We are lucky this week turned out mildly down. The return of volatility is pretty well entrenched in the market at the moment and that is not a good thing. The news that pushed the markets all over the map for the last few weeks is liquidity tightening up across Europe. At the heart of the matter is the question around the viability of some large banks in Europe. So, there you have it – We are looking at more banking problems in Europe, and here as well. Bank of America is scrambling to keep its pants on. In addition to this, there are rumors of potential problems at JP Morgan in relation to some inherited problems from Bear Stearns.
The trend for the market is still decidedly down. The one very strong technical indicator that I look at regarding the market’s breadth is still pointing south. That indicator is the New York Stock Exchange (NYSE) Bullish Percentage, which measures the percent of stocks on the NYSE that are trading in a bullish mode. In addition, the broad market and many of its components are below their 200-day EMAs. While I’m always on the lookout for bargains in the market, I need to see some of my investing targets turn north before going all in.
Blessing or Curse?
There are a number of ways you can make the same point such as how your greatest strength can be your greatest weakness. Current events in global economies are no different. Below are just a few examples that seem like reasons to buy into the market, but which may actually curse investors who do so:
Low interest rates – Artificially low rates encourage borrowers to take on more debt than they can really handle, as well as pushing investors out on the “plank of risk” where income seeking investors have to take on more risk to achieve a decent return or income on their investments. Taking on too much debt at low rates could become a curse when rates move up. In the case of investors, the further one goes out the plank of risk, the higher the risk to principal. On the corporate side, artificially low rates make companies appear more profitable than they really are as they can borrow cheap to cover gaps. A rise in rates can quickly turn a company with thin assets into vapor, read: Lehman Brothers.
Government stimulus – Sure the bailouts, money printing, and other financial wizardry of global central banks have kept the world from a financial meltdown (for now). However, a financial meltdown must occur. Adding more debt to fight debt is not going to win. In the end, a de-leveraging must take place, and the more central banks fight the natural market tendencies, the worse the end game will be.
Low value dollar – A weak dollar supports our big companies that export. The problem is 70% of our economy is consumer based. The vast majority of what we consume is imports. If a weak dollar helps exports, it harms imports. This means a weak dollar increases the price of what we buy from other countries. So, while a weak dollar helps corporate America, it harms main street America by decreasing purchasing power.
High corporate profits – The media is all a flutter with talk of corporate profits being so high and points to such a justification for the extraordinary level of the stock market relative to the economy, which is at best floundering. The reality is corporate profits are not high for good reasons. Corporate profits are high mostly due to the weak dollar. Keep in mind that a large chunk of our big companies sell 50% or more overseas. So, a transaction in a foreign currency comes back as more dollars as the dollar weakens. Another reason for high profits is payrolls have been slashed, leaving labor taking up an all-time low of corporate revenue. A final factor is government spending. Corporate profits are tempting investors back in, but if you look past the smoke and mirrors, one will see how fragile those corporate profits are. What happens if the dollar does strengthen versus the Euro, businesses start hiring, and the government does get spending under control? It is certainly within the realm of possibility that the Euro runs into serious problems. Since it runs counter to the dollar, a weakening Euro will push the dollar up (even though the Fed wants the dollar weak). The bottom line on corporate profits is that while they look like a good reason to invest in stocks, we have to look beyond the surface and realize the story for companies could turn nightmarish due to the flimsy reasons they look so good.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.693.7918.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.