Major market indices (S&P 500, Dow Jones Industrial Index, et al) have declined today, and have done so in a way that will make headlines. What do we really need to know? How should we react?
The "Technical" Picture
The chart at the top of the page illustrates the price movements of the S&P 500 over the last 12 months. Most people are referencing this index when they are talking about "The Market." It's actually a geometric average of the 500 largest publicly traded, American companies weighted by the total size. This means that the biggest companies make up most of the S&P 500 (As of September 30, Microsoft, Apple & Amazon were just over 11% of the index). Given these weightings, we know that most of "The Market" returns come from just a few companies. The S&P 500 is really more of a focused portfolio than it is a representation of the stock market.
None the less, the headlines, and an overwhelming amount of public opinion stems from it's movement, so we would be remiss to ignore it entirely. The first headline you'll hear about will probably be looking what the chart is doing. Gleaning information from the charts is a discipline called "technical Analysis." It's focus is to look at patterns of buying and selling behavior to predict upcoming price movements. Technical analysis isn't particularly useful except for short-term speculation, but many people think it is the only way to invest. While we should rarely make investment decisions based on technical analysis, knowing how it works can give us some short-term insight.
In the chart, you'll see that the S&P 500 has dropped below the Orange line (the moving average of the last 50 days), and also a flat red line. According to Technical Analysis, this was a support level, and the act of dropping below it means that the market should be looking to find the next level of support. The pink line is the moving average of the last 200 days. It's a significant point of support. The red lines that sit close to it provide some reinforcement too. "The market" is almost at that point, and we can expect (according to technical analysis) people to stop selling and start buying again.
Portfolio Construction
In good times and in turbulent ones, portfolio construction is important. Different risks impact different businesses differently, so investment in each of those companies needs to be made on a one-on-one basis. Concepts such as passive index investing have worked in the past decade in which almost all of the largest companies have seen steady or rapid growth in share price, but in a more turbulent environment, it can actually amplify declines in a portfolio. We need to go back to the foundations of our investment theory and consider each investment as an individual part of the whole and also look deeper than that mathematical shortcuts we begun to rely on (i.e. alpha, beta, CAPM) and evaluate our diversification on that same basis.
As I write this part, I'm realizing that I need to write an article translating that into plain English. I'll do that soon. What's important, is that your advisor is carefully constructing your portfolio so that your exposure to risk is as minimal as possible rather than exposing you to every risk knowing only some of them will hurt you.
If you're a current client of mine, your portfolio is already designed like this. It's created for situations like we're seeing today. If you're not a client yet, book an appointment on my website or give me a call.
Trump Impeachment & Economy
More than anything, this is just a frustrating headline in terms of the stock markets. Whether or not Trump should be impeached is a question to be handled in a different forum, and is really quite distinct from our economic conditions.
Remember the Clinton Era? I remember learning about impeachment. It isn't removal from office. It's really just a black mark on the president's record. Sure, congress could decide to pursue a removal afterward, but that's a very unlikely scenario, largely due to the time left on Trump's term.
If Trump is impeached, he still has all of the same powers of office and he still has similar challenges in uniting Washington D.C. (and the country) behind him. The largest impact will be on the next election, which is the reason Democrats are pursuing impeachment with such vigor. That isn't to slight those on the left; if we're really honest with ourselves, election is what drives both sides in Washington.
The President is captaining our trade negotiations and has some impact on fiscal policy and legislation, but he isn't a primary driver of the US economy. Aside from massive actions, like engaging our troops in war (which requires congress after 90 days, by the way), the President is more of an economic cheerleader — a figurehead for the rest of the system. Impeachment of Trump has a net effect on the economy of very little, but it makes for a very loud headline.
International Trade
I've been working to address this issue at length for a long time. The issue is really short and sweet. We've been in an economic cold war with China since before the end of the Cold War. China made some very aggressive moves during President Obama's administration. As an example, Consider their One Road One Belt initiative that was designed to open trade for China across Eurasia. The program, financed by China, is poised to create insurmountable indebtedness for these new trade partners. China's program is about more than opening trade routes. It gives them the economic leverage they need to command trade supremacy over half the globe.
For the Unites States, our risks in a trade conflict with China remain small. If we stop buying steel from China, or if it becomes overpriced due to tariffs, Another country will be excited to fill the gap. That country's economy will grow, and we can hope their political ties to the U.S. will do the same. The short term effect: a small slowing of GDP growth for the long term benefits of increased global economic and political stability. There are a number of ways we can misstep, but at this point, we should be losing any sleep.
September Economic Data
Nestled quietly on page 5 of whatever newspaper you read, you'll read about the economic data released for September. You'll read about slow-downs in share buy-backs, and some other miscellaneous data-points. These are the most important things we should be watching to see if the continues to slow down.
This morning, the Federal Reserve stated their confidence in the US economy's strength. Frankly, I agree with the sentiment, and believe we can look at history to see that one or two months of lackluster economic data doesn't indicate we will begin a recession. It's certainly true that every recession starts with declining economic data (it's required by the definition of recession), but there are many months in which these numbers are less than ideal in the midst of robust economic growth. This morning, Brian Wesbury, Chief Economist of First Trust Advisors, wrote a fantastic article looking at the ISM Manufacturing data making this point [Read it].
The conversation about share buybacks could get a bit of attention as many will say that the companies themselves don't believe in their own value. I see it differently for now. In order to adapt to changing trade situations, large companies need their cash, and shouldn't be willing to part with it in exchange for company stock until some of the trade tensions play out. Additionally, companies have engaged in record-setting buybacks and mergers for a number of years now, using capital they set on the sidelines during and after the Great Recession. To me, this feels more like a return to normal than the beginning of crisis.
