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Wade W. Slome, CFA, CFP
Articles (156)  | Author's Website |

Gravity Felt After Strong Surge

What caused this painful stock bump on the noggin?

June 14, 2019 | About:

Legend has it that the esteemed mathematician and physicist, Sir Isaac Newton, was hit on the head by an apple in 1667 while relaxing under an orchard tree in England. The story goes onto claim this led to an epiphany that prompted Newton to suddenly come up with his law of gravity. Well, the stock market experienced a similar “aha moment” last month. After a steep rise of +17.5% during the first four months of the year, gravity took effect and caused the S&P 500 stock index to pull back -6.6% in May. The Dow Jones Industrial Average didn’t fare any better…the index fell 1,777 points or -6.7% for the month to 24,815. The bond market, as measured by the iShares Core Aggregate ETF (ticker: AGG), bucked the negative short-term stock trend by rising +1.7% for the month, thereby bringing 2019 gains to approximately +3.7%.

What caused this painful stock bump on the noggin? Deterioration in trade negotiations with China and a new set of trade tariffs proposed against Mexico in hopes of mitigating illegal immigration problems on our country’s southern border are two main culprits of the downdraft. Fears of a global economic slowdown has also filtered into the bond market causing an ominous phenomenon called an “inverted yield curve,” which historically been a fairly reliable leading indicator of recessions (I wrote about this a decade ago).

All the nervousness relating to stock markets has spilled over into “nutty” bond market buying. If you were worried about a potential bubble forming in stock prices, those concerns would probably be better served by focusing on the more than $10 trillion dollars (with a “T”) in bonds offering a negative interest rate (see chart below).

negative yield

Source: Bloomberg

That’s right. Bond prices are so high currently, investors are paying financial institutions to babysit their money. In other words, not only are investors not receiving any income, they are paying the financial institutions for the money they are giving/lending. An example of this insanity can be found in the largest European powerhouse country. The yield on the 10-year German bund is now at a record low of negative -0.205%, meaning after 10 years an initial $1,000 investment would be worth less than $980. You would be better off preserving the value of your initial investment by stuffing it under your mattress and then waiting 10 years.

Not All Doom and Gloom

If you turned on the television, you might think Armageddon is upon us. However, that is not the case. Despite the recent setback, the S&P 500 index remains up +9.8% for 2019, excluding a current dividend yield of about +1.9%. What’s more, the economy posted better-than-expected economic activity in the first quarter (+3.1% Gross Domestic Product growth). Even though second quarter growth is currently expected to moderate to +1.3% to +1.8%, as you can see from the charts below, the unemployment rate is at a 50-year low (3.6%) and Consumer Confidence is hovering near 20-year highs.

unemp

Source: CNBC

consumer con

Source: Calafia Beach Pundit
The employment picture looks even more compelling once you consider the unprecedented two decade dynamic that has resulted in the existence of more job openings than the number of persons looking for work (see chart below).

job openings

Although the upward trajectory of stock returns for the first four months of the year may have defied the laws of physics, last month investors witnessed Sir Isaac Newton’s law of gravity take hold. There are no guarantees in the short-run more apples will stop flying around the stock market, but over the last 10 years, long-term investors have been handsomely rewarded by viewing these types of corrections as great purchase opportunities.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

About the author:

Wade W. Slome, CFA, CFP
John Dorfman founded Dorfman Value Investments in 1999. Previously he was a Senior Special Writer for The Wall Street Journal, executive editor of Consumer Reports, and a managing director at Dreman Value Management. His syndicated column appears on Tuesdays on this website and also in the Pittsburgh Tribune Review, Ohio.com, Virginian Pilot and Omaha World Herald.

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