Every day, I turn the TV on that hangs on the wall in my office. I have CNBC on all day long, and while the average person might think that having the volume turned all the way down might be strange, I do it for a reason. The vast majority of what you see on the news is horrible, distracting, pointless noise with no educational merit or actionable advice. However, I need to know if something is legitimately “breaking news,” and more importantly, I need to know what my clients are watching so that I can help put things into perspective and keep them on the right path – whether that’s 100% invested in the stock market – or 100% on the sidelines in cash.
I’ve seen countless articles referencing the Smoot-Hawley Tariff Act, which was signed during The Great Depression and was widely argued to have prolonged the economic downturn that occurred back in the 20s and 30s. These authors argue that these new Tariffs will not only hurt the U.S. as China counter-attacks with their own tax hikes on exports, which will cripple the U.S. economy as we are such a large consumer of Chinese goods. What they don’t tell you is that the $50 billion tariff is estimated to increase the cost of steel to a point where… wait for it… a can of coke could increase in cost by a half-cent.
Now sure, it’s possible that larger items (such as large appliances) could take a larger hit. When authors write that the tariff is a tax on American families, they’re correct. It’s not much different from raising minimum wage, actually. To elaborate, the same way a raise in minimum wage causes the price of all products sold to go up, the same goes for tariffs and taxes.
For instance, electronics and appliance maker LG reported that they were going to raise prices on their washing machines because of the higher prices for the raw materials to produce product. Whether it’s wages or taxes, when company costs go up, product prices go up and there you have the metaphorical “consumer tax.” It’s pretty simple. Companies won’t simply waive a white flag and go bankrupt. That wouldn’t make any sense at all. Not to mention, everyone would lose their job (so much for wages and washing machines).
Alright… if these tariffs aren’t really a big deal just yet, why did the market drop so much Thursday? Well, a few reasons:
- Global flash PMIs were softer this week, which implies a loss of momentum in the global economy.
- The new Federal Reserve Chairman, Jerome Powell, increased rates at his inaugural meeting by 0.25%, and
- Facebook was leading the tech sector down due to congressional hearings that spawned rumors of companies taking their advertising dollars elsewhere.
So if you take all three of the above, mix in some Trade War, and sprinkle some algorithmic selling on top, what you get is a larger-than-usual drop in the stock market. Furthermore, a -2.93% drop in the Dow sounds kind of scary, but a 724-point drop in the Dow sounds terrifying. But hold on a second…
On Thursday, May 6th, 2010, Dow fell by roughly -3.1% that day, but the point drop was equivalent to a mere 342-point fall from the open. That same day, the Dow dropped 993 points on an intra-day basis, which was equivalent to -9.0%. The same drop today would mean the Dow falling -2,156 points!
The point is, we need to be sure we’re always keeping things in perspective.
If you own a TV or radio station and you get paid based on viewers, listeners and/or ratings, what are you going to do, let this juicy news come and go without capitalizing on it?! No!!! You’re going to use each and every video clip and sound bite to the greatest extent possible, treating it as if there’s a literal hurricane coming through the Midwest! And can you blame them? It seems to work!
A slim few are calling for the top of the market, but I don’t see that yet. First off, an inverted yield curve (when short-term interest rates move to a point where they’re higher than long-term rates) has accurately predicted every recession since the 1960’s. As you can see below, the yield curve is still very stable (rates rising from left to right, over time/duration).
While some are calling Powell “hawkish” or aggressive in terms of his interest rate policy, we have to remember that under Bernanke and Yellen, the U.S. spent years with zero interest rates and no increases whatsoever. So a few quarter-point increases might seem crazy to some, but let’s be honest… rates can’t stay this low forever!
Lastly, I like to follow a handful of indicators to assist in determining whether or not a market crash is right around the corner and one of them is below. What you’re looking at is the S&P 500 (as of Thursday’s close) in the top pane and the S&P 500 Advance Decline Line (in the bottom pane). Because the Dow is made up of 30 enormous companies and since the S&P 500 is a cap-weighted index (where all the big companies carry most of the weight and thus, price movement), paying attention to advancing stocks vs. declining stocks is hugely helpful.
Notice above that the S&P500 created a short-term low. This isn’t the best news in the world, but it’s not the end of the world either. However, if you notice in the bottom pane, the S&P 500 A/D line still held above those same previous lows printed in early March.
What’s this mean? The A/D line takes the big price weighting out of the S&P 500 index and breaks it down into individual companies instead of price. It gives us the answer to the question, “Are there more companies advancing over time or are there more companies declining?”
Normally, well before market crashes, we see the A/D line fall first. Why? Because small and mid-cap stocks, which have a very low representation on the S&P 500 because, well… they’re small, don’t show up in the price chart (top-pane) when you have huge companies like Microsoft, Amazon, Apple, Google, and others creating most of what you see in the price movement each day (or week…or month).
Why is it important to be able to see the small and mid-caps? Because they crash first! When markets crash, small companies are the first to fall, mostly because people consider them to be riskier than larger companies. When they start to fall, the smart money sells them and moves up into mid-caps. When the mid-caps start to fall, the smart money moves up into the large-caps, but this is usually where the train comes to its last stop.
Most institutional money managers (like mutual funds) aren’t allowed to take their investors out of the market. Instead, they’re forced to buy something, and of course, they’re going to put as much of their money into the safest possible stocks they can, which end up being “blue chips” and high-dividend paying stocks (like utilities, etc.).
As we all know, whether you’re a blue chip large-cap company or a bench warming small-cap, you can’t hide in a market crash. So what happens? Well, this is why mutual funds lose so much money when the markets crash. But I digress…
The last point I want to make is that the A/D line in the chart above is NOT falling, nor is it diverging over time against the S&P 500. If it were, I’d be much more conservative right now, but that’s just not what I’m seeing.
What I am seeing at the moment is CNBC touting the fact that the market is down more than 1,100 POINTS (see, they won’t use percentages) to try and scare you into staring at financial news screen all day while their ratings fly through the roof. I say, “don’t do it.” That’s what we’re here for (sorry… shameless plug).
Markets give warnings in many different ways when crashes are coming and at least for now, all I’m seeing is a prolonged clearance sale on stocks in 2018.
If you’re interested in getting a 2nd opinion on your retirement plan, please call or email us so that we can confidentially discuss you and/or your company’s situation further.
If you have any questions about retirement or estate planning, the market, or our patented Defense First® portfolio management strategy, please reach out. You don’t have to be a client to ask a question!
If you know someone who would like to receive invitations to our events, our podcasts, screencasts, educational articles, or articles like the one you just read, please feel free to direct them to our website at www.LibertasWealth.com or Click Here to Subscribe for Free!
The opinions mentioned in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser and strongly consider interviewing a fee-only financial advisory firm, prior to investing. Past performance is not guarantee of future results. Economic forecasts set forth may not develop as predicted. The views and opinions expressed in this commentary are those of Adam D. Koos, CFP® and do not represent the views of TD Ameritrade Institutional and its affiliates. Investing involves risk including loss of principal.