Of Mutual Interest: The reaction after the market’s plunge
NEW YORK – There were few warning signs before the stock market’s plunge in early February, but so far, the slump hasn’t changed investors’ thinking very much.
Stocks did well throughout 2017, and the gains sped up in December and January. Investors were convinced that stocks would keep going up because the global economy continues to grow, which helps companies earn more money.
The market tumbled as investors worried that inflation is picking up and that interest rates also will rise, which would likely slow the economy. That helped pushed stocks to a 10 percent drop in less than two weeks.
The new worries about inflation haven’t much changed investors’ preferences for stocks, however. Last week investors bid up technology and industrial companies and banks, which tend to do better when economic growth is stronger. Those are the same types of companies they were buying before the market tumbled.
There’s a logic to that reaction, according to Tom Stringfellow, president and chief investment officer of Frost Investment Advisors: stocks have fallen to more reasonable prices, and there’s little reason to doubt that the economy will keep growing.
Answers have been edited for length and clarity.
Q: Is there any evidence investors are taking a different approach to stocks or bonds after this downturn? Does that mean we’re in for more turbulence?
A: This is the first real correction in close to two years, and investors have seen little volatility recently. Then all of a sudden it’s handed to them with record levels of volatility in a matter of days. I think it did serve as kind of a warning to weekend momentum investors to have a better strategy.
I would say that those stocks that investors have re-bought into were at a cheaper valuation in many cases than a few weeks before. The headline technology stocks, like Amazon, Google, Facebook, Netflix, Apple, are names that I think have very visible growth metrics and business models, and so there’s actually a visible stream of growth possibility and revenue that people are looking at. That’s a positive. As long as we’re still in a relatively low inflation (environment) …they’re not obscenely expensive right now.
Q: Did corporate earnings get overlooked? Fourth-quarter reports looked mostly good, but for the first two weeks of the month the market sold off anyway.
A: That should always be the number one target (for investors): what’s my earnings outlook? In a couple of days, not only did we get better visibility that earnings growth might continue into the teens through the balance of this year, we knocked a couple of basis points off of price-to-earnings ratios. We had cheaper multiples and we had earnings growth.
In a matter of a couple of days, stretched valuations fell more in line with what looks pretty reasonable. If inflation picks up because of economic growth, positive market and economic conditions, that is positive for the markets. We know that the markets seem to always sell off when somebody gets nervous about interest rates. They catch their breath and continue on.
Q: Were there any parts of the market that fared notably worse or notably better?
A: All sectors were down fairly uniformly, if you go from the January highs to Friday. I think the average sector of the S&P 500 was down about 9 percent. The worst was down about 11 percent and the best were down 8 percent. The top 50 stocks in the S&P and the bottom 50 stocks were down fairly uniformly. So that says there’s really not been any cover in terms of sell-off. What it does do is sets out some more interesting valuations.
Q: This was an unusual sell-off in some ways because bond prices didn’t rise and there wasn’t much of a move in gold or silver. Why was that?
A: What I found interesting was the absence of panicked buying. I really didn’t notice any flight to precious metals or other seemingly safe assets. There was certainly movement into cash and into shorter maturity instruments, but the real impact was the selling off of assets, not the buying into safe havens.
Q: The markets jumped 10 percent in two months without much news other than the tax cut package. Did that make sense? Are those cuts now priced in?
A: The level of price momentum didn’t make sense given the underlying message of pure tax reform. What it did highlight was pent-up demand for equities coupled with an improving picture in corporate earnings. I was very positive on the underlying fundamentals of the markets but in turn was concerned about the inevitable whipsaw effect of any negative news. Today, though, I really don’t feel the good news is completely priced into the markets given the recent sell-off and improved earnings outlook.
Q: Do you think stocks were or are too expensive, or do you think they went too far too fast?
A: Stocks are closer to fair value today than in recent past. But the outlook in improving corporate earnings, job growth, trade and consumption demand provides some upside for earnings expansion and perhaps a little multiple expansion.