Slowdown, Meltdown, or Short-term Correction?

Even in times of minor correction, we as individual investors feel the jitters of volatility. I always compare the emotion tied to investment for the individual to the feeling of being on a rollercoaster—markets go up and we have that feeling of anticipation and exhilaration, and as they fall it quickly turns to terror. It can be very hard to divorce one’s self entirely from the emotional side of investing.

While the individual views investment markets like a rollercoaster, institutions look at it like a railroad—with opportunities on one side of the tracks and risks on the other—and they aim to ride right down the middle of the track leaning toward opportunity when they can, and away from risk as needed.

The disciplined approach of the institution can be a tough one for the individual to mimic because of the emotions that play into buying and selling. Typically the euphoric feelings at the height of the market make the individual clamor for more, while the lows trigger emotions towards the exit. This leads to the “buy high, sell low” trap of emotional investing. Institutions take the opposite view; tuning out the noise, and looking for opportunities at the low, and exit strategies at the high.

So, how do we attempt to read through the lines of this current pull-back on the markets?  Let’s look at the economic data in May that potentially foreshadowed a slowdown

“Only 54,000 payroll jobs were added, auto sales declined significantly, retail sales were sluggish even excluding autos, growth in manufacturing slowed sharply, house prices continued to decline to new post-bubble lows (as of March), and home sales slowed.” (according to Calculated Risks Finance & Economics blog). Some of these issues could be attributed to interruptions in supply-chain in Japan following the earthquake (influencing auto sales), & rise in oil prices tied to geopolitics in the Middle East (influencing the price at the pump).

Monetary supply worldwide is on a tightening trend; which isn’t necessarily a bad thing. Responding to high inflation, both the Chinese and Indian banks tightened policy, which may slow growth, but it does not look as though they have gone too far to cut off potential growth completely.

Two political showdowns could play significantly on the continued upward trend of investment markets:

The first being the European Union’s move on Greek debt. If some form of restructuring is not rolled out, Greece could default and exit the Euro—a move that would not be good for any country participating in the single currency.  Domestically, the argument over the debt ceiling continues to be dicey; with one side refusing to cut spending, while the other refuses to raise taxes. Without action, the US government could find itself in technical default—though I do not believe politicians would make that type of dogmatic mistake.

Despite these risks, it bears to keep in mind that we are coming out of a steep recession fueled by a credit crisis, and after almost 2 years of positive growth, a correction at some point is inevitable. The economic data in the next couple of months will be telling as to whether we have a sustained pullback or if some of the shorter-term issues have been resolved—namely the slowdown in manufacturing fueled by supply chain issues. Taking an institutional approach to investment decision-making is not easy, but the ability to stomach normal corrections can prove to be the difference in meeting financial goals.

From an Investor’s Prospective: Understanding the disconnect between Wall St. & Main St.

Many people continue to ask how the stock market can have recovered significantly from the maelstrom of 2008, while the economy and employment still have the feel of “recession” to them.
The short answer is that the stock market is primarily focused on corporate profits. Hence, the stock market has done quite well over the past two years, a period of time when corporate profits have “surged” but the U.S. economy as a whole has merely “firmed up.”

The somewhat longer answer is that there is a very large difference between what drives “Main Street,” (the U.S. economy) and what drives “Wall Street” (the stock market). The table below highlights some of those key differences:

Source: BofA Merrill Lynch U.S. Equity Strategy

While your investment accounts may be enjoying the recovery in corporate prof­its, at the same time you may personally be feeling the effects of recession recovery (sluggish employment, higher than normal inflation, etc.). Hopefully, the above chart will help shed some light on the gap between recession/recovery “feelings” and what Wall Street may be “seeing.”