Friday’s plunge in the Dow seems to have finally rattled the complacency that has persisted in the equity markets for the past year. Whether this is just a pause for the markets to catch their breath or the beginning of something more sinister, no one has a clue.
What I found intriguing is that the “jarring” 2.5% decline (remember when a 20% drop in one day was considered life changing?) occurred on Groundhog day. This seemed appropriate both in context of Punxsutawney Phil’s call on the beginning of spring and in context of the movie bearing its name.
Up until this week, the last year has reminded me of the movie Groundhog Day, the one with Bill Murray where he is trapped living the same day over and over again. In the market’s version, every day the equity investor goes to work and starts buying stocks in response to hearing that in addition to a global economy that is strengthening, the US tax cuts will immediately boost earnings, incite massive repatriation that will spur buy-backs, dividend increases and all sorts of manna from heaven. Over the course of the day, this buying pushes the indices higher and the investor goes home. The next day, it is tableau rasa, groundhog day all over again. The investor goes into work the next day, with the indices at a higher level and hears for the first time that US tax cuts will be great for earnings and repatriation of foreign profits by US companies will rain cash down on the market and that the global economy is gathering steam. Investors have to get on board, so they start to buy equities, regardless of valuations, pushing the averages higher again. The investor then goes home, and then gets up and goes to work the next day and he hears for the first time exciting news about the impact of tax cuts and the global economy…You get the picture.
I know the market is suppose to be a forward-looking discounting machine, but is it possible the degree of good news being priced into global equities was overdone while participants seemingly were locked into an infinite loop with the same factors getting rediscounted again and again?
It is now possible that from these elevated equity valuations, there has been a subtle shift away from the sweet spot. The good news of global economic growth mixed with ample materials for financial engineering that for the last year have signalled all systems ‘go’ may now be interpreted as increasing the risk of higher yields and hence lower expected discounted future earnings. All of a sudden, good news maybe not that good after all.
Last Friday, up on Gobbler’s Knob, Punxsutawney Phil came out of his hole to be greeted by a perfect cold morning. With no clouds to protect him from the rising sun, he was startled by seeing his shadow and scurried back into his abode, the omen being we are in for a long winter.
On the same day, at 8:30 am, the market poked its head out to see the US employment release. The news was good and the resulting possibility of higher-than-expected yields startled the market and sent it reeling back under its desk. Now we just have to figure out if this means a long winter ahead for the market as well. Happy Groundhog day.
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