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Sunday, 09 December 2018 23:32

Irrational Markets

Written by Sreeni Meka
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Markets are irrational, often run by greed and fear. Now fear is dominating the market; some are dumping the stocks at the wrong time. All economic indicators are pointing positive trend, and there is no recession visible on the horizon. When it rains, it pours. For the past three weeks, markets are sliding downwards. Bear markets never start without recessionary symptoms just like storms never come without the dark clouds.

 

The recent dip has made many nervous, knowing the difference between short-term market jittery and a bear market might help calm the worries. A bear market is a prolonged, fundamentally driven, broad market decline of negative 20% or greater—while a correction is a short, sharp, sentiment-driven drop exceeding negative10%. The difference in the cause is critical. Bear markets have fundamental drivers can be identified as they materialize. Corrections are functions of mass sentiment or psychology. As such, it may make sense to reduce stock exposure if you see significant negative surprise others miss and believe a bear market is underway. Reacting to corrections—however tempting when fear swells—can wreak havoc on long-term returns.

Anytime you hear about the recession, keep in mind a few facts. A drop in average weekly hours, a spike in unemployment claims, a sudden drop in manufacturers' new orders, the narrower gap between the 10-year treasury bond and fed funds. None of these indicators showing signs of caution. Right before the recession yield curve inverts that is short-term rates go higher than 10-year rate. For the past year, the gap has been narrowing between the 10-year bond and fed rate. However, the 10-year rate is also going up along with the fed rate. 

Stronger third-quarter earnings but poor market reaction:

As per the FactSet, to date, 48% of the companies in the S&P 500 have reported actual results for Q3. Companies are outperforming recent averages on the earnings side and performing in line with current norms on the revenue side. Regarding earnings, the percentage of companies reporting actual EPS above estimates (77%) is above the 5-year average. In aggregate, companies are reporting earnings that are 6.5% above the forecast, which is also above the 5-year average. Regarding sales, the percentage of companies reporting sales above estimates (59%) is equal to the 5-year average. In aggregate, companies are reporting sales that are 0.8% above estimates, which is slightly above the 5-year average.

Though emotionally difficult, short-term market volatility is a normal and healthy part of bull markets. The best course of action for investors is to remain disciplined and avoid making knee-jerk decisions that often result in investment errors. Current fears—trade wars, slowing earnings growth, interest rates are old, re-hashed, or misguided and lack material surprise power for stocks. In our opinion,the bull market should continue as still robust fundamentals, gridlocked governments, and far-from-euphoric investor sentiment push future stock prices higher. 

Published on: October 30, 2018

 

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