How Will the Coronavirus Affect the Stock Market?

CNN reports that Goldman Sachs is warning of a stock market correction. At the root of their concern is the combination of an overbought market and the threat to earnings posed by the Chinese coronavirus.

Stocks keep reaching record highs. Goldman Sachs is worried that leaves investors vulnerable to surprises.

The investment bank told clients this week that a near-term correction, in which the market slides at least 10% from a recent peak, “is looking much more probable.”

The thinking: Equity markets look “increasingly exposed” to disappointing earnings growth due to the new coronavirus outbreak, Goldman warns.

The number of companies that have lowered their guidance on profits for the first quarter is still in line with past years. But Apple’s surprise update this week that it wouldn’t hit its revenue target has put investors on edge.

The FANG stocks have been steadily climbing higher as they continually increase earnings. Investors are paying a premium for each of these stocks based on the expectation of continually higher value based on steady increases in earnings. When that turns out not to be the case, the correction could be impressive.

How Will the Coronavirus Hurt Corporate Earnings?

The concern about lower earnings is widespread. According to Forbes, more than 400 companies have projected lower earnings based on the effects of the virus.

Some 421 different companies, 394 of which are U.S.-based, have talked about the coronavirus on first quarter earnings calls.

These range from the likes of Starbucks, McDonald’s, Nike, and Apple to Yum Brands China which includes Pizza Hut, Taco Bell, and KFC. Luxury goods will be hurting as well according to Este Lauder, Capri Holdings, and LVMH.

The reasons include shutdowns in production due to the virus, reduced access to parts made in China, few raw materials purchased by China, and reduced purchases within China due to business shutdowns and reduced income.

Projections by Apple and others tell us that the effects of the virus on production, sales, and earning will spread far and wide before all of this is over.

What Should Investors Do about a Potential Market Correction?

This depends on whether you are a long term investor or make your money swing trading stocks. Those who are in the market for the short term may wish to pick stocks to short a few stocks. However, they will want to heed the lesson of Tesla and the Short Squeeze. Long term investors will do well to assess the intrinsic stock values within their holdings, only get rid of the weak ones now, and plan on investing in stocks with the highest intrinsic value when the market corrects.

Stock Market Investment Perspective

The New York Times has an interesting article in this respect. Despite recent losses, stocks are riding high when you look at the longer term.

Lately, the markets have been rattled about the prospect that a protracted trade war with China could begin to take an economic toll at a time when global growth is slowing.

Viewed over a longer period, however, corrections often begin to look less severe.

Even after the current sell-off, for instance, the S&P 500 through the end of last week was up more than 16 percent since President Trump’s inauguration and more than 23 percent higher since Election Day 2016.

And, if you look at the market since the depths of the financial crisis, the S&P 500 is up three hundred percent. The Times article gives us a bit of perspective.

Despite the recent losses, stocks as measured by the S&P 500 are still up handsomely since Trump’s election or since his inauguration.  But, for long term investors the better comparison is this graph.

For anyone who invested in the market or stayed in the market in 2009, the chances are that they have experienced a 300% increase in value of their portfolio and the losses since the market’s peak amount to about a fifteenth of that!

Long Term Investing

Early last year we asked just how many years are required to make an investment long term. The answer was a least five years and ten is better. The value of the long term approach is that market timing is less important. You can certainly buy after you are certain that a big correction or crash has bottomed out but you do not have to be so worried about anticipating a correction, provided that you use the intrinsic stock value approach in your investment selections.

As Benjamin Graham taught us back in the 1930s and going forward, stocks are subject to mean reversion. This means that the current stock price may be higher or lower than the fundamental value of the company. But, over time in an efficient market the market price of a stock will trend towards the intrinsic value of the stock. Successful long term investments are those where you can safely estimate how much your investments will be worth in one, five, and ten years based on assessment of forward looking earnings and intrinsic stock value.

Should You Sell Your Stocks Based on the Risk of a Major Correction?

Despite all of the good investing advice that is available, the major drivers of the market are almost always greed and fear. It is certainly smart to invest and make money when you believe that the market or a given investment will be going up. And it is certainly wise to get out when things look bad. But, in both cases you may be making a mistake unless you have some sound basis aside from greed or fear. This is where the intrinsic value concept comes in. This indicator of stock value will tell you if the company will be making money into the distant future and thus will tell you whether or not to expect the stock price to go up over the next year, five years, or ten years. The market may get really enthusiastic or it may become fearful but a dispassionate appraisal of forward looking earnings will be your best guide to investment value over the coming years.

How Much Will Your Investments Be Worth in One, Five, and Ten Years? PPT

The (Reverse) Wealth Effect

Investopedia defines and explains the wealth effect.

The wealth effect is a theory suggesting that when the value of equity portfolios are on the rise because of accelerating stock prices, individuals feel more comfortable and confident about their wealth, which will cause them to spend more. In 1968, for instance, economists were mystified when a 10 percent tax hike failed to put the brakes on consumer spending. Later, the sustained spending was credited to the wealth effect. Even though disposable income declined because of the additional tax burden, wealth continued to grow because the stock market persistently climbed higher.

The wealth effect was especially pronounced in the years leading up to the financial crisis and Great Recession. Low interest rates encouraged people to buy more expensive homes than they could otherwise afford because mortgage payments were so low. Many purchased second and third homes, using equity taken out of their primary residence, because they were now “so well off.” This wealth effect also drove up stock prices past when fundamentals and technical indicators would support.

When this effect has gone on for a while, smart investors start to sell and take profits. Prices go down, and we have a reverse wealth effect. In a Forbes articles entitled, 4 Reasons to Sell Your Stocks Today, the author says the reverse wealth effect will drive stock and real estate prices down, and is already doing so.

Economic statistics reveal a critical connection between stocks, real estate and human psychology. When stock prices rise, those who own them feel confident in bidding up the price of real estate. What’s more, when interest rates are low, they don’t mind borrowing lots of money to buy the houses. Conversely, when stocks fall, it does not take long for people to suffer from a reverse wealth effect.

This effect is multiplicative. When stock prices go down, folks who feel less wealthy tend to panic and sell in order to preserve some of their wealth. The falling markets in stocks and real estate drive others to feel the reverse wealth effect and the downward price movements accelerate.

And, the reverse wealth effect reduced people’s spending by about cents for every dollar reduction in personal wealth. So, not only will stock and real estate prices go down but spending will reduce across the board which will slow the economy, further adding to the declines in property values and stock prices.

How Bad Could This Get?

According to Investopedia, Morgan Stanley says the worst is yet to come.

“Not only does the price action this year suggest we are in the midst of a bear market-more than 40% of the stocks in the S&P 500 are down at least 20% – but it also trades like a bear market,” wrote the bank’s analysts. Even companies with good news to report have seen their stocks sell off, a good indicator that the market is in bear territory. Overall, says Morgan Stanley, “The technical damage is irrefutable.”

It is our opinion that as investors feel less and less wealthy, they will sell and take the markets down for a protracted bear market both in stocks and real estate. The losses will probably not wipe out all of the gains of the last years, but may still be substantial.

What Should You Do?

The answer to dealing with a market correction has to do with your investment horizon. If you were looking for short term gains, this is probably a good time to take them. If you are in for the long term, consider adjusting your portfolio, looking for investments that do not lose money, and wait for the bottom of the market to pick up bargains.

How the Reverse Wealth Effect Will Change Your Investing and Your Investments PPT

Protected from a Trade War with China

One of the expected contributors to a market correction, or worse, is the evolving trade war with China. We looked at what you can invest in and not get hurt by a trade war.

It turns out that Facebook, Amazon, Netflix, and Google (Alphabet) either do not do business in China or have a very limited presence. Even though these stocks have become somewhat pricey in the current market they could not be directly hurt in a trade war with China.

CNBC quote Cramer of Mad Money who is saying basically the same thing as he suggests that investors buy given-up-on FANG stocks.

The FANG cohort benefits from having very few ties to the Chinese market, Cramer said, with the use of Facebook, Netflix and Google’s services almost entirely blocked by the government and Amazon facing a sprawling competitor in Alibaba.

Second, “the Federal Reserve is bent on squelching inflation wherever it can find it, ” the “Mad Money” host said, referring to the central bank’s rate hike agenda.

“When that happens, the companies with the highest price-to-earnings multiples are the ones that benefit,” he said.

Thus, the growth stocks that had become very pricey will look very attractive after a reasonable correction.

Slowing US and Global Growth

The stock market recently fell on news that both Caterpillar and 3M projected slower growth. Both of these companies have a huge international presence and are bellwethers of the world and US economies. Both of these companies easily qualify as value stocks but both will suffer a bit as a trade war and excessive debt affect economies around the world. In the meantime, people still watch home movies from Netflix, incessantly use Facebook, “Google” information, and buy everything including the kitchen sink via Amazon.com. These companies will be hurt less or not at all as the US-China trade relationship changes significantly.

Is It Time to Buy Facebook?

After years of stellar growth, Facebook is down 10% this year. There are regulatory issues that could affect the stock but it is still a broadly used platform and a money maker. CNBC’s Trading Nation notes that Facebook has probably hit bottom and is a strong buy.

Facebook is the only stock of the group negative for the year. It has dropped 10 percent in 2018, the bulk of those losses sustained after its notorious $120 billion drop in market cap in late July after its worrisome second-quarter earnings statement.

“If the market begins to roll over, you’re actually going to see the Googles and the Netflixes, some of that fast money, the momentum money, start to sell in a little bit of a panic move, but that money has already disappeared from Facebook,” said Maley.

Thus, it may be a good idea to invest in FANG on the correction with the first target being Facebook which may have already hit its bottom.

Should You Invest in the FANG on the Correction? PPT

The recent stock market retreat, which has sent the S&P 500 Index (SPX) down by 5.9% from its intraday high on Oct. 3, has intensified the debate between the bulls and the bears. Outspoken economist, hedge fund manager and market analyst John Hussman is renewing his prediction of a severe market crash that would send major U.S. stock market indices plummeting by 60% or more. He has been warning that stock valuations have been extreme for years, and long overdue for a return to historical norms. Putting this in dollar terms, Hussman recently said that the crash will wipe out $20 trillion of stock market value, Business Insider reports.

Timing a market correction is always difficult. Bears have been predicting this bull market’s demise for years! But all good things do come to an end and that includes rising stock market prices.

Steps to Take to Minimizes Losses when the Market Tanks

Investopedia offers advice from JPMorgan on how to avoid losses in the next recession.

They suggest that bonds will start outperforming stocks as much as a year before the market actually crashes. Rotating some of your profits out of stocks into bonds is their recommendation.
Cyclical stocks will take more of a hit than defensive stocks when the market heads south. Their suggestion is to start moving money out of some of your recent cyclical stock winners into long term growth stocks.

Growth stock prices are based on their earnings. When earnings drop off the stocks without a margin of safety will fall more rapidly than the general market. These folks suggest moving out of growth stocks and starting to buy value stocks.

And, things will get worse in developing markets, especially those economies afflicted by the “resource curse.”

Is This the Time to Buy Gold?

Investing in gold can be profitable if you pick and choose carefully when to buy and when to sell. We wrote about this in 2010.

There are a number of attractive options for investing in gold and there are pitfalls. Gold stock investing includes mining companies and derivatives. Many gold bugs will say that how to invest in the stock market during hard economic times is to invest in gold. However, the true gold bug will advise that you buy and hoard gold bullion or rare gold coins.

When we wrote this, gold was trading at about $1,400 an ounce. It rose for a couple of years to trade briefly in the $1,900 range before falling. Today gold trades at about $1,200 an ounce. The best time to buy gold was in the early 1970s during a period of historic inflation brought on by new social spending and the war in Vietnam. The next best time was in 2000 when interest rates plummeted and war raged in the Middle East. In each case, the price of gold steadily rose until economic conditions improved and it became contra productive to hold an asset that has quit appreciating and did not pay dividends or interest.

ow, however, might be a good time to balance your investment portfolio with a gold ETF or mining stock with the understanding that you will hold the investment for a few years and then rotate back to equities, bonds, or even cash.

How to Minimize Your Investment Losses in the Next Recession PPT

Market Corrections and Recoveries

Is There a Correction around the Corner?

There are signs of a market correction that you can watch for.

When the market keeps going up too many investors become impatient, looking for more and more profits. They forget risk management. An old piece of investing advice is that you do not have a profit until you take a profit. If you have done well with a volatile stock there is nothing wrong with taking a little profit, paying long term capital gains and holding on to cash until the market offers great deals again. Prior to the burst of the dot com bubble several well-known investors stated that they were essentially cashing out of the stock market because it made no sense. These folks were able to re-invest at very attractive prices a year or so later.

Today, according to CNBC, Deutsche Bank is cautious for the near term and expects a 3 percent to 5 percent pullback but a rebound later in the year.

Citigroup makes a similar prediction as reported in the same article. They use a proprietary formula that takes into account a brewing trade war, geopolitical uncertainty, Federal Reserve policies, and spreading weakness in emerging markets as part of a creeping economic weakness internationally.

There Is Always a Recovery, Somewhere

After all stock market crashes in recent memory there has been a market recovery. The S&P 500 fell from 1500 to 900 between September of 2000 and the beginning of 2003. Then it steadily rose again to a peak of 1560 before the financial crisis. At that time it fell to 680 by March of 2009. And, from there the index has climbed steadily for nearly a decade to 2870 today.
As we noted in our “signs of a market correction” article, smart investors decided that the market made no sense in the run-up to the dot com crash. And, smart investors saw the dangers of over-leveraged investments going into the financial crisis and got out. These folks all re-invested after the crash and resumed earning profits.

If you are a passive investor and just invest in index funds that track the S & P 500, you can expect the results like we just showed you. But, there were a lot of weak stocks with really poor intrinsic value going into both the dot com and financial crisis crashes. These stocks inflated the prices of index funds going into a crash. And these companies commonly went bankrupt and disappeared from the index after the crash.

Over the long term it is financially dangerous to follow the “rising tide raises all ships” method of investing. The stocks of strong companies go up because of strong earnings, strong products, and a margin of safety in the form of money in the bank and minimal debt. A company selling in the same market niche may see its stock go up based more on optimism than a fundamental-based promise of growth. Two stocks today that raise concerns are Facebook and Tesla. Facebook is looking at more regulation due to its prominent communication role in modern society and Tesla needs to start producing profits for investor get tired and start selling. Smart ways to predict a correction and protect your investments include culling out potentially dangerous investments, like Facebook and Tesla.

Smart Ways to Predict a Correction and Protect Your Investments PPT

The unique financial conditions of the last several years have been ideal for high tech growth stocks, the FANG group especially. But, now that conditions are changing, growth stocks are overpriced and at risk for a major correction. The better choice for many investors is to move into value stocks and other investments. But, what is a value stock?

In the article we revisited the concept of intrinsic value and how to calculate it. But, if you want to move into different investments what do you pick? The value of an investment in this regard is its forward looking income stream. Here we might consider looking at large, medium, or small cap investments. How have they done as groups and how are they doing now? As a group large caps provided more profits than medium and small caps in the last decade and as a group they are less likely to generate similar gains compared to medium and small caps today.

Large Cap Stocks

The most commonly watched indexes are the S&P 500 and the Dow Jones Industrial Average. These are both collections of large cap stocks. The S&P 500 has come from its lowest of 683 in March of 2009 to 2785 right now. That has been a spectacular rise. But, in the last three months the index has come from 2664 with a dip to 2581 in February. The Dow Jones was at 6626 in March 2009 and is 25,250 right now. In the last 3 months it went up to 26,616 and fell to 23,860. The point being that large cap stocks may have run their course and may be due for more of a correction. At this moment both the Dow and the S&P 500 are down about half a percent on the day.

From their lows in 2009 the large cap stocks have come up more than fourfold and they have showed signs of correction in the last 1 to 3 months.

Medium Cap Stocks

The S&P 400 is a medium cap index. It bottomed out at 406 in March of 2009 and stands at 1952 right now. A month ago it stood at 1839. The index is up a fraction of a percent on the day. This group is up nearly fourfold since its lows. And as a group medium caps look stronger than large caps in the short term.

Small Cap Stocks

The S&P 600 is an index of small cap stocks. It stood at 225 in March of 2009 and stands at 975 today. In the last month it has risen from 911 to its current level. Small caps have come up fourfold since their lows and like the midcaps they are doing better than large caps in the short term.

Penny Stocks

Investing in penny stocks can be tricky. First there is the question of knowing what penny stocks to watch. We have also written that it is wise to beware of penny stocks if you are not willing to do your homework, pay attention and accept the risk. The issue with penny stocks is that you basically need inside information in order to pick the winners and then you typically need impeccable market timing to gain your profits.

Concerns over a flattening U.S. Treasury yield curve – a sign to some of a coming economic slowdown – have quieted down for the moment, thanks to the recent pick-up in longer-dated yields. But the potential slowdown message has an echo in diminishing corporate cash flows, SocGen strategists including Andrew Lapthorne have highlighted.
There’s been a “steady” decline in the growth of net operating cash flow in U.S. stocks, excluding the financial and energy sectors.

The slowdown for the broader group of companies is noteworthy because it’s coincided with both a slump in the dollar and a decline in the yield curve, said the strategists. An inverted yield curve, which will occur if the trend continues, has historically come before economic slumps like the one that started about 10 years ago. And a falling dollar could reflect relatively more positive investor sentiment about economies outside the U.S.

How about the inverted yield curve? What is it and should you be concerned? Investopedia writes about the inverted yield curve.

An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.

Typically investors demand a higher interest rate if they are going to tie up their capital in a long term bond or CD. When investors start losing faith in the stock market and want to hold cash instruments they will flock to long term bonds and CDs and drive those rates down. Thus an inverted yield curve is indicative of a lot of investors starting the hedge their bets in expectation of economic and stock market downturns.

Broad Based Indicators

Congress just passed legislation to increase the debt ceiling and remove the government from a shutdown. And the market rallied. Many investors are still excited about the Trump and Republican tax cuts. But there is an underlying concern. And that concern is seen in the inverted yield curve. Many investors are slowly but surely moving their money out of stocks and short-term bonds into long term bonds. They are doing this for a variety of reasons, all based on their belief that the economy and the stock market will falter. The value of the inverted yield curve as an indicator is that it is broad based thus indicative of a lot of people who have arrived at the same conclusion by a variety of routes. This is why you should be concerned about the inverted yield curve.

Last month, libertarian and multiple campaigner for president Ron Paul made headlines with his gloomy prediction that the stock market, plagued by an overrated recovery for the U.S. economy, could plunge 25% by October.

Obviously, not much in the way of positive news has come along since then to change his views. In fact, he just took his bearish outlook up a few notches.
“A 50% pullback is conceivable,” he told CNBC, earning our call of the day. “I don’t believe it’s 10 years off. I don’t even believe it’s a year off.”

That kind of damage would bring the S&P SPX, +0.09%  down to 1,212 and the Dow Jones Industrial Average DJIA, +0.03% to 10,837.

Paul is not blaming Trump but rather says that the causes of the upcoming market demise go back as far as the late Bush administration. Paul may not be right on the amount of a correction or the timing but eventually all rallies tend to overshoot and then correct. How much will it cost you to stay in the market through a correction?

Microsoft and the Dot Com and 2008 Crashes

Microsoft has done well in the last few years as have a handful of high end tech stocks. Its growth is reminiscent of the years preceding the dot com crash. What it cost Microsoft shareholders when the stock crashed in 2000 was 55% of value and that value did not come back until the start of 2013. The S&P 500 fell 40% after the dot com crash and after recovering to 1999 levels fell 50% in the 2008 crash. It would appear that with a big crash/correction that losing half of your portfolio value can happen if you stay in the market through the next crash. Although the broader market did as badly as Microsoft when things went bad, Microsoft is perhaps a better example of what might happen to the FANG tech darlings when illusion replaces reality as we noted last week.

Crash Proof Stocks

If you have seen your portfolio grow during the market rally is there a way to protect your gains aside from selling and holding cash? NASDAQ suggests a crash proof way to bank 13% in today’s market.

The key to getting a strong return when stocks are overvalued is simple: you need to be selective, and you need to diversify into other investments. If you choose stocks that can withstand a correction, you’re going to protect your portfolio; if you add other assets, like bonds, your portfolio is going to grow– even during a bear market.

Their suggestion is a 50% mix of dividend or preferred stocks and bonds. Two examples are PIMCO Dynamic Income Fund (PDI) and Goldman Sacks preferred stock.

How Much Will It Cost You to Stay in the Market DOC

How Much Will It Cost You to Stay in the Market PDF

How Much Will It Cost You to Stay in the Market PPT

The first month and a half of 2016 was brutal for the U.S. equity market, as the major averages plunged over 10 percent. But since hitting the February lows, the market has managed to hobble back, with the Dow Jones Industrial Average closing above 18,000 for the first time on Monday.

The sad truth is that there isn’t any solid fundamental factor to drive stocks higher. Therefore, investors have misplaced their hopes on betting the inflation produced from a falling dollar will be able to bail out the entire market.

The weakening dollar may well help US manufacturers compete in world markets but the world economy is slowing. A larger slice of a smaller pie will probably amount to the same amount of pie in the end. How far will stocks fall? CNBC says 25% or more. How about other projections?

Not All Stocks Are Headed Down

Bloomberg Business reports that U.S. stocks climb as investors watch earnings reports.

U.S. stocks advanced, with the Dow Jones Industrial Average closing above the 18,000 level for the first time since July, as investors shook off oil’s losses on failed output talks and looked toward a bevy of corporate earnings this week.

Hasbro Inc. surged 5.8 percent to a record, buoying sentiment after its results beat expectations thanks in part to demand for Walt Disney Co.’s “Star Wars”-licensed toys. Disney added 2.9 percent. Energy producers rallied as crude trimmed declines that had reached as much as 6.8 percent. Morgan Stanley was little changed as cost cuts helped the firm report a better-than-forecast profit. Netflix Inc. dropped after the market closed as it forecast weakening subscriber growth.

Morgan Stanley has seen profits sink by half and its stock slide from $40 a share to $25 a share over the last nine months. On the other hand Hasbro has gone from $65 last December to $85 now largely on the strength of its toys that are tied to the successful Star Wars movies. The point is that while some stocks that are tied to the U.S. economy may lose ground there are unique stocks in unique niches that will rise. And of course there are always consumer goods stocks that tend to weather bad markets fairly well. For example Clorox is selling in the $130 a share range compared to the $100 a share range a year ago. So, as you wonder how far stocks will fall consider which stocks, which market sector and what products they are selling.

Offshore Might Be Another Matter

The banker who accurately predicted the demise of Japan’s run to become the world’s first economy says that China faces a make-or-break moment according to Bloomberg. It is all about debt.

China’s decades of rapid development under tight Communist Party control may be coming to an end, according to Roy Smith, the New York University academic who as a banker in 1990 anticipated Japan’s decline.

“China has now arrived at an existential moment after nearly 40 years of extraordinary economic progress,” said Smith, who also warned about budding Japan-like financial strains ahead of the Chinese stock rout in 2015. The country’s “increasingly complex and troubled economic and social system with all its scarcities” will make it tougher for Communist cadres to manage, he said.

So, while stocks may fall as much as 25% in the West the odds are getting stronger that stocks in China have a lot farther to fall, especially if the country descends into social and political chaos.

How Far Will Stocks Fall? PPT