Don’t Be Spooked by Market Volatility-Opportunity Is Still Knocking! by Frank Holmes

One of the greatest fears this October—possibly the most volatile month of the year—has been the correlation between the S&P 500 Index’s ascent in the first three quarters of the year and the possible ramifications of the end of quantitative easing (QE).

It’s well known that Japan and Singapore have been buying their countries’ blue chip stocks with their excessive money printing. Today, about 1.8 percent of the Japanese market is owned by the Bank of Japan. American investors fear the Federal Reserve might do the same and take away the punch bowl, so to speak.

As you can see, the S&P 500 Index has been rising in tandem with government securities, and it’s uncertain what will happen when QE ends.

Volatility
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The Ebola epidemic has also contributed toward moving the needle to the fear side of the spectrum and driven investors to seek shelter not in gold necessarily but in so-called “Ebola stocks.” For every negative, as tragic as they often are, there is a positive. When a major hurricane hits Florida, for instance, insurance stocks fall while real estate stocks rise. The deadly Ebola virus, on top of an aging demographic, has helped make health care and biotechnology pop this year. The Daily Reckoning’s Paul Mampilly, in fact, calls this rally “the biggest biotech market ever.”

Possibly. Before we get too excited, let’s look at the numbers. Over the last 10 years, the S&P 500 Biotechnology Index has had a rolling 12-month percentage change of ±23. As of this writing, the index is up 32 percent, meaning it’s up by only 1.3 standard deviation. In other words, biotech is behaving approximately within its expected range.

Gold bullion, over the same period, has had a percentage change of ±19—not so dramatically different from biotech—and is down by 1.3 standard deviation. Again, this is “normal” behavior.

Volatility
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As you can see, biotech corrected and then rallied firmly into the sell zone. Seventy percent of the time, it’s normal for the asset class to rise and fall one standard deviation. As I always say, each asset class has had its own DNA of volatility over the last 10 years. Knowing this helps you manage your expectations of how they perform.

Asset ClassStandard Deviation
WTI Crude Oil34%
Gold Stocks34%
Emerging Markets29%
S&P 500 Index17%

Even health care and biotech companies not actively working toward finding treatments and vaccines for the virus seem to have incidentally benefited from the rally. California-based Gilead Sciences and New Jersey-based Celgene, for instance—both of which we own in our All American Equity Fund (GBTFX) and Holmes Macro Trends Fund (MEGAX) and were named by Motley Fool as two of the four most important stocks of the last 16 years—have hit all-time highs. Gilead Sciences concentrates mostly on drug therapies for HIV and hepatitis B, while Celgene conducts similar work for cancer and inflammatory disorders.

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And it’s not just American health care stocks that are doing well. We’ve been impressed lately with the performance of the Stock Exchange of Thailand Health Care Index and Bangkok Dusit Medical Services, Thailand’s largest private hospital operator, which we hold in our China Region Fund (USCOX). Both the index and the equity have excelled year-to-date, delivering 57 percent.

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Bullion and Gold Stocks

As for gold, between mid-August and October 3, the precious metal completely ignored the fact that September is historically its best-performing month, tumbling 9 percent from $1,310 to $1,190. It soon rebounded in the days leading up to Diwali.

Gold stocks, on the other hand, have yet to recover. Since the end of August, the NYSE Arca Gold BUGS Index has plunged 25 percent to lows we haven’t seen since April 2005. The Market Vectors Junior Gold Miners ETF has lost nearly 30 percent; the Philadelphia Gold and Silver Index (XAU), 25 percent.

On a few occasions I’ve pointed out that in the last 30 years, the XAU has never experienced a losing streak of more than three years. As of this writing, it’s lost close to 17 percent, with only two months left. The cards are definitely stacked against the XAU, but I remain optimistic it can continue the trend.

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Many investors are understandably concerned that mining companies in West Africa will suffer because of Ebola. Several companies operating in the three hardest-hit countries have indeed been hurt by the virus, some of them being forced to halt production. However, none of our funds has any direct exposure to them. Three companies that we own in our Gold and Precious Metals Fund (USERX) and World Precious Minerals Fund (UNWPX)—IAMGOLD, Newmont Mining and Randgold Resources—continue to operate normally in the region.

Here I must remind investors that we recommend 10-percent holding in gold: 5 percent in bullion, 5 percent in stocks. Rebalance every year.

Looking Past Ebola

One of our most important tenets at U.S. Global is to always stay curious. That includes being familiar with world events and determining how they might affect our funds. Ebola certainly falls into this category, but that doesn’t necessarily mean our funds will undergo any significant changes based on this unfortunate event. Again, other factors have contributed, including the so-called October effect. We remain committed to our fundamentals and pick stocks because they’ve been well-screened and fit in our results-oriented models.

If the markets seem too volatile for you right now, we’re proud to offer investors a “no-drama” alternative. Check out our Near-Term Tax Free Fund (NEARX), which has delivered positive returns for the past 13 years.

Happy investing, and stay safe!

Index Summary

  • Major market indices finished higher this week.  The Dow Jones Industrial Average rose 3.48 percent. The S&P 500 Stock Index gained 2.72 percent, while the Nasdaq Composite advanced 3.28 percent. The Russell 2000 small capitalization index rose 4.89 percent this week.
  • The Hang Seng Composite rose 2.78 percent; Taiwan rose 3.80 percent and the KOSPI rose 2.01 percent.
  • The 10-year Treasury bond yield rose six basis points to 2.33 percent.

Domestic Equity Market

The S&P 500 Index advanced sharply again this week, closing at a new all-time high.  Equity markets rallied on earnings and were pushed higher on Friday on news that the Bank of Japan increased its quantitative easing (QE) program by roughly $135 billion dollars. This more than offsets the Federal Reserve’s exit from its own QE program and just reinforces the idea that continual increases in global liquidity is good for risky assets such as stocks.

Volatility
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Strengths

  • The technology sector led the way in a very strong week as MasterCard and Visa both rallied by more than 13 percent to pace the sector. Both companies reported strong quarterly earnings results with increased spending and higher fees as positive drivers. Electronic Arts was not far behind, rising 12.7 percent this week as it also beat quarterly expectations and continued its turnaround.
  • The health care and financial sectors were just fractionally behind technology. Health care experienced broad-based strength with health care suppliers and managed care companies particularly strong. Financials were also very strong with good results from insurance companies leading the way.
  • Goodyear Tire & Rubber was the best-performing stock in the S&P 500 this week, rising 16.43 percent. The company reported very strong results relative to expectations and reaffirmed expectations for 2015-2016.

Weaknesses

  • The materials sector managed to eke out a small gain but was dragged down by the big mining companies, Freeport-McMoRan and Newmont Mining, as the dollar rallied and commodities were generally under pressure.
  • Other areas of weakness included commodity chemicals, construction materials and homebuilders.
  • A notable underperformer this week was Facebook, which fell 7 percent as the company guided for sharply higher expenses next year that caught analysts by surprise.

Opportunities

  • Earnings season remains in full swing next week with a few notable companies to watch for including Priceline.com, Michael Kors and Qualcomm just to name a few.
  • Next week is also a big week for meaningful economic reports with both the ISM manufacturing index and nonfarm payrolls coming out. Employment data has recently surprised on the upside and has the potential to be a positive market mover next Friday.
  • The market made a fresh new high this week and the bull market continues.

Threats

  • After two very strong weeks the market may take a breather to consolidate recent gains.
  • The market has become somewhat dependent on global central bankers to move higher and with additional easing steps unlikely after a recent flurry of activity the market may languish.
  • Geopolitical tensions continue to be at elevated levels and there is always the possibility of a political misstep that impacts the markets.

The Economy and Bond Market

U.S. Treasury bond yields rose across the board again this week as the Federal Reserve exited its quantitative easing program. The Fed surprised the market somewhat with a more hawkish tone in the statement released after Wednesday’s FOMC meeting. A few weeks ago a more hawkish tone wouldn’t have been a surprise, but the market’s expectations of the Fed had shifted quite a bit with global growth expectations getting reined in. The market’s reaction was particularly acute in shorter maturities that are more sensitive to Fed interest rate increases.

Volatility
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Strengths

  • The Bank of Japan surprised the market on Friday by increasing its quantitative easing (QE) program by roughly an additional $135 billion dollars.
  • In addition to Japan, other global central bankers are responding to sluggish economic growth. The Bank of England set a lower-than-expected minimum regulatory capital ratio, which set off a significant
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