The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.


Don’t think about the Fed

The surest way to get anyone to think about elephants, the saying goes, is to sternly admonish them not to think about elephants. This week, all anyone in the markets is going to be thinking about is whether or not the Fed announce the start of a rate-rising campaign on Sept 17.

elephantCalculated Risk, a fine economics blog, thinks the Fed will pull the trigger this week, and provides a nice roundup of the evidence. The Wall Street Journal, meanwhile, notes this morning that rate hikes by other big central banks haven’t stuck. And, just to stir in a bit more uncertainty, the Federal Reserve Bank of Atlanta notes that the probability of deflation is no longer zero. 

But there are, honestly, other things going on in the world that could affect the stock market, and they’re useful to look at. For example, many people look at hedge funds as the pinnacle of money management skills. This may be true, but you have to overlook the funds’ horrific failure rate, says Larry Swedroe at

Approximately 30% of new hedge funds don’t make it past 36 months due to poor performance,” Swedroe writes. “Almost half of all hedge funds never reach their fifth anniversary. And only about 40% survive for seven years or longer.” And, while there’s some evidence that the very best hedge funds can stay hot for extended periods of time, good luck getting into one.

And then there’s China, the other elephant in the room. “We did analysis recently where we said, what if the Chinese economy is not growing at 7.5% or 8%, which is what they hope to do?,” bond manager Jeffrey Gundlach told, “What if it’s growing at 2% or 0% instead? And we came to the conclusion that the global economic growth could very well be only 1 percent right now on an annualized basis. That’s an incredibly low rate of growth.”

And Russia. Moscow is apparently ferrying arms and soldiers to the aid of the Syrian government, flying over Iran and Iraq to do so. Other things to ponder, aside from elephants:

Did you get in on a big initial public offering this year? Why aren’t you smiling? Could it be because 40% of the $1 billion IPOs in the last 12 months are selling below their offering price?

Want to buy a new house? October is the best month.

The Bloomberg terminal, a fixture in trading rooms for three decades, is finding new competition.

Daily roundups that should be on your reading list: Barry Ritholtz’s The Big Picture, Josh Brown’s The Reformed Broker, Dealbreaker’s Opening Bell, Naked Capitalism’s links. The latter is where I found this gem: A Colorado Canyon is closed because too many people are taking selfies with bears. 

Fear and the FOMC

The current tone on Wall Street is that the Federal Reserve will destroy all that you hold dear. Not only will the Fed raise interest rates, Janet Yellen will give your credit card number to the Russian mafia. Members of the Federal Open Market Committee will dig up your dead grandmother and kill her again. You will get chestnut blight.

Bear in mind that we’re talking about raising the federal funds rate to 0.25% from zero.

But Wall Street probably does have two things on its mind, at least when it comes to Federal Reserve policy. The first is that it’s not entirely clear that an interest rate hike would be a good idea. As Calculated Risk notes, the key sentence in last month’s statement by the powerful FOMC is this: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

fourweekThe labor market has indeed been improving. The unemployment rate is 5.1%. Initial jobless claims were 275,000 the week of September 5. The four-week average rose slightly, but is still at historically low levels.

But there’s room for improvement. The total percentage of the unemployed, including those who would prefer to be working full-time but are working part-time, is still hovering around 10%. More importantly, real wages remain stubbornly low.

The other item the Fed wants to see is inflation at about 2%. Using the headline level for the Consumer Price Index, which includes food and energy, inflation is running at 0.2%. If you throw out food and energy, prices have gained 1.8% the 12 months ended July. The Fed’s own favorite inflation measure, the price index for personal consumption expenditures, has gained 0.3% the 12 months ended July.

Furthermore, a rate increase would simply propel the already strong dollar higher, which has been making other countries, most notably emerging markets, miserable. So there’s great uncertainty about whether the Fed will raise interest rates this month, and Wall Street just hates uncertainty.

The other fear is not so much a quarter-point increase in rates, which isn’t going to bankrupt anyone. Instead, it’s the notion that this is just the first in a long series of increases. All other things being equal, this means that bonds and money funds will eventually become more competitive with stocks and that Fed’s longstanding easy money policy will be over. Stocks will not only have to be the best-looking investment available, they will have to earn investors’ attention through higher earnings. And given the current level of earnings — near-record, but showing signs of slowing — that won’t be easy.

Reasons to be cheerful

If you’ve accumulated any significant amount in your retirement savings, the worst thing you can do is think about how much fun you could have had with the money you’ve lost in the stock market recently.

For example, let’s say you had $50,000 in your 401(k). We’ll use as our example fund the Vanguard 500 Stock Index fund, which, as of Tuesday, had shed 9.54% since the Standard and Poor’s 500 stock index peaked on May 20, 2015. As of yesterday, $50,000 in that fund has become $45,230, a loss of $4,770.

laborThis is not an insignificant amount of money. You could put together a fun vacation for $4,770. You could have a huge Labor Day cookout and invite half the town. You could buy about a half-ton of fireworks and set them off. Heck, if your money is going to go up in smoke, you may as well get to watch it go up in smoke.

Which brings us to our first reason to be cheerful: You probably didn’t have all your money in the stock market. According to the Investment Company Institute, the funds’ trade group, investors have $16.3 trillion in mutual funds. Of that, $8.7 trillion, or 53%, is in stock funds of all sorts. Had you used the same formula as the average fund investor, you’d be down $2,538 rather than $4,770. You could still have fun with that amount of money — let’s say a big day at the Apple store — but not as much.

Both bonds and cash have made negligible gains. But teeny-tiny gains are always better than honking big losses.

Another reason to be cheerful: If you’re a reasonably sober investor, you probably didn’t have a big chunk of money riding on China A shares, or Brazilian stocks, or emerging markets debt funds, all of which have been clobbered during the recent downturn.

If you do the bulk of your investing in corporate 401(k) savings plans, you’re probably — probably — investing in relatively low-cost institutional funds. Costs always count against you, but they inflict particular pain in a downturn. If the S&P 500 is down 10% and you’re paying 1.25% for fund management, you’ve lost 11.25%. On a $50,000 stock portfolio, that’s $625 a year, which could buy you a movie ticket a week all year.

Finally, if you do have money in cash or bonds, you have some dry powder for when the market does indeed recover. Bear in mind that you’re probably not going to nail the exact bottom of the market, except by accident. If you buy before the correction is over, you’ll probably feel dumb for a few months. Don’t. If you’re a long-term investor, buying high-quality stocks when they’re down is another reason to be cheerful.

The problem with stop-loss orders

If you’ve ever owned a very old car, you may have experienced the giddy feeling of pressing down on the brake pedal and having it go straight to the floor. Brakes are Good Things.

modeltFor investors, one form of emergency brake is the stop-loss order. Basically, you tell your broker to sell a stock (or mutual fund) if it declines below a certain level. It’s convenient, in that you don’t have to monitor the stock all the time, and generally sensible. If your stock is down, say, 11% from where you bought it, it’s probably best to take your losses and wait for a better time to buy the stock.

So what’s the downside? Suppose you’d put in a stop-loss order for Micron at $14.50 last week. The stock closed at $14.53 yesterday. Today, however, the stock opened at $13.81. What price did you get? $13.81. A stop-loss order simply means that your broker will try to sell the stock at the best price below below your stop. If the stock gaps below your price, you get the first bid below your stop order  — in this case, $13.81.

All the more galling, of course, is that fact that Micron quickly regained its mojo, and, at this writing, is trading for $14.93.

By and large, it’s better to have a stop-loss order on a position than not. (Many companies will now let you put in a stop-loss order at a set percentage below its most recent closing high — a nice feature if you want to preserve gains). Just don’t think that it will slam on the brakes just in the nick of time.

One observation about yesterday’s selloff:  It was big, it was bad. But it was a piker compared to Black Monday in 1987, which saw the Dow fall 22.61% in a single day. Had it been of similar magnitude, we’d be contemplating a 3,723-point loss in the Dow this morning.



Reinvesting in the business

If you own a home, you know that somewhere in the basement is a sensor that’s linked to your bank account. Too much cash on hand? There goes the furnace! Getting a bit ahead? Where did that leak in the ceiling come from? Just finishing the car payments? Look, we have bats in the attic!

Chaplin_-_Modern_TimesMany of these woes can be prevented, or at least postponed, by regular maintenance. While spending $5.000 on a new roof is probably the least exciting way to spend a five large, it’s way more fun than replacing your entire kitchen after a downpour, and cheaper, too. For many companies, capital expenditures are unexciting — but good for the firm and its profits in the long run. Unfortunately, it may take Wall Street a while to get used to the notion.

In recent years, companies have been delaying reinvesting in their people and equipment, while hoarding cash and buying back shares. But this, like putting off that new roof, has its drawbacks. If you don’t pay people well, they go away.  If you don’t modernize your equipment, your product quality falls behind.

Furthermore, while capital expenditures detract from a company’s earnings in the short term, they are a powerful driver of the economy. When you start buying new forklifts, computers or delivery trucks, other companies typically see their profits rise — and they start hiring as well. It’s a virtuous cycle.

Reinvesting in capital equipment is good for a company in the long run. Nasdaq has an admittedly obscure index called the Nasdaq US CapEx Achievers Index, which tracks companies that have increased capital expenditures for three consecutive years.

Through 2014, the CapEx Achievers index has gained an average 15.99%, according to Nasdaq, vs. 15.45% annually for the S&P 500. And for the past five years ended July, CapEx Achievers have gained 119.5% vs. 91.7% for Dividend Achievers — stocks that have raised their dividends each year for 10 years or more.

Big investments in business don’t usually please investors, who often have the attention span of a gna. For example, investors punished Walmart stock Tuesday in part because the company has been increasing its investment in its U.S. stores, and raising salaries, albeit reluctantly. (The rising dollar also hurt its returns from overseas). So far this year, several of the CapEx achievers have also been clobbered:

  • Chevron: -19.6%
  • Procter & Gamble: -13.6%
  • Oracle: -10.3%
  • 3M: -6.7%

Nevertheless, capital spending does seem to be coming back into vogue. If you take out energy spending, which is in clear contraction, capital expenditures for companies in the Standard and Poor’s 500 have risen 9.4% the past 12 months.. And, says S&P, strategies to woo shareholders — buybacks and dividend increases — are set to fall slightly in the second quarter both on a quarterly basis and last 12 months.

If, in fact, companies are starting to loosen their purse strings for a bit, that’s good news for the economy. But it may also foretell a slowdown in earnings — and stock prices — in the next few quarters. But that seems like a relatively small price to pay for much-needed improvements.

Going on a bear hunt

Just as there’s something riveting about seeing a giant lizard stomp through a major metropolitan area — New York, Los Angeles, Tokyo — it’s also fascinating to watch the bears romp through the major market indexes.

Godzilla, of course.
Godzilla, of course.

An official bear market begins with a 20% loss. (A correction is a 10% to 20% loss, and an annoyance is anything below that). Right now, the S&P 500 isn’t even in correction territory. But as of yesterday, 115 stocks in the S&P 500, or 23%, were down at least 20% from their 52-week highs.

If you own one of these stocks, it’s a bit like watching your new car squashed like a tin can. But if you’re thinking of owning one of these stocks on a scratch-and-dent basis, some are pretty interesting.

As you can imagine, most of the stocks with big green footprints on their backs are energy companies, such as ExxonMobil, now selling at $77.42 a share, down from its 52-week high of $100.31. Dividend yield: 3.56%.

But ExxonMobil has actually held up pretty well. Apache Oil got squashed to $47.69 from $102.55. And perennially snakebit Chesapeake Energy was compacted to $8.21 from $27.24.

The price of all these stocks, of course, depends on the price of oil, which is now flirting with $43 a barrel. Until oil settles down, it’s pretty hard to argue for a bottom for energy stocks. (Those with long memories will recall that oil traded below $17 in 1998.) Rather than trying to time the bottom, it might be better to wait for a bit of an upswing.

But a few interesting stocks are showing up on bear market list, including:

  • Nucor, the generally admired steel maker, now at $45.29, down from its 52-week high of $58.56. Dividend yield: 3.2%. Part of the reason for the company’s tumble is that China’s appetite for steel is falling, and the economy hasn’t been growing as quickly as some would like. Nevertheless, the company is highly cost-efficient and has a 3.3% dividend, so you get paid — a bit — to wait for business to turn around.
  • Wal-Mart, down 21% from its 52-week high. China’s currency devaluation, announced today, would make some of Wal-Mart’s products cheaper, and low gas prices should translate into higher sales at the nation’s largest retailer.
  • Intel, down 24% from its most recent high. Semiconductor prices have been drifting down this year, while investors have been slamming semiconductor stocks with a hammer. Intel, at least, pays a 3.2% dividend. More aggressive investors might consider Micron, down, 49%.
  • Franklin Resources, the San Mateo-based mutual fund powerhouse. The complex is noted for its bond management, and the Puerto Rico default has been no help at all to the stock. Nevertheless, the company has strong international and domestic stock funds, and typically has a robust profit margin — all thanks to you, investors!

Bear in mind that combing through the new lows list is just the beginning of your research. There’s nearly always a compelling reason for a stock to fall, and it rarely has anything to do with radioactive lizards. But if you’re looking for some relative bargains among high-quality stocks, this might be a good place to start.