Category Archives: Historical Lessons

Market Volatility Could Derail Momentum Stocks

Momentum investors beware — the recent rise in market volatility could make for challenging times for momentum stocks, while quality growth plays could emerge as the market’s new leadership group, according to a report in Barron’s. Momentum investment strategies invest in companies exhibiting strong price momentum, but that momentum may or may not be supported by the underlying fundamentals, which can lead to declines when they fall out of favor. According to Bank of America strategist Savita Subramanian, “momentum stocks traded at a 50% premium to the market before the selloff, versus a historical average premium of 20%”, but once momentum stocks peak in a particular market cycle, they fall, on average, 27%. One indicator investors can look at is the CBOE Volatility index, or VIX, says Subramanian. Once the VIX moves over $25, momentum stocks have tended to underperform the market by a wide margin and it currently hovers just above that level.

So where do investors go when momentum starts to underperform? Growth companies could be one group that starts to take the lead. “When there’s a scarcity of growth in the economy, investors go to names they know can grow on their own,” says Joe Fath, manager of the $45 billion T. Rowe Price Growth Stock fund. Below is a list of some growth companies he thinks may be worthy of consideration.

barrons table

Dalio Sees Significant QE Before Significant Rate Hike

Hedge fund guru Ray Dalio says he expects the Federal Reserve to make a significant quantitative easing move before it makes a significant interest rate hike.

“To be clear, we are not saying that we don’t believe that there will be a tightening before there is an easing,” Dalio writes in a recent post on his LinkedIn page (h/t MarketWatch). “We are saying that we believe that there will be a big easing before a big tightening. We don’t consider a 25-50 basis point tightening to be a big tightening. Rather, it would be tied with the smallest tightening ever.”

Dalio says that the risks of the world being “at or near the end of its long-term debt cycle are significant”. Being at the end of the long-term debt cycle means interest rates around the world are near zero, spreads are low, and debt levels are high, he says, and central banks have a limited ability to ease — all while many people have a dangerous bias to the long side. He says those secular factors should outweigh short term debt and business cycle factors –which the Fed seems to be weighing more heavily — that would typically mean a tightening phase is due.

Despite the very limited ability to ease at this point, he thinks easing is the path the Fed needs to take. “While we don’t know if we have just passed the key turning point, we think that it should now be apparent that the risks of deflationary contractions are increasing relative to the risks of inflationary expansion because of these secular forces,” he writes. “These long-term debt cycle forces are clearly having big effects on China, oil producers, and emerging countries which are overly indebted in dollars and holding a huge amount of dollar assets—at the same time as the world is holding large leveraged long positions.”

Dalio says that, while the Fed has been more focused on short-term business cycles than the long-term debt cycle, it will react to what happens going forward. He seems to think that will mean more quantitative easing before we hit a significant tightening phase, but he also says that he is worried that the Fed will feel that it must stick to its guns and follow through with the tightening it has been discussing.

Nygren: Relax, and Rebalance

Much of the speculation about the reason for the market’s recent plunge has been that investors are downright scared about China’s slowing growth. But top mutual fund manager Bill Nygren says the sort of correction we’ve seen recently is simply a part of life when you are investing in stocks. And from a long-term investing perspective, he does not think China’s slowdown will have as big an impact as many believe.

“I think sometimes we just forget that the market doesn’t really need a reason to have a 10% correction, which we basically had over the past four trading days,” Nygren tells Morningstar. “They occur pretty frequently–about once every year and a half, on average, historically–and they are really nothing for investors to worry about as they are pretty common.”

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As for China, Nygren laid out some interesting numbers regarding its slowdown’s possible impact on the US. “For long-term investors … where we’re trying to estimate the value of a business five to seven years from now, it’s hard to imagine China being important enough to cause a 10% reduction in values,” he explained. He says China accounts for about 16% of world GDP, so a 5% to 10% change in Chinese output would represent a 1% hit to global GDP, and an even smaller impact on US multinational firms. “We’re seeing this as increased opportunity of values falling substantially less than prices,” he says.

Nygren says that, historically, the stock market has been the best investment vehicle, even though there are periodic corrections and bear markets. And, he says, no one has found a way to time those declines. He says investors should use the recent market declines as a chance to rebalance their portfolios. “Over a long period of time, the best way for an individual to make sure that they can sleep at night and get through these tough periods is to have a balanced portfolio and use large moves in the market–either direction–to frequently restore balance to that portfolio,” he says. “If you don’t do that, the market is taking your portfolio out of that balanced position and giving you more risk exposure to a sector that’s already performed well and maybe getting extended. So, I think most investors should take a deep breath, know that equities are good long-term performers, and take a look at their portfolio and see if they can take advantage of it.”

Nygren also talks about the pros and cons of rising interest rates as they pertain to bank stocks, why he is high on some industrial stocks, and why he thinks investors are overreacting to oil price declines, creating opportunities in oil stocks.

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The Search For The Silver Value Metric Bullet

Is there a single, silver bullet valuation metric that you can use to accurately evaluate any stock in the market? An interesting recent piece from Barron’s looks at a couple of attempts to develop one.

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Doubleline’s Baha: Don’t Think Short Duration Bonds Are A Rate-Hike Panacea

Conventional wisdom seems to be that the best way to deal with looming interest rate hikes is by buying only short duration bonds, or dumping bonds altogether. But in a recent Forbes column, DoubleLine’s Bonnie Baha takes aim at those notions.

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El-Erian: “Classic Overshoot” In EMs Will Hurt Now, Create Opportunities Later

Mohamed El-Erian says we are seeing a “classic overshoot” to the downside in emerging markets right now, which should lead to more pain in the near term but opportunity over the longer term.

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Should You Use Dividend Yield As A Value Metric?

Is dividend yield an effective value metric? Not in the US, says Patrick O’Shaughnessy.

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