some stabilization and is on the rise recently. More importantly, and what the "if it bleeds, it leads" types seem to not focus on, is the fact that exports to China from the U.S. only account for 1% of the U.S. GDP. That's right just 1%.
Energy earnings have been in decline in large part because of oil. Oil is not a minor market concern; producers are pulling back on spending and cutting back on the workforce all of which effect energy earnings and the market as a whole. There is still much distance to be made up, but oil has seen some recovery recently.
China and oil and a whole host of other things have led to some fears of recession. The idea of a new recession around the corner hasn't just been put out there by our economic card sign holders, always letting us know that THE END IS NIGH, THE END IS NIGH. Economists and a wide assortment of industry leads are maintaining the risk of a recession in the next 12 months has increased, “Economists at Bank of America Merrill Lynch peg the chance of recession in the next 12 months at 25%.” There is by no means a consensus on this and even if there were, forecasting the economic future is in no way an exact science. The most highly trusted out there are often wrong. Ben Bernake, Chairman of the Federal Reserve from 2006 to 2014, stated:
“Overall, the U.S. economy seems likely to expand at a moderate pace this year (2007) and next, with growth strengthening somewhat as the drag from housing diminishes”
That Bernake quote dates from February of 2007, the National Bureau of Economic Research points to December of 2007 as the beginning of the recession, or as is otherwise know, the Great Recession. There are countless indicators, forecasting models, and truly intelligent people who are constantly pocking and prodding at the data but it is just not possible to predict the future, not for anyone. In fact Warren Buffet himself had this to say about predictions:
“The cemetery for seers has a huge section set aside for macro forecasters. We have in fact made few macro forecasts at Berkshire, and we have seldom seen others make them with sustained success.”
For all the doom and gloom, there are also a lot of reasons pointing to a positive outlook for the U.S. economic forecasts of 2016. Take for instance the unemployment rate which was at 4.9 percent in January and continued on at the same rate through to February. That is the lowest it has been since April of 2008, it’s the first time it has been under 5 percent in 8 years. Along with the unemployment numbers there was some very strong job growth, in fact job growth far exceeded economist’s earlier expectations.
The markets should also find some amount of pricing stability as the presidential election cycle moves closer to its conclusion and less uncertainty. In general the markets react better when the unknowns in terms of candidates is reduced, i.e. fewer candidates remaining with fewer variations to look at.
That’s just in general though, no seers over here.
The thing about worrying about a recession is that any feelings on the subject also feed into the wisdom that makes up stock prices. There are indicators, and the market itself is one, but the thing is the market often overshoots or undershoots what is happening. It's often impossible to tell if prices are as they should be until later, hindsight and all that.
There have been up to 47 recessions since 1790, that’s a recession every 4.8 years if we average it out. Markets do and will continue to go up over long periods of time, but they don’t usually do so in a straight line.
Is 2016 gearing up for the next one? The truth is that nobody really knows. There will be a recession again though, there always is. It is within the very cyclical nature of the economy, of the markets. This is why we diversify, what thrives in one market period will flounder in another. This is why we work with you to discover your investment objectives and the levels of risk you are will to take as an investor.
Whatever the news is, it's often just so much noise that is better left ignored. The bottom line is that the market has its seasons of smooth and its seasons of high volatility. We can’t predict the future either, but we do diligently strive to prepare you and your investments for the likeliest possibilities.
Market Commentary Disclosures:
The information contained herein is obtained from sources believed to be reliable but its accuracy and completeness is not guaranteed. Due to market volatility, any opinions expressed herein are subject to change without notice. Investors should be aware that there are risks inherent in all investments, such as fluctuation in investment principal.
The S&P is a market-cap weighted index composed of common stocks of 500 leading companies in leading industries of the U.S. economy.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
Indexes are unmanaged, do not incur management fees, costs and expenses cannot be invested directly. Past performance is no guarantee of future results. Returns do not include sales charges or fees an investor would pay to purchase the securities they represent. Such costs would lower performance. Index returns include reinvestment of all dividends.
http://www.wsj.com/articles/economists-ceos-recession-risk-rising-1455237811
http://www.marketwatch.com/story/bank-of-america-sees-25-chance-of-a-us-recession-in-2016-2016-02-09
http://247wallst.com/economy/2016/03/17/philly-fed-shows-unexpected-return-to-growth-in-manufacturing/
http://www.latimes.com/business/la-fi-jobs-report-takeways-20160304-story.html