The Stock Market – Economy Disconnect: Just Stay The Course…

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The Stock Market – Economy Disconnect: Just Stay The Course… by John, Vintage Value

The stock market is finally getting interesting again.

  • The S&P 500 is down 8.6% for the year and the Dow Jones Industrial Average is down 8.9%. Both are currently in “correction” territory (10% off their peaks) and are headed toward a bear market (20% off their peaks).
  • European and Japanese stocks are now in a bear market.
  • As oil prices plunged to 15-year lows, analysts who once called the bottom at $60, $50, and $40 a barrel are now predicting oil to fall to below $20 or even $10 a barrel (this was before a 4% rally yesterday).
  • The rout in commodities has driven the MSCI Emerging Markets Index to its lowest level since May 2009. The index is down 13% so far this year, the worst start to a year since 1998 during the Asian financial crisis.
  • China reported that the country’s GDP grew by 6.9% in 2015, down from 2014’s 7.3%, and the slowest pace of economic expansion since 1990. Many people are worried that the Chinese economy is actually faring worse than government officials are reporting.
  • Headlines are now saying things like: “The World Economy Teetering on Edge of Recession

So what’s the deal? Should you sell your entire stock portfolio before another 2008 happens?

The Market-Economy Disconnect

Well, as Greg Ip from the WSJ points out: Financial markets are in a panic over a sharp economic downturn that has yet to make an appearance—and may never.

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While financial markets have been getting hurt, there’s been no sign of similar stress in the broader economy:

  • While U.S. growth was probably near zero in the last quarter of 2015, employment growth actually accelerated.
  • Consumer sentiment rose in early January despite anxieties about stocks.
  • Housing typically leads the economy into a downturn, yet the number of permits issued to build single-family homes actually rose in December.
  • China’s growth of 6.9% in 2015 was a 25-year low (if that growth rate can be believed)… but that’s the rate the government had long targeted. December imports and export data suggest China is in fact stabilizing. Olivier Blanchard, former chief economist of the International Monetary Fund, recently wrote that just no evidence of an impending collapse in china and called the stock market movements of the past 2 weeks “puzzling”.
  • Surveys of purchasing managers from around the world compiled by J.P. Morgan Chase and Markit show that overall economic activity slowed a bit in December but to a level consistent with normal, long-term trend growth.

The Likelihood of a Recession

This isn’t to say that a recession isn’t possible. After all, the economic expansion in the U.S. is now the fourth-longest since World War II and the nearly 6-year old bull market is the 3rd-longest in U.S. history.

It could be that a recession is coming but hasn’t shown up in the data yet. It could also be that the current panic in the stock market itself produces a crisis or recession in the economy.

As Greg Ip notes, the collapse in oil prices, for example, has caused yields on corporate bonds issued by both energy and non-energy companies to jump, and many banks have reported big loan losses to energy companies. The spread between interest rates on super-safe Treasury bills and slightly less safe offshore three-month interbank dollar loans, known as the “TED spread,” a gauge of financial stress, has jumped.

But on the other hand, banks have little exposure to energy compared with their exposure to subprime mortgages in 2008 or Latin American debt in 1982. And regulators have forced them to thicken their capital and liquidity buffers since the last crisis.

Now I’m not saying everything is all sunshine and roses. The P/E ratio for the S&P 500 is 19.69, which – although lower than at year-end 2015 and 2014 – is still well above the 15.57 long-term average. And the record amount of stock buybacks – fueled by low interest rates – that have been contributing to EPS growth the past few years may finally be coming to an end.

But to me, the possibility of an impending economic recession seems less likely than the probability that a confluence of scary-sounding events – the Fed raising interest rates, the Chinese stock market tumble in early January, the lower GDP growth in China, and the falling price of oil (driven in part by a combination of the prior three events) – made investors afraid. The media and human emotion then let that fear feed itself, and the end result is what we’ve been experiencing the past 2 weeks.

Just Stay the Course

Investing legend and Vanguard Group founder Jack Bogle talked with CNBC on Wednesday, in the midst of a 400 point drop in the DJIA. I would heed his advice:

“Just stay the course. Don’t do something, just stand there. This is speculation that we’re seeing out there, and you can’t respond to it. Nothing has changed. In the short run, listen to the economy; don’t listen to the stock market. These moves in the market are like a tale told by an idiot: full of sound and fury, signalling nothing.”

Drown out the noise. Stay focused on fundamentals. Just stay the course.

 

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