The Fear Factor
October was a scary month to be an investor. The month of Halloween and several infamous stock market crashes (Black Monday, October 19, 1987, the Dow Jones Industrial Average fell 22%). October 2014 made investors in the stock market extremely uncomfortable. By the end of the month, stock prices (measured by the S&P 500) had risen a remarkable 2.4% for the month. More impressive, stock prices are up over 9% year to date. With a heightened level of price volatility in the markets, we head into November and December, two of the seasonally strongest months to own stocks.
October’s scary backdrop led to a spike in the volatility levels. The VIX, the traditional measure of volatility in stock prices, spiked to a high of 31 on October 15th, more than two times the 200 day moving average. Of the 23 trading days, 13 were positive and 12 involved a move of +/- 1%. We haven’t seen levels that high in a good three years, dating back to the summer of 2011 when we suffered a late-Summer “mini-crash” echoing the bear market of ’08-‘09.
The stock price turbulence we endured in October was likely sparked by several factors. The most obvious was the Ebola “pandemic” which has luckily not materialized in Europe or the US. To a certain extent the impact on the markets is a clear study in the significance of the behavioral aspects of investment decision making. Though fear in that form does not take hold often, when it does, it becomes irrational and difficult to curb.
Another factor stoking tension is multiple geo-political hot spots. The Ukraine crisis is shocking, to the extent Russia looks like it wants to annex more territory, as it did with the Crimean peninsula in March. There has been no improvement in the Middle East with respect to ISIS or Iran. China’s growth has completely stalled while the pollution levels in Beijing have gone off the charts, and reached levels more than 15x the World Health Organization’s guidelines. Finally, Germany and the rest of Europe surprised everyone with decelerating growth rates. There is speculation this is related to geo-political concerns stemming from Russia and the Ukraine.
The most curious factor is the sharply falling price of oil. It is not clear whether this is some form of political retaliation or new-market forces working their invisible hand. The current bear market in oil prices is not remarkable in its percent decline, but it is growing notably old. Energy, and related stocks, has suffered. Some evidence supports the view oil prices are in secular decline. For example, the average fuel efficiency of cars is improving, rapidly. People are driving less: 1) total miles driven has been falling since 2004, 2) the millennials are moving in force into urban settings where they can walk and bike, and 3) more young adults (16 – 24 yrs.) than ever are not signing up for a driver’s license. Finally, the proliferation of EV and natural gas vehicles is here to stay, both in the US and even more so globally.
So, while October was scary and volatile, it ended up being a good month, if you didn’t panic and sell. Buying on the dips can take a lot of moxie. In my opinion, the outlook is supportive for owning stocks. I think the fundamentals, such as job growth, consumer spending and consumer confidence have been trending nicely over the last several years. 3Q2014 earnings reports were impressive, the price/earnings ratio or valuation of the market is goldilocks, and the fundamental business backdrop (interest rates, sentiment, and inflation) is constructive. Finally, after several years, the Federal Reserve peacefully brought QE-3 to an end, heartening investors chomping at the bit for a yield curve more in line with historical averages.
In my opinion, the expected return from all asset classes (stocks, fixed income, MLP’s and REIT’s) needs to be adjusted downward. I think the upside is lower while the downside is just as present as ever. Increased price volatility may be here to stay, making owning stocks too nerve-wracking. The risk/return balance has shifted somewhat and while I expect reasonable returns, I think more caution is called for in this environment. Please do not hesitate to call if you would like to discuss further.
Bruce Hotaling, CFA