Last week a New York Times reporter reported his experience from a Royal Caribbean cruise ship steaming from Bayonne, New Jersey to Cape Canaveral, Florida. (full article)
It was around 5 p.m. on [SuperBowl] Sunday when I began contemplating whether or not I should start composing goodbye messages to the people I love, as well as one to the friend dog-sitting my golden retriever to ask her to find him a good home for me in the event I didn't live to see another day.
Just a few minutes earlier, the ship's cruise director had made an announcement to the 4,000 or so passengers on board stating that "things are going O.K." and asked for everyone to "remain in your rooms and enjoy the complimentary movies."
Things did not seem to be going "okay."
The "Anthem of the Seas" endured hurricane force winds of 150 MPH, waves of 30 feet, sustained much cosmetic damage to the ship's interior, and, more seriously, to one of two steering pods. Fortunately, the ship's Wi-Fi never lost its signal, so passengers were able to "enjoy" the Super Bowl while clinging to their bunks. The ship turned back to New Jersey the following morning rather than risk driving ahead into another storm. (video)
Metaphorically speaking, our clients feel like those cruise ship passengers right now. The weather wasn't great in 2015, and seems to be getting worse in 2016. The S&P 500 declined 12.6% since last May, 8.5% since start of year, touching levels seen briefly in January 2016, August 2015, and is now back at the level of January 2014. And yet, compared to 2008-9, these are only 10 foot waves (a decline of 12.6% versus a decline of 55%.) Our "all-weather" portfolios survived the storm of 2008-9, and will survive this storm as well.
Up here on the bridge, we forecast clearing skies. We often talk about market lows being set as the "weak hands" are washed out. The CNN Fear & Greed Index shows "Extreme Fear," which is generally a contrarian signal. We also know that stocks swing from over-valued to undervalued, and that buying when stocks are undervalued is generally a success strategy. The Morningstar Model shows stocks undervalued at this time:
The index is not at the extremes of undervaluation we saw in 2008-9 or in 2011. The nightmare scenario is that we replicate the experience of 2008-9 where stocks went from 15% undervalued to 45% undervalued. However, we think the 2002 and 2011 patterns are more relevant, which is to say that we're already past the point of maximum pain and can look forward to two years of robust gains.
The most important statistic we're tracking is the US unemployment rate, now 4.9%. Factoring in discouraged workers, the true unemployment
rate is still around 7%, which is why real wages are unchanged from the 1990's. However, we're seeing anecdotal evidence that the labor supply is tightening, bad news for corporations as labor costs rise, but good news for American families who may see an increase in disposable income for the first time in a decade.
Lastly, we're waiting for the current correlation between the price of oil and US stock prices to break down. This past Thursday, oil hit a 12 year low of $26/barrel, and stocks hit a two year low. Oil rallied 12% to $29.44 on Friday, and stocks rebounded in tandem, delivering positive returns for the week. Eventually, investors will remember that low energy prices are GOOD news for the US economy, delivering savings of $2,000/year to the average American family, trimming $120 billion/year from the US trade deficit, and tamping down inflation. Yes, a number of small oil companies will go bankrupt (35 already in 2015) and, yes, US banks will write down some bad energy loans, so short term earnings pain, but long term economic gain.
Net, we have a divergence between the US economy (currently B) and S&P 500 earnings (C-) which are depressed by the energy sector, slow or negative growth in emerging and European economies, and the strong dollar. Earnings growth may remain negative through September, turn positive in December as comparisons become easier. We don't need to wait until September to buy stocks however, as the stock market tends to lead changes in earnings by 9-12 months. Indeed, as we wrote in our January 23rd commentary, we are taking our clients fully invested. Nothing in the last three weeks has changed our course.