The Independent Market Observer

2/3/14 – The End of the World, Again and Again

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Feb 3, 2014 12:06:59 PM

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With the market’s recent declines, it’s not surprising that the doomsayers are showing up again. In the past couple of days, I’ve heard from several advisors whose clients have received e-mails or read articles that highlight all of the things going wrong, forecasting the imminent collapse of, well, just about everything. Perhaps you’ve received or seen one of these publications yourself.

Let’s start with the real risks. Stock markets worldwide seem to be in the midst of a correction. Here in the U.S., we appear to face the risk of further declines. This has been reinforced by recent economic news that was somewhat less positive than expected. We could be seeing a stock market correction and a slowdown in the recovery. These are real risks, and they shouldn’t be ignored or minimized. They are, however, normal risks, signifying that the economy has recovered to a more normal place. They are not catastrophic risks.

We also need to differentiate the real risks that matter, to us here in the U.S., from those that don’t. There is, and has always been, trouble and disasters around the world—but it rarely hits here in the U.S. Let’s look at some examples from one of those e-mails I mentioned, which lays out 20 reasons for global collapse:

  1. Argentina and Venezuela are experiencing economic chaos. This is trotted out as an example of how things could go bad, but it’s actually a much better example of why they won’t—at least here in the U.S. In these two countries, you have very real cases of economic mismanagement, but for both countries, it’s been this way for decades, without collapse. With a real market economy and an open exchange rate and financial markets, the U.S. is in no way like these countries. If they’ve managed to muddle through, there is no possible way we’ll collapse.
  2. Brazil/China/U.S. stock markets have declined. Well, yes, that is what an open economy does in response to changing conditions. Here in the U.S., if you want to use the stock market as an indicator of the real economy (which you really can’t), you have to remember that we’re still at very high levels, and even another 10-percent correction will take us back to around where we were in 2007. Rational adjustments to changes in conditions are a sign of health in markets, not a sign of weakness.
  3. China’s economy is slowing down, and the banking system has very serious issues. True, but that’s neither a surprise nor, at this point, a systemic risk. China has very large reserves of capital and can afford to recapitalize its banking system; it has done so before, without crashing the international economy. China is also well aware of its slowdown and is working to address it. Issues? Certainly. Pain? Very likely. Collapse? Most likely not—and even if that happened, it could end up benefiting U.S. markets as capital fled to a safer place. Again, the fact that we even know of these issues indicates growing transparency in China, which is a sign of strength.
  4. European economies are weak, and unemployment is very high. Yes, but everything is better than it was five years ago, and the trends are in the right direction. What the doomsayers never explain is, if things didn’t collapse several years ago, what would make them collapse now? This question is particularly appropriate for Europe.

Looking at the signs of impending doom, none of them really adds up—and that’s before we even get to the very real signs of recovery and strength in the U.S. As I mentioned in Friday’s post, the U.S. economy in many ways has recovered to normal levels of growth. We’re not fully back yet, as recovery in growth doesn’t equate to recovery in absolute terms, but even at that, we’re either there or getting close.

The final point worth considering about these pessimistic e-mails and articles is that many of the authors have been predicting doom since 2008—in many cases, well before then. At some point, they may be right. But the fact that they’ve been wrong so far says, at least to me, that they’ll most likely continue to be wrong and we’ll all survive, if not unharmed then at least unbowed.

Apart from all of the e-mails and articles, though, what’s driving the very real concern—and even fear—out there are the market declines of the past several days. With day after day of decline, the worry is whether the market is destined to collapse.

First, some perspective. As I write this, the S&P 500 is at 1,750—that is, at levels from last October, and more than 15 percent higher than a year ago. Even with the correction we’ve seen so far, we’re still looking at double-digit gains over the past 12 months, and we’re still above the levels of the middle of last year. This is not a collapse.

Even if the S&P 500 were to drop further, we’d still be at reasonably healthy levels from a valuation perspective. As I’ve said many times on this blog, a return to a more normal valuation level would be just that—normal—and not cause for panic. No one likes to lose money, but the current pullback, as painful as it is, is still well within the normal range.

That said, it’s quite possible that the market might continue to decline for a while—and we will be watching it. Today may violate the 100-day moving average, which would be a sign that further declines are likely. For investors who have thought through their goals and plans, such pullbacks will be painful but, at the end of the day, no big deal. For investors who panic, however, they can be very damaging. As an example, compare an investor who sold in 2008 and never bought back in with one who held on; the latter would be much better off. This isn’t to say that should be your strategy, but rather to say that you should have a strategy. Times like these are what make that strategy worthwhile.

As I’ve said before, with a well-thought-out plan and allocation strategy, the best thing to do with most events is sit them out. Lots of things might go wrong, but Mark Twain said it best: “I am an old man and have known a great many troubles, but most of them never happened.” This too will pass.

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