In July the Brexit vote created significant global stock market volatility with massive investor selling. The selloff resulted in a drop in world equity values by trillions. Investors continued their selling the week following, but since then the US stock market has been in a steady recovery. This appears to be the modus operandi of this year. Big selloff and then equal rally bounce back without any apparent improvement in the issues that caused the selloff in the first place. January was the worst start of the DJIA in history on concerns of slow economic growth. These early 2016 concerns plunged all the main indices down 9%+ in 6 weeks. The major indices bottomed on February 11 and since rallied back over 15% with no change in domestic and global economies.
“These are challenging times for investors to navigate through with no apparent basis to predict market direction.”
In the investment world, there are two key factors that investors monitor to determine investment strategy and projections. They are fundamental and technical data. Fundamental information is the data of economic conditions such as employment, corporate earnings, domestic and international growth. Technical data is simply the charts of stock activity. The challenge is fundamental data of economic activity is not encouraging and clearly does not reflect the 18% rally in the S&P 500 since February 11.
For example, below is a chart of International Trade as of June 3, 2016, as reported by Econoday. You do not have to be a chartist to observe the conditions that have been deteriorating since January 2015.
Not only is trade activity declining but worse is Import and Export pricing has also decreased significantly.
Meanwhile, the S&P 500 has rallied back 18% since February 11 and now at all-time historical highs as illustrated below.
So what do investors do? During times like this, investors depend heavily on technical indicators, especially when there is a distinct lack of correlation between fundamentals and technical. A reverse of today’s condition was apparent in the late 1990’s when tech stocks with virtually no earnings and little revenue were soaring in price. Some new IPO’s tech stocks would blast up 100% in one day simply due to favorable analyst reports. Other start-ups exploded in price simply due to billion dollar valuation projections. Fundamentally, though, these companies had nothing. Little history, no earnings, marginal sales and some with less than 50 employees. Warren Buffet, a staunch fundamental investor, rebuffed the tech rally and had no investment in the technology sector. He stated many times that “fundamental matters” and predicted a terrible end to the tech rally. Well as it turned, the tech rally lasted almost five solid years (1995 to 2000). However, fundamentals do matter and beginning March 2000 investors started selling the non-performing tech stocks like they were the plague. In the following three years, all the major indices and especially NASDAQ dropped over 50% decimating investor’s individual and retirement accounts.
So what can we learn from the past? First is fundamentals do matter, eventually. Stocks and indices can rally for months or years despite the disconnect between weak fundamentals. However, investors must be on high alert should fundamentals remain unfavorable because history indicates that eventually, some factor can tip the fragile rally into a massive tailspin of decline.
WHAT DOES THIS MEAN TO ME?
We are encouraged by the technical breakthrough of the SP 500 but remain cautious. It is impressive how investors have reversed the course of selling to buying in such short order. Stock markets rallying today would indicate that investors are regaining their risk appetite and forecasting resolutions in many areas that have been plaguing economic growth for the past eight years both in the US and globally. It will be important to monitor corporate earnings reports over the next several weeks to determine if indeed economic conditions are improving for a more favorable stock market environment.