- By: Sanjay Pawar
As we sit in October 2016, the biggest question on everyone’s mind seems to be, what is going to happen next in the markets?
The single biggest factor contributing to this question is that since March 3rd 2009, the S&P 500 index has been up about 210%! That is about 91 months of an upmarket cycle. Based on a study done by Invesco, on an average a bull market lasts about 60 months and a bear market lasts about 12 to 18 months. In my opinion, from a pure cyclical perspective the markets are more likely to correct downwards in the next 12-18 months, than to make another 20% run up.
Let’s look at the US economy. Sure we have recovered from a drop in GDP growth rate of -6.3% in Q4 2008, but over the last 5-6 years GDP growth has stayed around 1.5%. Over the last 4 quarters (Q1 of 2016 and back), GDP growth rate has been down from 3.9% in Q2 2015 to 1.1% in Q1 2016. And this is reflected in the TTM earnings of S&P 500 over the last 4-5 quarters. They peaked in Q4 of 2014. Granted the news is not alarming, but it also does not suggest great economic conditions and an environment of high growth.
Looking at global conditions, both economic and political, there are a few factors that I worry about. Growth in Europe has been slow, around .30%-0.6%. With the latest round of problems in their strongest economy, Germany, these growth numbers could turn to negative very quickly.
China appears to have recovered well from a drop in its GDP in Q1 of 2016 and stabilized. They did have some concerns in their banking sector earlier this year but there has been no significant bad news since Q1 2016.
Recent OPEC deal to cut production to bolster oil prices, should help a few industries, both domestic and international. Not to mention, a rise in price of oil would create a lot of buying power for the oil exporting nations around the world and could in turn drive demand and economic growth.
Underlying all of the above, is the overarching central bank actions across the world. There has been a movement across the globe for central banks to cut interest rates and make cheap money available. In my opinion, this has artificially (not sure how that word fits in a market situation) pushed global markets higher because money is cheap and rates being low, investors have fewer opportunities in risk free assets to make Real returns.
Ideally low interest rates should have created a higher demand for credit by businesses but I am not sure if that has happened. 10 year yield is currently at around 1.6% and 30 year is at 2.33%. I am not sure what the argument would be to buy 30 years for a meagre 0.73% of additional yield, while taking inflation and interest rate risk. Fortunately, the non-government credit markets are yielding higher.
All considered, in my opinion (and I am not saying I am right), it would be a good strategy to reduce risk across portfolios, gradually over the next few quarters. My focus is on cash income generation with dividends and interests. Reduce risk both on equities and bonds. Fortunately, volatile markets have stayed high enough to give investors more time to reallocate and reduce risk.