The Anxieties Of August
The stock drop on the last day of July was the type of abrupt decline that we have not experienced for quite some time. April had brought an earlier big dip but that was concentrated in higher risk, headline-hunting stocks. Large-cap stocks have been carrying extra weight recently as smaller cap stocks have been slipping; they encountered short-lived selling although and are recovering more quickly than the small fry.
The overall market’s uptrend has been under pressure for several weeks and increasing selling finally pushed it into a confirmed short-term downtrend. Earlier this year, similar pressures provoked short downturns of only a few percent, far short of the ten percent drop customarily used to establish a “correction.”
Investors always ask “Why?” and the financial media always provide reasons, in this case blaming news from Gaza and Ukraine. These are tragic events, however, institutional investors typically soon place such troubling developments on their periphery, focusing on prospective economic changes and corporate earnings 6-9 months in the future.
Markets never go up forever and pauses, although frustrating, are to be expected. Stock investors are subject to the human tendency to strongly prefer avoiding losses to acquiring gains. Studies in behavioral finance indicate that this risk aversion may favor avoiding losses by over twice the weight given to gains. Consequently, stock market dips arouse fears that often exaggerate these dips.
The recovery of the U.S. economy is slowly accelerating. This is certainly overall good news even though it will inevitably bring higher interest rates. Rates have been down so long that investors may have become a bit complacent and days like July 31st. are likely to revisit us in the months ahead as the Federal Reserve lifts interest rates.
Stock valuations should be viewed in the context of interest rates. Even with rates almost certainly headed higher in several months, multiples of company earnings could be higher and remain quite reasonably valued. The financial crisis, now six years past, still triggers nervous memories, prompting nervous investors to cling to supposedly risk-free investments that are actually riskier than traditionally riskier assets like stocks.
Today’s traditional “risk-free” investments like Treasury bonds pay 1.6% for five-year bonds and 2.5% for ten-years. Even though principal will reliably be paid at expiration, a one-percent interest rate increase over the next year would knock 3-8% off the current value of the bond. Rather than lending at today’s rates, it is difficult to imagine an investor who would not be better off investing in Apple (AAPL-$95) or Amgen (AMGN-$126) with two percent yields or Intel (INTC-$32) with three percent.
Despite these obvious advantages, retail mutual fund sales are low and even supposedly more sophisticated pension funds have their lowest allocations to stocks in thirty years. These sources of latent stock buying power reflect seared memories and reputations from being burned in 2008. Mark Twain said, “If a cat sits on a hot stove, that cat won’t sit n a hot stove again. That cat won’t sit on a cold stove either.”
The nature of markets is to fluctuate and of humans to overreact to fluctuations. Investors should not let news events keep them away from quality stocks like Thermo Scientific (TMO-$119). This new buy recommendation provides a wide variety of medical research services, equipment, consumables and software.
Sales are approaching $17 billion, growing at over 25%. The company just posted second-quarter earnings of $1.72, beating analyst estimates of $1.62. It increased its estimate for the year to a range of $6.85-$6.97, an annualized growth rate also over 25% and a very reasonable valuation of 17 times forecast earnings.
August has a bad stock market reputation, probably aggravated by light trading volume, which is generally not conducive to big rallies. Actually, its long-range history is surprisingly strong. Anxieties will always spook selling spasms that are inevitably overcome by economic and business advances.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622