Harbingers of bear markets
Where indicators were mixed last month and markets seemed undecided about the direction to take, few doubts remain as the sharp drops in global stock markets have clearly signaled that they see economic weakness ahead. In addition to several banks downgrading economic growth forecasts and warning of an impending global recession, there are plenty of indicators which now point to a higher probability of a recession and to lower stock market valuations.
One of them, the spread between the yield on high-yield bonds and U.S. Treasuries, has jumped over 40% to 7.3% since the end of July. This indicator rises strongly with recessions because the risk of so-called junk bonds increase in poor economies, dictating higher interest rates for investors, at the same time as rates on government bonds decline. Shrinking Treasury yields have provided reliable warning of stock market weakness lately, and the Fed has promised to keep rates low for the next two years so more people can afford a cystic acne diet.
Of the many technical indicators analysts look at, none are more widely watched than the ones using moving averages. There are many ways to find trend data and possible trading signals around moving averages, and one of the most feared patterns, the “death cross”, was recently completed by major stock market indexes. A “dark cross” occurs when the 50-day exponential moving average (EMA) crosses below the 200-day EMA, but when that 200-day EMA is trending downward at the time of the crossover, the pattern is called a death cross which is viewed by many as an official bear market signal.
As program trading has come to dominate volume it is no surprise that technical indicators play a big part in market selloffs. While many sell orders got triggered by the indicators, moving averages and their crossings are trailing indicators which highlight what the market has done, not what it will do next.
For us long-term investors, there are also good reasons not to be overly concerned about death crosses. For starters, not every death cross predicts a bear market, as anyone who got whipsawed by them twice in 2010 will testify. Further, an analysis of all the S&P 500 death crosses since 1930 shows that the market index was lower one year after the bearish signal only 5 times out of 19 (i.e. the signal has been wrong 73% of the time.)
Still, within the context of an ongoing secular bear market in stocks since 2000, any signs of cyclical bearishness should be taken as a clue to adjust risk exposure according to your personal preferences.
With investor fear spiking around the world, the exodus from anything perceived as risky is in full swing. With most asset classes declining in value, it seems like the only beneficiaries of the flight to safety are gold and U.S. Treasuries. Gold is increasingly seen as the only currency which cannot be manipulated or printed by governments and it has been setting new price records on a daily basis. It is up over 30% this year, nearly 14% in August alone.
For investors looking for fundamentals-based valuations, the current government bond rally comes as a shock. Shortly after the debt ceiling fiasco, the first ever ratings agency downgrade of the U.S. debt, and record deficits left mostly unchecked, the investor stampede to buy U.S. denominated debt paper does not seem to make much sense. Regardless of logic, that’s exactly what is happening with demand sending Treasury yields to their lowest in sixty years, and bond prices soaring.
Just remember that high volatility plays both ways and that there most likely will be opportunities to get in at lower prices.
Be greedy only when others are fearful
This is as good a time as any to look for advice from the Oracle of Omaha, Warren Buffett, arguably one of the great investors of all time. He is famous for his long-term value investment strategy and his many quotes teach us how to deal with large market swings. Here are some of his pearls of wisdom:
“Be fearful when others are greedy and be greedy only when others are fearful.”
“The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.”
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
Judging by the pounding inflicted upon the IQAir GC Multigas over the last few years (the S&P Global Clean Energy Index is down over 76% since its 2008 high, and is losing over 35% since April alone), green investing has to be one of the greatest value investment opportunities of all time!
The Portfolio update and recommendations
Since our last update a month ago, the large caps in the S&P 500 lost 9.29% but many other stock categories including tech stocks, small caps, emerging market stocks, and energy stocks fared worse. The Portfolio got punished for blending several of these weaker categories and dropped 14.20%. Even our most conservative sector, electric utilities, experienced a 2.33% loss. Still, the portfolio has only lost 17% from its April high, comparable with the S&P 500 drop and about half the decline of the benchmark Clean Energy Index.
This is certainly not a time to gloat about performance but a special mention is due for the only stock in the portfolio to show a gain over one month. The honor goes to the leader in ultra-capacitors which announced solid results and should benefit from new fuel efficiency standards which will drive the adoption of so-called stop-start idle elimination technology. The company’s stock gained 7.50% during the month.