“The Worst Day of 2014″ – The Reformed Broker

ByJoshua M Brown chief, current, economic, king, market, multiple, nasdaq, people Comments Off

Today was the first truly bad day of 2014 for the stock market. The Dow closed down 175, although off the lows, while the Nasdaq and S&P 500 shed half a percent each. In the recent past, these have been shrugged off. But that was in the pre-taper environment, when dips were scarce and corrections were federally outlawed.

Today “felt” different for some reason, though. Lots of people talking about currencies and shit we haven’t cared about since 2011…

Now we are squarely in a good news is good news, bad news is bad news phase and weakening economic data, domestic or international, will not be looked upon favorably by the stock market. Equity flows have been directed toward pro-cyclical sectors over the last few months – techs, banks, industrials. These were not merely purchases of positions, these were votes for expansion and even a touch of inflation (in wages, for god’s sake). On days where we don’t get confirmation of this sort of thing – and today was one of them – this is what the reaction will probably be.

Fortunately, the November FHFA Home Price Index and Chinese Flash PMI are not the be-all, end-all of economic indicators.

One thing I think is highly apparent and disturbing is the current lack of tolerance for stock market losses. Newbie investors and veterans with selective memory seem to be incapable of quietly coping with downward moves in the stocks they own. It’s like they weren’t counting on not being immediately up in everything they bought, as though unrealized gains were an unalienable right in the constitution.

Financial media and the Twittersphere are wailing as though we’re at a Great Chieftain’s funeral. The reality is that we’re within a percent or two of all-time record highs.

Goldman’s chief equity strategists David Kostin shocked the firm’s institutional client base two weeks ago by suggesting that the market was expensive and would need more earnings growth to justify further gains. They were furious at his notion that the multiple was probably as stretched as it could be. “Give us a smartypants rationale for 18x, 20x earnings, David!” the spoiled brats clamored as he made his rounds. He’s not biting.

This overly sensitive, emotionally fragile condition is an unhealthy one. It ought to be rectified fairly quickly should the slide extend from here. I hope it does. People need a reminder that they aren’t geniuses nor are they promised immediate gratification from every investment they make.

The research suggests that investors tend to be extrapolative about future returns in the stock market. Meaning a positive 10% year leads them to expect a positive 15% year ahead. That’s all well and good, I admire the optimism. Except when you’re coming off of one of the all-time great five-year periods in market history and PE ratios have pierced through to the highest 75th percentile of all time. We could certainly get through 2014 without so much as a hiccup, but historically that would be a pretty far-fetched probability to be tilted toward.

In my practice, we manage other people’s money by a set of rules, so that our own emotions and biases don’t get in the way of making responsible decisions. As the year began we de-risked our model portfolios to account for the fact that stocks may have already pulled forward some of the upswing in the economy. Having spent the entirety of 2013 being (pretty vocally) overweight equities and underweight bonds, it was time to realign our client accounts back to their original benchmark weightings. It felt a little weird to do given how well stocks had been “treating”us – nobody wants to sell what’s making them feel good – but that icky feeling only reinforced the rightness of the decision.

We have no idea what’s going to happen this year. We’ll be thrilled if stocks put up another double-digit gain through 2014, but even more thrilled if they sell off first, giving us time to add at lower levels.

Now if you’ll excuse me, I have two kids under seven with bronchitis to tend to.

Author

Joshua M Brown