This post was originally published on this site
The stock market is a measuring stick or a pricing mechanism, incorporating daily data and weighing factors constantly towards value estimation. Lately, it seems to be getting in its own way, though, acting more like a paranoid person than a reasonable man. There are various substantial reasons for that, but I suggest investors remember the wisdom of old and not get caught up in the daily fear and greed that drives very short-term moves in markets. The long-term investor needs to keep perspective and control emotions even when the news seems to demand otherwise. But is this time different?
Stocks Missing a Positive Presence
It feels like since Gary Cohn left the Administration in early March, data flow and decision making from Washington has been a bit less market-friendly. The chart of the iPath S&P 500 VIX ST Futures ETN (VXX) reflects the uptick in volatility since the message from the Oval Office shifted from fruitful tax reform legislation and infrastructure spending to troubling tariffs, trade wars and nuclear negotiations. While it’s all being driven by good intentions, the uncertainty and noise it stirs into the soup is terrifying nonetheless to a stock market that must measure risk and reward. Investors are on edge, which does not help judgement when the Federal Reserve makes a communique or when it drives our trading partners’ rough rebuttals.
Over the past several weeks, we have seen China and Iran stand strongly against our forceful advances, partly because there seems to be a growing opinion that the bark of our policies is not backed by bite; that it is simply a negotiation tactic. That troubles me because I wonder if it might lead to an actual dog fight. Iranian leaders just warned that a U.S. withdrawal from the Nuclear Deal with Iran (with implied sanctions against Iran coming) would be met by harsh rebuttal. Information from Israel added fuel to the fire, and it seems markets have been pricing escalating concern into oil. What if this time is different and bark is backed by bite? It seems to some to be reason enough to sell stocks over the short-term, or at least build protective hedges with volatility and energy instruments.
Oil prices have steadily risen into the big decision date of May 12, which is the date by when the President will either quit the Iran deal or not.
Last week, stock market volatility increased again partly on U.S.-China trade war concerns. U.S. Administration negotiators traveled to China to communicate our hopes and expectations for trade. Equities did not react well to it all, but by Friday, fear eased on a decent jobs report and signs that our worst fears may be overdone. Namely, the two sides are talking now rather than imposing tariffs on one another.
I’m uneasy because I keep placing bets on short-term VXX puts, on expectations that volatility should be easing as economic and corporate earnings data reminds investors that things are good and well in America. But when the daily morning message from Washington continuously causes indigestion and raises alarm about war and more, investors go right back to panic. Without any change apparently in sight, at least in the very near-term, perhaps we should all just focus on the long-term.
Stock Market Wisdom of Old
Stock market wisdom of old tells of managing emotions, buying into fear, and holding stocks for the long-term. Since 1928, investors could count on that resulting in about a 10% average annual return.
A wise investor might even leverage these sharp shifts in stocks to buy great names at discounted pricing. Stocks are more cheaply valued than they were in January, after another quarter’s worth of earnings growth and on lower stock prices. The current P/E ratio of the S&P 500 Index appears rich at about 24.2X, but index participant earnings results have been excellent, with 24% profit growth so far this quarter and forward estimates that are on the rise. The implication here is that greater future earnings will justify the current price of the market.
It’s my view that corporate earnings have a couple years of especially good growth ahead of them too, as U.S. corporates continue to benefit from U.S. expansion, complementary global growth and U.S. tax reform & full employment. And I’m not afraid of an appropriate Fed policy to control growth, and its aftereffects, nor a higher 10-year yield, which I see as a symptom of good times.
A paranoid market participant will buy and sell on every fresh bit of news over the short short-term (30 days). But as (or if) fright fades and trade tariffs prove to be negotiation tactics, and war threats end up being a means to achieve a surer peace, well equities will give weight back to what matters most to them, the economy and corporate earnings. And the equity valuation premium (to earnings) might even make a parallel shift higher over the long-term if trade is made more favorable for American firms and if intangible and potentially disruptive threats disappear thanks to the current disruptive policies of the Administration. Plus, it would help if tax reform were made permanent, though alongside more sensible spending and possibly more efficient entitlement programs.
The Thing About Paranoia
But what if today’s crisis keeps being replaced by tomorrow’s, and so paranoia never goes away? That is how it feels these days, with North Korea being replaced by Iran on the war siren schedule, and NAFTA renegotiations being traded in for tensions with China. What’s next, an uptick in tensions with Russia and trade threats against allies like Germany and Japan? It’s not out of the question, if not likely. Sometimes I wonder if after four years pass we’ll have a much better situation or if unforeseen long-term harm will have critically wounded important relationships with both allies and enemies. That’s something worthy of discussion, and I do not have the answer, but for stocks, I think the more likely scenario is savory.
The Conclusion is Buy Stocks
So in this case, reasonable investors should be buying stocks broadly for the long-term on these paranoia driven pullbacks to their 200-day moving averages. The economy is still expected to expand at a more robust pace in coming quarters (average of 3.4% GDP growth expected for Q2), and first quarter earnings results have been splendid. These are the factors that matter for the long-term investor, and what will weigh for stocks a year from today, when their earnings demand a higher stock price and after the frenetic news driver of the day has dissipated. For my coverage of markets and securities, readers are welcome to follow the column here at Seeking Alpha.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.