Stocks fell amid profit taking and heightened geopolitical risk as tensions escalated along the Gaza Strip.
The Dow Industrials fell more than 100 points. That no longer sounds very large. It’s just a little over 0.6%. But it was the second down day in a row after a rally that brought the Dow above 17000 for the first time. As I noted Monday as the Dow was setting its record, bulls will scream there’s more to come, while bears will scream that the end is near. After two down days the bears’ collective growl sounds a lot more forceful.
We have heard these noises before. Since the bull market began over 5 years ago, every one or two-day correction is quickly followed with shouts of “major correction pending.” We have all heard how many months it has been since there has been a 10% correction almost constantly. Every time we hear that statement the streak is another month or two longer. Logically, we know there is no economic dictate that says a 10%+ correction has to occur every so many months, but that doesn’t stop commentators from bringing the subject up every time the market experiences a couple of down days in a row.
One of these days there will be a 10%+ correction and those predicting it will finally be right. But when that happens there will be a fundamental reason for it, not just a few days bout of profit taking or some hostilities in a part of the world which produces no oil. We can all play the hypotheticals and extrapolate hostilities in Gaza to something more dangerous. As Israel brings tanks to the border, we might even hear more of that today. Traders tried to do the same with the Ukraine crisis and the ISIS invasion of Western Iraq. However, the real dots ended up connecting much different than the hypothetical dots. They always do and almost always the consequences prove less dire than the alarmists predict. There are a lot of analysts and commentators looking for the fame of picking the exact top or exact bottom. The law of large numbers suggests that someone will eventually be right. But that doesn’t mean we need to listen to predictions that almost always have very little basis in fact. Markets have minor corrections all the time. Serious corrections need a serious cause. I don’t see one at the moment.
With that said, earnings season is just around the corner. Alcoa reported last night and results were OK. But Alcoa rarely moves the overall market. When earnings season really gets going next week we will hear from a few big banks and tech companies. The banks don’t offer a promising outlook. A flat yield curve and costs related to Dodd-Frank will keep a lid on profits. Bond trading desks are likely to have a tough quarter as well. On the tech side, we already heard from Intel# that business was nice. Markets are unlikely to react again when it reports actual earnings. But Google# is always problematic on the expense side and IBM# has failed to report increased revenues for many quarters. The early part of earnings season looks iffy just as it has been now for several quarters. It would not be illogical (double negative noted!) for the two-day correction to morph into one lasting a week or two stretching to 4-5%, particularly if events in the Middle East stay tense.
But once we get past the few iffy tech companies and the largest banks whose results are almost incomprehensible (too many moving parts), earnings season should start to improve. Maybe even better than OK as second quarter numbers will get some delayed benefit from sales deferred from the winter quarter. Without some unknown event, what we are seeing today doesn’t look like the start of the 10%+ correction so many people have been looking for. Indeed, the skepticism that surrounds the market is in effect a protective layer that means the bull market should stay enduring. Individual investors are still pulling money out of equity mutual funds and adding to bond fund holdings. If there is a “bubble” it is more likely to be in the bond market than in the equity market.
But there is one segment of the stock market where bubble characteristics have infiltrated and that is the social networking/neophyte biotech/cloud computing speculative end of the market. That part of the market got slaughtered in March and April before rallying strongly through June. But the June rally that spilled over into early July ran out of gas well before reaching old highs. Over the past two days these stocks got crushed again. I said previously that many of the highest profile names may never reach their March highs again, and the price action this week reinforces my opinion. You can trade this group if you choose and there will be plenty of volatility that might allow a short term profit if your timing is perfect. But these stocks collectively remain obscenely overvalued. In some cases, avarice-inspired desires to get rich early have led to bubble valuations in the private market even before IPOs. Valuations for names like Uber already defy imagination and the company hasn’t even gone public yet. I love the Uber experience as a consumer. Ditto Pandora and Yelp. But that doesn’t rationalize the stock market’s valuation. Indeed, the speculation that has been contained to a relatively small corner of the market continues to dissipate. That is a very healthy sign for the bull market’s longevity.
Today Tom Hanks is 58. OJ Simpson is 67.
James M. Meyer, CFA 610-260-2220
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