Yesterday, while I was boarding an overseas flight, the markets were experiencing significant turmoil. During the long flight, I had the opportunity to contemplate the causes of the recent turmoil. The list below, while not necessarily exhaustive, covers the most important causes in my humble opinion.
The list might seem long, and the reason is that the different causes have a tendency to converge and synchronize in times of turmoil. If I could summarize my message, I would say the following:
The market is going through a repricing of earnings expectations and is adjusting to lower and possibly healthier valuations (please review the commentary we published yesterday on this topic, https://blacksummitfg.com/repricing-expectations-reconciling-market-disruptions-and-the-earnings-momentum/).
In situations like this, we stay calm and we do not rush into panic moves – i.e., we do not jump from a train when it goes through a dark tunnel. Moreover, we understand that when the dust settles – like in previous situations – we can deploy cash and buy good names at lower prices.
Here is the list of those factors most responsible for the turmoil:
1. The high earnings growth between 18-22% that the market experienced in the last several quarters, are not sustainable and need to be readjusted downwards between 9-12%. Disappointment is caused by unmet expectations and thus the selling and the drop. The lower earnings growth are still healthy and the basic fundamentals have not changed. As earnings growth expectations are adjusted downwards, the market reprices them and moves to lower valuations, which as stated above is healthy.
2. The changing monetary policy of higher rates (which reduce future earnings) and the abandonment of easy money contribute also to the reversal in market momentum. Again, this is not necessarily unhealthy. As momentum reverses, volatility rises and so the market reversal is exacerbated.
3. Emerging markets and especially China are experiencing significant pains. The Chinese market is down close to 30% this year due to slower growth, deleveraging, corporate defaults, and tariffs from the US.
4. The EU is going through a testing period that questions its institutional backbone. Brexit, Italian defiance to the directives from Brussels regarding budget deficits, and sclerotic policies are contributing to slower growth, and thus the European markets contribute to the downturn.
5. As the four factors listed above play out, some sectors in the economy are affected more negatively than others such as tech, housing, transportation, etc. Again, even in the those sectors which have dropped by more than 20% in the last three months – and hence are in bear territory – the underlying fundamentals remain healthy, implying that we are just experiencing a revaluation/repricing and opportunities will arise.
6. The US budget deficit is rising and is projected to be 8% of GDP within 8-10 years. This is unhealthy and in the medium term will hurt the dollar (a commentary is forthcoming on that).
7. From a technical analysis standpoint when we look at charts and moving averages, some support levels (like the 50 and 200-day moving average of indexes) are broken. That forces some sales which in turn pushes the market even lower, especially when algorithmic trading is involved.
8. Oil and other commodity prices (copper, zinc, etc.), are dropping. The former is mainly due to oversupply while the latter due to slower global growth. Lower commodity prices discourage investment spending and that too reduces expectations.
In closing, allow me please to reiterate that the above unfolding, while worrisome and disturbing, does not imply that there is a reason to panic. The dust will settle and as it settles, buying opportunities will emerge.
Reflections on the Market’s Turmoil
Author : John E. Charalambakis
Date : October 25, 2018
Yesterday, while I was boarding an overseas flight, the markets were experiencing significant turmoil. During the long flight, I had the opportunity to contemplate the causes of the recent turmoil. The list below, while not necessarily exhaustive, covers the most important causes in my humble opinion.
The list might seem long, and the reason is that the different causes have a tendency to converge and synchronize in times of turmoil. If I could summarize my message, I would say the following:
The market is going through a repricing of earnings expectations and is adjusting to lower and possibly healthier valuations (please review the commentary we published yesterday on this topic, https://blacksummitfg.com/repricing-expectations-reconciling-market-disruptions-and-the-earnings-momentum/).
In situations like this, we stay calm and we do not rush into panic moves – i.e., we do not jump from a train when it goes through a dark tunnel. Moreover, we understand that when the dust settles – like in previous situations – we can deploy cash and buy good names at lower prices.
Here is the list of those factors most responsible for the turmoil:
1. The high earnings growth between 18-22% that the market experienced in the last several quarters, are not sustainable and need to be readjusted downwards between 9-12%. Disappointment is caused by unmet expectations and thus the selling and the drop. The lower earnings growth are still healthy and the basic fundamentals have not changed. As earnings growth expectations are adjusted downwards, the market reprices them and moves to lower valuations, which as stated above is healthy.
2. The changing monetary policy of higher rates (which reduce future earnings) and the abandonment of easy money contribute also to the reversal in market momentum. Again, this is not necessarily unhealthy. As momentum reverses, volatility rises and so the market reversal is exacerbated.
3. Emerging markets and especially China are experiencing significant pains. The Chinese market is down close to 30% this year due to slower growth, deleveraging, corporate defaults, and tariffs from the US.
4. The EU is going through a testing period that questions its institutional backbone. Brexit, Italian defiance to the directives from Brussels regarding budget deficits, and sclerotic policies are contributing to slower growth, and thus the European markets contribute to the downturn.
5. As the four factors listed above play out, some sectors in the economy are affected more negatively than others such as tech, housing, transportation, etc. Again, even in the those sectors which have dropped by more than 20% in the last three months – and hence are in bear territory – the underlying fundamentals remain healthy, implying that we are just experiencing a revaluation/repricing and opportunities will arise.
6. The US budget deficit is rising and is projected to be 8% of GDP within 8-10 years. This is unhealthy and in the medium term will hurt the dollar (a commentary is forthcoming on that).
7. From a technical analysis standpoint when we look at charts and moving averages, some support levels (like the 50 and 200-day moving average of indexes) are broken. That forces some sales which in turn pushes the market even lower, especially when algorithmic trading is involved.
8. Oil and other commodity prices (copper, zinc, etc.), are dropping. The former is mainly due to oversupply while the latter due to slower global growth. Lower commodity prices discourage investment spending and that too reduces expectations.
In closing, allow me please to reiterate that the above unfolding, while worrisome and disturbing, does not imply that there is a reason to panic. The dust will settle and as it settles, buying opportunities will emerge.