by Art Patten, Symmetry Capital Management
The broad rally in equities in October was massive, regardless of whether one views it as a dead cat bounce or a new leg up. Either way, it was enough to cause investor whiplash, and correlations across individual stocks remain historically high.
For the S&P 500, it was the eighth highest monthly return since 1950.
Click on graph for larger image.
This was clearly a “right tail” outcome:
Though sympathetic to the ‘wall of worry’ arguments out there (and in our active strategy, licking our wounds from October), we’re still skeptical and believe that equity markets will end lower before embarking on a bull market:
- Credit markets are still flashing recession warnings for most of the world, especially Europe.
- At current levels, following their rallies, equity markets look fairly priced at the very least and highly optimistic compared to other asset classes.
- Certain credit market indicators are also warning that corporate earnings forecasts may contract by double digits, rendering low price-to-earnings arguments moot.
- Demographic headwinds will remain in place in much of the world until at least the latter half of this decade.
- Policymakers worldwide are still favoring austerity over growth.
That said, it looks to us like the U.S. economy, although we expect it to enter recession sometime between early 2012 and early 2013, could still outperform expectations along the way. One of our recently-triggered recession indicators turned around after only a month, for example:
The last time this occurred was in 1989 (a positive recession signal) and at the end of 2002 (a negative signal), so the forecasting power would appear to be no better than a coin flip, especially considering the small sample size we’re working with. The only qualitative data we can bring to bear is that in 1989, policy measures were trending in the direction of austerity (higher taxes, strong dollar, rising interest rates), while in 2002-2003 policy was headed in a more stimulative direction (other than uncertainty over whether an invasion of Iraq was imminent).
Finally, it’s interesting to take a close look at the demographic aspects. As shown below, seven of the ten largest one-month moves in the S&P 500 from 1950 through October 2011 occurred from 1974 to 1984, a period in which age structure in the U.S. and many other developed nations fluctuated dramatically. In the 1970s, Baby Boomers began entering their household formation years in earnest, while in the 1980s, they began entering their peak earning, saving, and investment years:
The volatility of the 1970s was associated with a secular bear and eventually range-bound stock market, while the volatility of the early 1980s was associated with the beginning of an almost two-decades-long bull market.
Today, Baby Boomers in advanced western economies are entering their retirement years (in Japan, this occurred about ten years earlier), which could have persistently negative implications for stock markets, at least until their children, the Echo Boomers, begin saving and investing in earnest (an activity that events of recent years may influence them away from at the margin). Thus, it seems likely that we’ll continue to see 1970s-style volatility and sideways or downward trends in stock markets for at least a few more years.
However, investors with suitably long time horizons should keep in mind that, despite the popular characterization of a lousy investing climate in the 1970s, it was actually a great time to buy stocks in general. As long as the global economy can manage to hold it together and avoid a low-probability 1940s-style outcome, long-term equity investors who stick to a disciplined process (and where suitable, take advantage of the opportunities presented by periods of high volatility, i.e., buying low and selling high) should do OK over the coming decades.
IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (SCM) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Past performance is not indicative of future results. This material does not take into account your personal investment objectives, your personal financial situation and needs, or your personal tolerance for risk. Thus, any investment strategies or securities discussed may not be suitable for you. You should be aware of the real risk of loss that accompanies any investment strategy or security. It is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any particular strategy or investment. We do not guarantee any specific outcome or profit from any strategy or security discussed herein. The opinions expressed are based on information believed to be reliable, but SCM does not warrant its completeness or accuracy, and you should not rely on it as such. All views and positions are subject to change without notice.