Primary Season -October 2015

21 Jan Primary Season -October 2015

It is finally here. 

I do dread primary season. Particularly Presidential primary season. We have an early primary in South Carolina; so the candidates work us over pretty hard for a good showing before they move on to the next primary states. The candidates are desperate to show leadership or gains in the polls. They are trying to build momentum to carry them through. They desperately want momentum so that people will jump on their bandwagon. They are so desperate for momentum that they make embarrassingly poor decisions. (Like Lindsey Graham smashing his cell phone with a baseball bat after Donald Trump gave his number out to the public.) Momentum can be good or bad and I dread bad momentum.

Momentum in investing can be good or bad as well. Once leadership is shown, the momentum can really pick up for investments. In the past few months, we experienced leadership and momentum changes in a bad way. After 4 years, we finally have a correction. It is finally here. The S&P500 has fallen over 12% since May 21st. The 3rd quarter had a loss of 6.9%. Fairly gruesome. All 9 Morningstar style boxes were negative for the quarter. Only Large Cap Growth was positive for the year (+0.09%).

Morningstar Year-to-Date style box returns

-7.85% -7.91% +0.09% Large
-6.54% -5.61% -3.10% Mid
-11.11% -7.55% -4.30% Small
Value Core Growth  

Growth outpaced value during the 3rd qtr. except for small cap stocks. Small cap growth lost 13% to value’s loss of 10%. Regardless, small company stocks suffered steep declines in the 3rd qtr.

While a loss of 6.9% for large capitalization U.S. stocks sounds bad, they were among the best performers around. Every single country in the MSCI ACWI (All Cap World Index) lost value in the 3rd quarter. Chinese equities have been cut in half and commodity indexes have reached six year lows.

It is pretty easy to show some of the reasons for the significant declines:

  • Fears of a hard landing (or a recession) in China
  • Corporate earnings declines
  • Unknown ramifications when interest rates are increased

Drilling down a little bit further than style and market capitalization boxes into the markets, we can see how different asset classes have performed and the momentum they have. The chart is by time period and listed from best to worst performance of each asset class.

July Aug. Sep. Q3 YTD
EAFE 3.52 Gold 3.43 T-Bonds 1.54 T-Bonds 5.08 Dollar 6.60
T-Bonds 3.50 GSCI 0.65 Bond 0.68 Bond 1.23 Bond 1.13
NASDQ 2.84 T-Bills 0.01 Dollar 0.30 Dollar 0.73 T-Bonds 0.17
S&P 500
T-Bonds- 0.02 T-Bills 0.00 T-Bills 0.01 T-Bills 0.02
Dollar 1.74 Bond


Bond 0.70 Dollar
S&P 500


S&P 500
S&P 500
T-Bills 0.00 EM
S&P 500
DJIA Dow Jones Industrial Average
S&P 500 S&P 500 Total Return Index
EAFE MSCI EAFE Total Return Index (local currency)
EM MSCI Emerging Markets Total Return Index (local currency)
T-Bills Three-Month Treasury Bill Total Return Index
T-Bonds Barclays Long-Term Treasury Bond Total Return Index
Bond Barclays Aggregate Bond Total Return Index
GSCI S&P/GSCI Commodity Index
Gold Gold Perpetual Futures Contract
Dollar U.S. Dollar Index
MSCI, Barclays, Commodity Systems, Inc. (CSI), Ned Davis Research, S&P Dow Jones Indices

Bonds performed better than stocks. One exception is high-yield (a.k.a. Junk) bonds which fell just over 5% for the quarter and are now negative 4% for the year.

U.S. outperformed international. At the end of June, the MSCI EAFE was up 9% for the year. The EAFE gave all of this up in the 3rd qtr. And now is down 1% for the year.

Commodities continued their decline. The S&P GSCI (commodity index) dropped 18% in the 3rd qtr. To reach its lowest level since March of 2009. Adjusting for inflation, oil has not seen this low of a price since December of 2003.

The next level to analyze is market sector. Sectors are broken down into some of the following:

– Consumer Staples         – Consumer Discretionary

– Energy                               – Financials

– Health Care                      – Utilities

Consumer discretionary is still leading as it is the only sector to have a positive return for the year (+3.65%). However, consumer discretionary stocks did have a -2.23% return in the 3rd qtr. There was a shift of momentum in sectors. With its gain of 3.65%, the utilities sector is the only sector to have a positive 3rd qtr.

Without going too far into sub-sectors, a few are worth noting. Biotechnology stocks were mentioned by a leading presidential candidate as making too much money and that sub-sector subsequently lost -15.5%. The 3rd qtr. also hit the coal industry (-53.3%) as well as the renewable electricity producers (-41.1%). Ironically, it has been a very bad time to be trying to pollute the world by burning coal and by trying to clean it up by making wind mills and solar panels.

In spite of all of the losses to U.S. equities during the 3rd qtr, our markets fared better than most. There are seven regions in the All Cap World Index.

All-Countries World Index
Region % Gain % Weight  
United States -7.21 51.50 -3.71
Europe ex. UK -7.33 15.44 -1.13
United Kingdom -7.52 7.03 -0.53
Canada -8.32 3.22 -0.27
Pacific ex. Japan -11.92 4.05 -0.48
Emerging Markets -12.78 10.62 -1.36
Japan -14.26 7.93 -1.13
ACWI % -8.64

The three listed reasons (China, earnings and interest rates) for the declines are still true today. There is a fear that China will suffer a ‘hard landing’ and start an economic wildfire. I wrote about this extensively in the August newsletter (Here are dragons). Almost all of China’s market declines are a result of the margin fueled boom they experienced the year before. Investors are looking for dragons where there are not any.

I wrote about the decline in corporate earnings last month (Feel the Sting). Almost all of the earnings declines have come from energy companies as they take losses on their books as oil and gas prices have declined. We should absolutely be concerned about future corporate earnings. What is happening is being exaggerated in the media.

Finally, there is a fear of what will happen as interest rates are raised. There should be. At the same time, we have been climbing a wall of worry (June article) for some time now. For years, we were happy to see our investments gain value fueled by a zero interest rate policy. Some of this has been unwound.

So, our correction is finally here and we had a completely miserable 3rd qtr, now what? Valuations matter and we should not invest in overvalued things. The capital markets are simply not out of line with historic multiples. But markets do not have to behave rationally and can spend large amounts of time outside of fair value. Time matters too. Sometimes markets remain irrational longer than you can remain rational. If you need (to spend on something) your investments in the next few years, they should not be invested. Do not take risk on something you cannot afford to lose.