Quote of the Week
“Choosing to be positive and having a grateful attitude is going to determine how you’re going to live your life.” – Joel Osteen
Last week we had a typical Quad IV week. The S&P 500 was down -2.18%, the Dow was down -1.27%, and the Nasdaq was down -4.12%. At the moment there doesn’t seem to be a bottom to the stock market.
This week I have been calling some clients to check in with them to see how they are doing. Other than catching up I had an alternative motive to see if they had read last week’s letter. The response was around 50% who read the letter which is about what I would expect.
In last week’s letter I discussed how valuations have effected the stock market decline so far this year. I also discussed that we have not yet experienced the next potential leg down due to the up-coming corporate earnings reporting. What I am saying is that I don’t think the carnage is close to being over. Because I think that it is important for you to understand, I am repeating last week’s letter this week.
I am also re-printing a chart showing how much you would need in percentage return to get back to even for various percentage losses.
If you have any friends that are invested in the stock market and they are hoping that it will turn around soon we would be happy to discuss with them the market forces about to happen and why.
We are currently 70% in cash with the remainder invested in gold, US dollar, China, and some bonds.
Before I start I want to recommend a video on YouTube. If you go to YouTube and type in the search box: “Financial Advisor Summit Kyle Bass CNBC”, it is the first video to pop up and lasts just over 20 minutes. Kyle Bass is one of the people I follow. You will learn a lot, I promise.
Last week the markets had a big rally. However so far this week the markets are giving some of it back. Unfortunately, we will always get strong short-term rallies in a bear market which gives the uninformed investor (not paying attention to the math) hope that the markets are going to start going back up. Note: until the math changes we won’t change our positions.
Last week the Dow was up +5.4%, the S&P 500 was up +6.4% and the Nasdaq was up +7.5%.
I want to explain how stock market valuations work. In general when interest rates on bonds go up that negatively affects stock valuations. So far this year interest rates for the 10-yr US Treasury Note has risen from 1.55% on January 1st to 3.24% as of today. Put yourself in the position of buying the stock market vs the bond market. If bond yields are up, that makes the bond market more attractive and the stock market less attractive when you are looking for a safe return. So you would be more tempted to buy bonds vs stocks. That being, stock valuations tend to go down.
The graph below shows how valuations of the stock market have been driven down because interest rates on bonds has risen. The valuation of the stock market is down between 25% and 30%. On the graph the earnings line shows an increase. What happens if the earnings line starts to decline? Answer: the P/E ratio (price/earnings) starts to go down. If the earnings go down (the denominator) it will drag down the Price (the numerator).
So what does this all mean for stock prices? According to projections for corporate earnings to be reported for the second quarter, they are expected to fall very steeply. So far we have had a valuation decline due to rising bond rates. That is the first leg of the decline. If corporate earnings come in as expected that could or should be the second leg down. I don’t know for sure what will happen, but it wouldn’t surprise me if we have a second leg down for the stock market. How’s that for a math lesson?
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These are Larry Lof’s opinions and not necessarily those of Cambridge, are for informational purposes only and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
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