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Why we're stuck with the market madness
Madness is prevailing on stock markets because the consensus of the main influencers of the market right now have it in their heads that a recession is coming. How do we know that?
Well, the behavior of the bond market is a pretty good indicator, and it’s especially so when stock prices are falling and bond prices are rising.
You see, if you are an influential investor, hedge fund manager or a fund manager of a retirement fund and you believe a US recession is coming, then you will sell your stocks, so stock prices fall.
Then you want a safe place to put your money and US government bonds are your best bet. Now as there is a rush to buy these bonds, the price of existing bonds go up.
Now imagine if the bond in question was for $100,000 at 2%, or $2,000 a year interest, and new bonds were offering lower rates of interest and you are prepared to pay $105,000 for this bond.
You get $2000 for $105,000 so you have lowered the effective rate on this bond down to 1.905%.
Because you are scared of a recession, you are rushing into safe harbours. However, if your belief that there is a recession is wrong, then your actions are MAD!
Recession talk
The most important woman in the world — well, the material world — is the US Fed boss Janet Yellen and today she basically said a recession is always possible, but we don’t think it’s going to happen.
Just about every respectable economist puts a recession in the USA, in Australia and, for that matter, the world economy at a really low risk, but the market opinion says “Mr Market” is punting on a recession.
The big problem at the moment is that there are too many bad things outnumbering good things.
The bad
The bad things are:
Question marks over Chinese growth but it did come in at 6.9%, only a bit below the 7% tipped by the Chinese government. That’s a bit mad.
Oil prices are falling and while it is bad for the companies related to oil, this is a great boost to consumers worldwide and businesses that use energy, which of course is all businesses! That’s mad too.
The IMF downgraded its world growth forecast by 0.2% and it was still over 3% and was faster than 2015. A recession is growth that is negative, so growth concerns are a little mad.
US economic growth is tipped to rise in the first quarter and the January jobs report came in at a lower unemployment number at 4.8%, higher wages and a rising participation rate, but the jobs created was less than expected by the average job creation per month over the last year and is around 212,000 jobs. You’d be mad if you think that this sounds like the job market getting ready for a recession.
Japan has recently gone for negative interest rates to get its economy growing but we all know Japan has special problems with an ageing population and a growth problem when it comes to people. It has also over-protected lots of industries and that’s why it has been mired in low growth for two decades. Janet Yellen said negative rates were possible in the USA, when asked, but also suggested she doesn’t see them happening.
Overcooked market slump
The only non-mad aspect of the recent stock market sell-off is that we thought the world and the US economy was stronger than we thought a year ago.
We also thought commodity prices would be higher but we were wrong and so share prices needed to come down, but just about every seriously smart commentator thinks the market slump is overcooked!
Yep, madmen are running the ‘kitchen’ called the stock market and the old saying is prevailing that if you can’t take the heat get out of the kitchen.
Smart guys who can do the maths say our market has sold off so much we are now at fair value, so I’m hoping we see some buying in coming days and weeks, but expecting rational behavior when markets are going mad can be a little naïve.
Switzer’s view
So what am I doing?
Well, I am buying quality companies I want to hold for a long time at these lower prices. I might get in too early but I think in two or three years time I will be really happy that I fought this madness now.
I did like this from CNBC’s William Hobbs, head of investment strategy for Europe at Barclays, who overnight said, "You're getting the capital markets being buffeted from gales from all corners…to our mind, the world economy, the real economy, looks in better shape than markets are telling us…that probably is telling us that those with strong constitutions will want to add to their developed market equities in particular."
Negative is positive!
And I loved this more.
Investor sentiment has become so negative, it’s actually seen as a positive sign! The Bank of America Merrill Lynch (BOM) Sell Side Indicator has gone close to where it was in March 2009!
That was a great month, as it was when my predictions that the GFC crash of stock prices would eventually give way to a big rebound. It started in March and was over 30% for the year!
The measure looks at the percentage of assets held by investors surveyed in stocks. The long-term average is 60% but it’s now at 51.2, according to CNBC. Historically, the 51.9 level is the “buy” signal.
The BOM team sees a 17% rebound as a possibility, given the reliability of this measure. I know some of you might think this sounds mad but it’s no madder than the lack of logic that’s driving stocks right now.
As Warren Buffett counseled us: “Be fearful when others are greedy and greedy when others are fearful”.
Peter Switzer is the founder of the Switzer Super Report, a newsletter and website for self-managed super funds.
