dealing with market volatility

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today


more on Monday


more on coronavirus and the stock market

In an earlier post, I outlined what I saw then as differences between SARS in 2002 and the new COVID-19 in 2019.


–it appears China has mishandled COVID-19 in the same way it bungled SARS, surpressing information about the disease, allowing it to become more widespread than I might have hoped.  Not a plus, nor a good look for Xi.

–if press reports are correct, the administration in Washington is ignoring the advice of the Center for Disease Control and approaching COVID-19 in the same (hare-brained) way it is dealing with the economy–potentially making a bad situation worse


I think COVID-19 will be in the rear view mirror by July–as SARS was in 2003–but the road to get there will be bumpier than I would have guessed.


–the way the stock market has reacted to the new coronavirus  gives some insight, I think, into the differences between how AI discounts news vs. when human analysts were in charge.

when humans ruled 

Pre-AI, analysts like me would look to past examples of similar situations–in this case, SARS.

Immediate points of difference:  COVID-19 is not a unique occurrence–it’s the latest coronavirus from China but not the first so the fact of a new coronavirus should not be as shocking as the first was.  COVID-19 carriers are contagious before they exhibit symptoms, so quarantine is more difficult–i.e., transmission is harder to stop.  On the other hand, the death rate appears to be significantly lower than from SARS.

Two other factors:  the first half of 2003 was the time of greatest medical risk; generally speaking, the stock market back then rose during that period (because the world was just entering recovery from the popping of the stock market internet bubble in early 2000;  given that we’re in year 11 of recovery from the financial crisis, gains shouldn’t be anywhere top of the list of possibilities).

Obvious investment areas to avoid would be operations physically located in China or with large sales to/in China; anything travel- or vacation-related, like airlines, hotels, cruise ships, amusement parks, tourist destinations.

It’s harder for me to think of areas that would prosper during a time like this, mostly because I’m not a big fan of healthcare stocks.  Arguably anything operating totally outside China and not dependent on inputs from China; highly-automated capital-intensive operations rather than labor-intensive,   Public utility-like stocks.

Portfolio reorientation–becoming defensive and raising cash–would have started in early February.

the AI world

What I find interesting is that the thought process/behavior I just described only started happening, as far as I can see, about a week ago. That’s when news headlines began to emphasize that COVID-19 was spreading to areas outside China.  Put another way, the selloff came maybe three weeks later than it would were traditional investment professionals running the show.  In the in-between time, speculative tech stocks shot up like rockets.  The ensuing selloff has hit those high-fliers at least as badly as stocks that are directly affected.

In sum:

–late reaction

–violent, December 2018-like selloff

–recent outperformers targeted, whether fundamentals affected or not.

what to do

Better said, what I’m doing.

The two questions about every market selloff are:  how long and how far down.  On the first front, it seems likely that COVID-19 will be a continuing topic of concern through the first half.  The second is harder to gauge.  There was a one-month selloff in December 2018 that came out of nowhere and pushed stocks down by about 10%.  Today’s situation is probably worse, but that’s purely a guess.

I’ve found that even professional investors tend to not want to confront the ugliness of falling markets, and tend to do nothing.  However, in a downdraft stocks that have been clunkers don’t go down as much as former outperformers.  Nothing esoteric here.  It’s simply because they haven’t gone up in the first place.

A market like the one we’re in now almost always gives us the chance to get rid of clunkers and reposition into long-term winners at a more favorable relative price than we could in an up market.  My experience is that this is what we all should be doing now.  As I wrote above, my hunch is that we don’t need to be in a big hurry, but there’s no reason (especially in a zero commission world) not to get started.




is the US becoming “great again”?

At first glance, the performance of the S&P 500 would seem to say yes–the S&P 500 is up by 47% since the first trading day of January 2017.  That’s substantially better than Europe or Japan has done over the same time period.   On the other hand, the US–which caused the global financial crisis–was first out of the blocks in repairing ailing banks.

Look a little closer, however, and the evidence from the S&P is not so clear.  There are a number of factors involved:

–about half the earnings of the S&P come from outside the US

–major domestic industries like housing or autos have little representation in the S&P

–tech companies, which don’t employ a ton of people and many of which don’t need offices or showrooms, make up about a quarter of the index.

The Russell 2000, an index made up of mid-sized, mostly domestic firms, is–I think–a much better indicator of how things are going for the average American.

looking at US stocks


Russell 2000 = US-based, US-serving firms       flat

S&P 500 = half US/half foreign earnings         +3%

S&P 500 software = half US/half foreign earnings, no US plants needed      +13%

MSFT          +16%

Tesla        +100%


2 years

Russell 2000     +8%

S&P 500          +22%

S&P 500 software       +32%

MSFT          +98%

TSLA          +140%.


1/1/17 onward

Russell 2000          +23%

S&P 500          +47%

S&P 500 software        +75%

MSFT          +197%

TSLA          +270%


What’s going on?

To state the obvious, investors are much more interested in betting on forces of structural change than on the administration’s efforts to pump life into traditional industries.  It may also be that the market thinks, as I do, that the MAGA plan (if that’s the right word) will end up being a lot like Mr. Trump’s foray into Atlantic City gambling–where he profited personally but knew surprisingly little, with the result that the people who supported and trusted him lost almost everything.

What’s been running through my mind recently, though, is the resemblance between this US market and the Mexican bolsa in the 1980s.

More tomorrow.






more on the new coronavirus


SARS emerged in China in November 2002.  Local authorities, later removed from office in disgrace, initially failed to sound an alarm about the new disease, apparently thinking reporting it would reflect badly on them and hoping it would just go away if ignored.

The world first became aware of SARS as a public health threat in February 2003.  The disease was declared under control in July 2003.  By that time there had been 8000+ reported cases and about 800 deaths.  The overwhelming majority of the fatalities were in China.  The elderly and the very young were the age groups hardest hit.

the new virus

As of yesterday, there had been 2700+ cases of the new coronavirus reported and 80+ deaths.

There are four differences I see between the SARS epidemic and this year’s outbreak:

–faster reporting and more aggressive quarantining today (the disease is passed through contact with an infected person’s bodily fluids.  There’s no medicine that works against it, so isolating victims is the only “cure”)

–symptoms emerge on average about ten days after infection, pretty much the same as with SARS.   But unlike the case with SARS, where carriers only became infectious after they showed symptoms, carriers of the new virus appear to be infectious from day one, long before they become visibly ill

–China is a much larger part of the world economy today than it was back then.  While the US has grown by 80% (using conventional GDP) since 2003, China is 12x the size it was then.  So the slowdown in global economic activity that will result from quarantine measures in China today will be greater than it was for SARS.  If SARS is a good indicator–and it’s the only one we have, so it is in a sense our best guide–the current outbreak will be well past the worst by mid-year

–SARS happened just as the world was beginning to recover from the recession caused by the internet bubble collapse of early 2000.  The new virus comes during year 11 of recovery from the downturn caused by the near-collapse of the US banking system from losses that piled up during years of wildly speculative lending and securities trading.  In other words, SARS happened when profits were beginning to boom and stocks really wanted to go up; in contrast, this virus is happening when profits are plateauing and stocks want to go sideways mostly because interest rates are crazy low.

investment thoughts

During the SARS outbreak business travel came to a screeching halt because people feared becoming sick/being quarantined in a foreign country. If it’s correct that the new virus can be passed on even before the carrier shows symptoms, the risk in using public transport is substantially greater.  So too the possibility that one’s home country will temporarily bar returnees from virus-infected areas.

Securities markets in China are currently closed for the New Year holiday.  It isn’t clear that they will reopen on schedule.  In the meantime, China-related selling pressure will likely be redirected to markets like New York.  Alibaba (BABA) shares (which I hold), for example, are down about 6% in pre-market trading.  At some point, assuming as I do that the SARS analogy will be a good indicator, there’ll be a buying opportunity.  For me, it’s not today, although if I weren’t a BABA holder I’d probably buy a little.

It will be interesting to see how AI handles trading today.



starting out in 2020

The S&P 500 is trading at about 25x current earnings, with 10% eps growth in prospect, implying the market is trading at around 22.7x forward earnings.  During my working career, which covers 40+ years, high multiple/lower growth has virtually always been an unfavorable combination for market bulls.

Could the growth figure be too low, on the idea that forecasters give themselves some wiggle room at the beginning of the year?

For the 50% or so of earnings that come from the US, probably not.  This is partly due to the sheer length of the expansion since the recession of 2008-09 (pent up demand from the bad years has been satisfied, even in left-behind areas of the country–look at Walmart and dollar store sales).  It’s also a function of shoot-yourself-in-the-foot Washington policies the have ended up retarding growth–tariff wars, suppression of labor force expansion, tax cuts for those least likely to consume, no infrastructure spending, no concern about education…  So I find it hard to imagine positive surprises for most US-focused firms.

Prospects are probably better for the non-US half.  How so?  In the EU early signs are emerging that structural change is occurring, forced by a long period of stagnation.  The region is also several years behind the US in recovering from the recession, so one would expect that the same uptick for ordinary citizens we’ve recently seen in the US.  Firms seeking to relocate from the US and the UK are another possible plus.  In addition, Mr. Trump’s life-long addiction to risky, superficially attractive but ultimately destructive, ventures (think:  Atlantic City casinos) may finally achieve the weaker dollar he desires–implying the domestic currency value of foreign earnings may turn out to be higher than the consensus expects.


The biggest saving grace for stocks may be the relative unattractiveness of fixed income, the main investment alternative.  The 10-year Treasury is yielding 1.81% as I’m writing this  That’s 10 basis points below the dividend yield on the S&P 500, which sports an earnings yield (1/PE) of 4.  I say “may” because, other than Japan, the world has little practical experience with the behavior of stocks while interest rates are ultra-low.  In Japan, where rates have flirted with zero for several decades, PE ratios have declined from an initial 50 or so into the low 20s. Yes, Japan is also the prime example of the economic destructiveness of anti-immigration, anti-trade, defend-the-status-quo policies Washington is now espousing. On the other hand, it’s still a samurai-mentality (yearning for the pre-Black Ship past) culture, the population is much older than in the US and the national government is a voracious buyer of equities.   So there are big differences.  Still, ithe analogy with Japan holds–that is, if the differences don’t matter so much in the short term–then PEs here would be bouncing along the bottom and should be stable unless the Fed Funds rate begins to rise.

That’s my best guess.


The consensus was of viewing last year for the S&P is that all the running was in American tech industries.   Another way of looking at the results is that the big winners were multinational firms traded in the US but with worldwide markets and very small domestic manufacturing and distribution footprints.   They are secular change beneficiaries located in a country whose national government is now adamantly opposing that change.  In other words, the winners were bets on the company but against the country.  Look at, for example,  AMZN (+15%) vs. MSFT (+60%) over the past year.

The biggest issue I see with the 2019 winners is that on a PE to growth basis they seem expensive to me.  Some, especially newer, smaller firms seem wildly so.  But I don’t see the situation changing until rates begin to rise.


Having said that, low rates are an antidote to government dysfunction, so I don’t see them going up any time soon.  So my practical bottom line ends up being one of the gallows humor conclusions that Wall Streeters seem to love:  the more unhinged Mr. Trump talks and acts–the threat of bombing Iranian cultural sites, which other governments have politely pointed out would be a war crime, is a good example–the better the tech sector will do.  As a citizen, I hope for a (new testament) road-to-Damascus event for him; as an investor, I know that would be a sell signal.









thinking about 2020

where we are

The S&P 500 is trading at around 25x current earnings, up from a PE of 20x a year ago.  Multiple expansion, not earnings growth, is the key factor behind the S&P rise last year.In fact, earnings per share growth, now at about +10%/year, has been decelerating since the one-time boost from the domestic corporate income tax cut cycled through income statements in 2018.  Typically earnings deceleration is a red flag.  Not so in 2019.

EPS growth in 2020 will probably be around +10% again.

About half the earnings of the S&P come from the US, a quarter from Europe and the rest from emerging economies.  The US will likely be the weakest of the three areas this year, as ongoing tariff wars take a further toll on agriculture and manufacturing, as population growth continues to wane given the administration’s hostility toward foreigners, and as multinationals continue to shift operations elsewhere to escape these policies.  On the other hand, Europe ex the UK should perk up a bit, emerging markets arguably can’t get much worse, and multinationals will likely invest more abroad.


interest rates:  the biggest question 

What motivated investors to bid up the S&P by 30% last year despite pedestrian eps growth and Washington dysfunction?

Investors don’t buy stocks in a vacuum.  We’re constantly comparing stocks with bonds and cash as alternative liquid investments.  And in 2019 bonds and cash were distinctly unattractive.   The yield on cash is close to zero here (elsewhere in the world bank depositors have been charged for holding cash).  The 10-year Treasury started 2019 yielding 2.66%.  The yield dipped to 1.52% during the summer and has risen to 1.92% now.  In contrast, the earnings yield (1/PE, the academic point of comparison of stocks vs. bonds)) on the S&P was 5% last January and is 4% now.

The dividend yield on the S&P is now about 1.9%.  That’s higher than the 10-year yield, a situation that has occurred in our lifetimes only after a bear market has crushed stock valuations.  In my working career, this has happened mostly outside the US and has always been a clear buy signal for stocks.  Not now, though–in my view–unless we’re willing to believe that the current situation is permanent.

The situation is even stranger outside the US, where the yield on many government bonds is actually negative.

In short, wild distortions in sovereign bond markets, a product of unconventional central bank measures aimed at rescuing the world economy after the 2008-09 collapse, have migrated into stocks.

How long will this situation last and how will it unwind?


more on Monday





Keeping Score, September 2019

