Rumble, rumble, rumble! Can you hear it? That’s the sound of the herd. The herd mentality, that is. It’s been flipping back and forth between bearish and bullish throughout the year. The current rumble is that the US stock market has gone over 25 months without a 10% correction. From a historical perspective, the market usually experiences a major correction every 15 months. Rumble, rumble! The herd says a big market pull back is on its way. But only two months ago the rumble was coming from the other direction—the rumble of stock market bulls. This year is reminding us all that when everyone in the herd knows something is a forgone conclusion, the market has a unique way of serving up a big old slice of humble (not rumble) pie—and over our 20 years in the business, we have eaten our fair share.
At the beginning of the year many economist were calling for 3%+ GDP growth for 2014. The economy promptly served up a bit of humble pie, delivering a negative GDP number for the first quarter. Strategists and pundits then began chanting “Sell in May!” But as the stock market rallied to a new high in early July, a second slice of humble pie was served. This outcome, backed by strong economic data out of the US over the summer, led to improved outlooks for the end of the year. But this scenario is now being questioned as Europe’s economy slows while it waits for recent monetary policy stimulation to take hold. With global tensions rising in multiple arenas, that 10% correction may happen yet. Just in time for a third slice of humble pie.
In support of the optimists, consumer spending has been ticking upward, and July marked the 6th month in a row that the new-jobs number was over 200,000. That has not happened since 1997. Other leading indicators continue to show strength, including a US services index, whose growth is at an 8 ½ year high, largely due to growth in business activity, new orders, and employment.
New York Fed President, Bill Dudley—who blames fiscal policy (the Affordable Care Act, the 2013 tax hike, and the “Sequester”) for having slowed economic growth as much as 1.75% annually—recently indicated that he felt these issues were largely behind us now and that he foresees GDP growth nearing 3% for future quarters. Additionally, both the European Central Bank and the Bank of Japan are in the early stages of extraordinary monetary stimulus which, if the US is any example, should bode well for global equities.
On the other hand, US unemployment remains high, while growth in wages and GDP are lackluster—facts cited by Fed Chair Yellen as supporting her desire to keep interest rates at current levels until mid-2015. Adding to economic woes is Europe, where both German and Italian GDP stalled out in the second quarter, with Italy slumping into a recession. And of course, geopolitical tensions abound.
For most of our clients we have been increasing the diversification of our equities exposure, increasing international equities (while maintaining our overall underweight to this sector) and adding emerging markets. We have also been reducing exposure to underperforming commodities and hedged equity strategies.
As we finish up the summer and look to the 3rd quarter, it all seems clear. The Fed is on hold with interest rates until mid-2015, and investors should raise cash for the 10% correction that is going to happen any minute now...or maybe not. By the way, are you going to eat all that pie? Humble is my favorite flavor.
As always call or email us with any questions or comments