Now the angst preceding and following a market sell off is real. In this case there are a couple catalysts which are as follows:
1. China is having an economic slump. This is one of the reasons why they have unpegged their currency from the dollar. The hope is that the Yuan will drop in value against the dollar and help Chinese exports. China needs these exports for their economic growth. But to me this is nothing new. China was eventually going to have to unpeg their currency and it just means they have more control over their monetary policy going forward. I agree that a drop in Chinese demand will affect world wide demand but I personally see this as an adjustment to a lower GDP going forward and not a GDP crash. Demand will be there but just at a slightly lower level for the near future.
2. The price of oil: Oil has always been a symbol of world wide demand and price drops indicate lower demand traditionally. I think there is some of this but there are other factors to consider. The United States companies have focused their technology on extracting oil from some heretofore unavailable sources. This has increased supply. At the same time Saudi Arabia continues to pump oil at a continuous rate and is not cutting production to maintain price levels. I think this is because they want to see if they can push some of the US production out of business AND, by keeping prices low, the Saudi government might limit the funds available to Iran to build their economy and - possibly - nuclear weapons. In essence, might the Saudis be imposing market based sanctions on Iran now that many of our sanctions are being lifted? At any rate, the lower oil price is not JUST a function of a lower demand curve. In fact, such low prices might juice other corporate profits where lower energy costs are beneficial.
3.
Federal Reserve Rate increase: People have been dreading this one for months but we are due. While I figured this would be coming at the end of the year I am inclined to say "just do it". The data might be weak but right now - especially after this selloff - I think delaying the hike would be the wrong message. It is time to just get back to business as normal and the easing cycle should officially stop.
Now to continue from point 3, there is a lot of worry that if we start raising rates stock values will plummet. I guess if you assume that the economy will completely stall that might be the case but historically this has not proven true.
In 1950 interest rates were a bit higher than 2% on the 10 year treasury and the S and P index priced around 15. By 1970 the 10 year treasury rate had increased to almost 8% and the S and P index to around 100 (an approximate 566% gain) (source
www.multpl.com charts). This makes sense if you think of rising interest rates as a demand for money which would likely not happen without some economic growth. So please, if you hear that stocks won't grow as interest rates get higher I suggest you shut off the TV.
The next mantra you will probably hear over the next few days is "the market is overvalued". It is my guess that most networks will trot out those most bearish and you will hear about such esoteric terms like "Cyclically Adjusted P/E ratios". The fact that these measures might have kept you out of the market beginning in 2009 will not likely get mentioned.
My basic view is this (and likely similar to Jeremy Siegel's):
As of close yesterday the S and P 500 index was 1971 (the measure, not the year). If we accept the projection of annual earnings (JP Morgan and others) for the index at $123 dollars we end up with a P/E ratio of around 16 which is not that bad. Even before this pullback the P/E (Price to Earnings ratio) would have been around 17 for this years earnings. For some perspective, the P/E ratio before the tech crash in 2000 was around 35 or 40.
But of course we need some more perspective. A P/E ratio doesn't consider other investments available into which money can flow. To do this let's look at the 10 year treasury yield which is currently 2.05% and compare it to the earnings yield of the S and P 500. We get this earnings yield by simply dividing the $123 in earnings by the market value of 1971. This gives us an earnings yield for the S and P 500 index of 6.2%. So unless earnings crash you are still getting a better yield - so far - out of the S and P 500 index than you are out of treasuries.
Now a lot of things can change; earnings can crash, interest rates can spike, etc. but let's not go crazy just yet.
Certainly the energy companies will add some pressure to ongoing earnings but some other companies are doing quite well. The key here is to not automatically accept the "overvalued" mantra that will be rampant over the next week or so. If you do hear this from friends just ask them to "put some data behind it".
From my perspective this is the time to do some fundamental analysis and reviews on companies that I like to target; companies that have been unfairly dumped.
I believe I have been consistent in saying that there were some challenges with this market and that I had been raising cash and looking for some buying opportunities.
So here are some suggestions:
1. If you raised some cash and are being tactical then pick your targets and do some selective shopping in stocks and funds you know.
2. If you are saving consistently into your 401k and your time horizon is still long term then I see no reason to change this habit. The market has a negative year every 4 or 5 years on average and it is just part of the process.
3. Keep an eye on future earnings for new developments that might change valuations etc.
