All of a sudden, the market is volatile… but why?
That was one of the main topics of conversation I had with investors over the past couple of days at the Las Vegas MoneyShow. In fact, I fielded a lot of questions about why stocks wobbled last week, and that’s completely understandable.
Fortunately, I was well-equipped to answer these questions. You see, when it comes to understanding the underlying reasons why markets behave as they do, you have to think a bit deeper than just the headlines.
Indeed, that’s why I call this publication “The Deep Woods,” because it is here that we peel back the surface layers of the onion skin so that we can get deep into the real reasons why things are as they are. In doing so, we can get a much greater sense of where things might likely go in the future. That’s because when you have a good sense of why things are the way they are, you have an even better chance of being right about how things are going to be in the future. And when it comes to our money, knowing what is likely to happen going forward is essential to investing success.
Your editor at the Eagle Financial Publications booth, Las Vegas MoneyShow.
So, why did market volatility pick up last week? Well, first there were lingering concerns about the health of the economic recovery after the soft August jobs report and the increasing threat of a more “hawkish” shift at global central banks. Then there was a soft German ZEW Survey, which offset bullish Chinese export data. Politically, there was a Wall Street Journal article that warned corporate tax rates could rise before the end of the year, and that further pressured stocks.
Another reason for last week’s volatility and subsequent selling was that the Treasury Department said the federal government would hit the debt ceiling in October, which was sooner than previously thought. The market will soon have to deal with what is potentially another volatility-inspiring political battle over raising the debt ceiling.
And while I suspect the outcome here will be as it always is, i.e., yet another raising of the debt ceiling, there will be more volatility in markets as the battle on this issue in Washington rages. Finally, last week, stocks bounced around as derivatives trading continued to influence markets ahead of this week’s options and futures “quadruple witching” expiration.
So, last week we had 1) Confirmation of Fed and global central bank tapering, 2) Tax hike headlines, 3) Debt ceiling warnings and 4) A series of earnings warnings related to the COVID-19 spike and subsequent margin pressures.
Yet while all of these are legitimate headwinds, the first three issues we’ve known about for some time — it’s just now the market has to deal with them as they are all coming to a head (tapering, tax hike headline risk and debt ceiling drama). However, none of these got materially worse last week, it’s just investors can’t ignore them anymore as a future risk. But while these events will continue to cause volatility, they are unlikely to be bearish gamechangers unless there’s a major surprise (accelerated tapering, massive tax hikes or a debt ceiling breach).
The one headwind here that I am most concerned about is fundamental, and it is one that we have been watching closely and writing about every day in the “Eagle Eye Opener,” our daily “insider” market briefing designed to give you this type of market analysis in your inbox every morning at 8 a.m. Eastern.
That headwind is earnings, and last week, we saw numerous businesses from multiple industries (industrials, airlines, grocery stores) issue earnings warnings on a combination of reduced demand (airlines), supply chain issues (industrials) and margin compression (grocery stores). If expected earnings growth begins to suffer at the hands of inflation, supply chain issues or margin compression, then that is something more substantial we need to consider.
The following is an excerpt from the “Eagle Eye Opener” dated Sept. 13, and it explains in detail why earnings growth is so important to understanding what could happen in markets next.
The market is trading at 20X expected 2022 S&P 500 EPS of $220. That’s 4,400 in the S&P 500. But if expected 2022 EPS falls to $210, then the general market “ceiling” would be 20 * 210, or 4,200. That’s more than 5% lower from here. Worse still, it’s unlikely the market would trade at a 20X multiple if earnings expectations were falling, which would put a “reasonable” level of the S&P 500 even lower (around 4,000, more than 10% lower).
Positively, a few earnings warnings don’t mean we’re going to see the overall EPS target for the S&P 500 materially cut. But this is a risk we need to watch closely, and you can be assured we will do just that.
In sum, the declines in stocks last week weren’t because the outlook turned materially worse, it did not. However, at these levels and these valuations the S&P 500 has essentially zero room for error. And as investors are forced to digest tapering headlines, tax hike threats, debt ceiling earnings and other issues, we should expect more volatility and the chance of a quick 5%-10% “air pocket” remains very real.
The bottom line here is that we all should expect to see more volatility in the coming weeks; however, more volatility doesn’t mean the end of the broader market rally.
And with the help of this publication, and with the daily analysis subscribers get in the “Eagle Eye Opener,” we can help you focus on making sure you can quickly differentiate between market “noise” and real, legitimate bearish gamechangers as we move towards Q4 and into the year’s end — and what can be better than that?
A Simple Formula
“Sitting Alone is better than walking with the wrong people.”
— A.P.J. Abdul Kalam
What’s the secret to a happy life? Well, “happy” is different for everyone, but as humans, we generally share some basic characteristics and desires. Yet whatever our differences, there is one simple formula we can follow to enhance our existence.
First, we can look at our interactions with others as a way for both participants to win, and not as a way for one party to defeat the other. Second, we should look to laugh along with everyone, and not laugh at anyone. Finally, we can employ the wisdom of former president of India, rocket scientist, writer and Renaissance Man, A.P.J. Abdul Kalam, by choosing to surround ourselves with the right people, and by not engaging in futile relationships with the wrong people. Do these three things and watch your life improve immediately.
Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.