February 2018 Market Commentary
I have always thought of myself as a fairly emotional guy (Although my wife would have serious rational objections to my claim). When it comes to investing in tumultuous times, I always try to ask myself, what would the OPPOSITE OF ME DO? That is also why I utilize artificial intelligence models, to keep the emotions in check. Aside from our models’ direction, which still leans bullish, I feel that panic has finally struck in the markets. During a secular bull market, it is forever tempting to sell during a panic sell-off to book profits and declare an overwhelming victory. However, we believe that would be a mistake and patience may prove to be a virtue in this market environment.
Markets have had a history of Welcoming New Fed Chairs with steep downturns. We saw this with Mr. Volcker in 1979, certainly with Mr. Greenspan in 1987, Mr. Bernanke in 2006, with Mrs. Yellen in 2014 and now Mr. Powell. Welcome to Wall Street Mr. Powell! As of last month we had not had a correction of 3% or more in over a year and in our opinion this was necessary and welcomed. The recent downturn exceeded 10% in most equity indices and certainly appeared climactic.
Once panic strikes in the equity market, it is usually a sign of opportunity. Our discipline, which includes artificial intelligence models, help us identify these areas of potential opportunity. Panic can be characterized as a sharp decline in index prices accompanied with high volume, and in textbook cases, coupled with the unwinding of leverage accumulated during happy times. Leverage usually becomes conspicuous only when prices decline. However, when positions begin to lose money, the unwinding of leverage happens fast and is rather painful. The good news is that it appears that the unwinding of leverage is well underway; therefore, the underlying strength of the market is better than it was prior to the financial bloodbath.
In our view, a correction was highly likely and a welcome scenario during a secular bull market that we have been in for the last ~9-years; therefore, we believe this week’s sell-off represents a buying opportunity. Corrections are an inevitable part of bull markets. Investors don’t like corrections, because they could be gut wrenching and emotional. But, if you accept corrections as a necessary dose in order to enjoy a secular bull market, a correction that is quick, like the one we just had, is like swallowing a rotten sandwich. I am not sure about you, but if I have to have a rotten sandwich, I would rather swallow it than nibble on it. And I am not suggesting that this is over until I see an upsurge in prices on accelerating volume, which could be coming soon. For those looking to minimize risk, note that panic sell-offs usually define a low within five to ten trading sessions. Once prices stabilize, equities tend to settle into a trading range over the next three to six months. This is the pattern we expect will evolve over coming weeks. Be patient!
We look at corrections in context of price, time and sentient. The price component appears to be climactic and probably closer to the bottom. After reviewing all our models, we believe, the bulk of the decline is probably behind us. 8o% of the S&P 500 Index stocks were down at least 10%. As for the time, we expect to see more volatility in the coming months. Market internals appear climactic as well. The troubling part is that this drama is only about 9-days old and a bottoming process can usually take a few weeks to few months. Stated softly, I cannot rule out a retest of the lows, from what our Artificial Intelligence models are indicating. Moreover, what we would like to see in the near future, is some indiscriminate buying like we saw indiscriminate selling earlier this week.
As for our discipline, our Artificial Intelligence models continue to lean bullish and we do not yet see any indications for the model going any more conservative than she already is. Although she continues to point away from domestic small cap stocks and moving toward Japan and emerging market equities. She continues to like Large Cap Growth stocks in the U.S. and prefers Value Equity components in international and emerging markets area of the globe.
What we recommend to our clients, is to stay calm and stick to your investment goals. Don’t let the tape dictate your investment philosophy. We won’t either. Longer-term, we lean bullish and do not expect higher interest rates to start acting as an anchor for the equity markets yet. There have been a lot of ingredients that have fed this bull market and we still see some of those variables continuing to feed it.
Shashi Mehrotra, Chartered Financial Analyst, is the Chief Operating Officer and Chief Investment Officer of Legend Advisory. The opinions and predictions expressed herein are those of Shashi Mehrotra solely and not necessarily the opinions or expectations of Legend Advisory or any of its affiliates. Such opinions and predictions are as of February 9, 2018 , and are subject to change at any time based on market and other conditions. No predictions or forecasts can be guaranteed. Current market and economic data is as-of February 9, 2018. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.
Important Disclosures and Definitions
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The S&P 500 Index is a capitalization weighted index of 500 of the largest exchange-traded stocks in the U.S. from a broad range of Industries whose collective performance mirrors the overall stock market. Capitalization weighting results in the larger components (stocks) carrying a larger percentage weighting. The Equal Weighted S&P 500 consists of the same stocks but equally weighted and consequently may provide insight into the breadth/disparity of market performance. Investors cannot invest directly in an index.
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Large Cap refers to companies with a market capitalization value of more than $10 billion. Large cap is an abbreviation of the term “large market capitalization.” Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. Large cap stocks typically have at least $5 billion in outstanding market value.
Emerging markets are sought by investors for the prospect of high returns, as they often experience faster economic growth as measured by GDP. Investments in emerging markets come with much greater risk due to political instability, domestic infrastructure problems, currency volatility and limited equity opportunities (many large companies may still be “state-run” or private). Also, local stock exchanges may not offer liquid markets for outside investors.
Value investments focus on stocks of income-producing companies whose price is low relative to one or more valuation factors, such as earnings or book value. Such investments are subject to risks that their intrinsic values may never be realized by the market, or such stock may turn out not to have been undervalued. Investors should carefully consider the additional risks involved in value investments.
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