After experiencing losses in August and September stocks have come back strongly in October. This column is being written on Oct. 23, and as of that date the stock market has recouped its losses for the year, as measured by the broad based S&P 500.
Whenever the stock market makes major moves, whether up or down, analysts will try to determine a cause. In some cases there is an obvious reason, but most of the time there are several factors at work that are influencing prices.
The rally we are seeing in October is certainly the case of several factors at work. The key reasons at least in my mind are: stabilization in the Chinese economy and stock market, monetary easing in Europe, and decent corporate earnings.
The situation in China has been weighing on world markets for much of this year. China’s economy has been slowing, and given its size it certainly has an impact on world markets. The stock market in China has been especially volatile this year.
What really appears to be the case, is that China’s reduction in purchases of raw materials reflects a normal transition in its economy. In the U.S. economy manufacturing employment has been declining in recent decades, as most jobs are in services. China is just starting that transition, so while manufacturing is starting to slow, the services side in China is showing significant growth.
As long as the services side of China’s economy continues to expand, the likelihood of China falling into a recession is low. In addition China’s stock market has recently been showing some signs of stabilization, which is helping to remove fear from our market.
The weak European economy has been more of a longer-term issue for global stock markets. However, growth figures out of Europe are at least a little better than they have been in recent years. Also, new rounds of monetary stimulus are also helping to set a more favorable tone for financial markets.
Companies issue earnings reports on a quarterly basis, and October is a month when earnings are reported for many corporations. Given the weak market that we had experienced in August and September, earnings expectations were not that favorable going into this month.
Reports that have come out this month have for the most part been decent. There are still a number of companies that are reporting disappointing results, and their stocks are getting punished on the day of the announcement. However, there have been enough companies showing positive results to more than make up for those who have disappointed.
Various investors will have different reactions to the kind of price action that we have experienced in recent months. There will be some who are uncomfortable with the volatility, and will just not to want to deal with stocks. There will be others who will think that all you have to do is time the market, and will do very well. Just buy when stocks are down, and sell when they rise.
There are deficiencies in both approaches. Stocks have risk, but people should not overly focus on the short run. Over long periods of time stocks are very likely to do better than less risky investments, though in the short run anything can happen.
For those who think they can time the market, oftentimes you might be right one time, and think you can be correct consistently. Inevitably market timers will be wrong enough times that most will do worse than those who trade less frequently.
The best approach is to periodically rebalance your investments. For example, if stocks drop 10% you would make additional purchases to get your percentage back to where it was. On the flip side you would reduce your allocation to stocks after they have been strong.
Market corrections and recoveries are all different. Most corrections are not too severe, like the one we just experienced, but clearly are stressful when they are happening. However, periodically more severe ones do occur, as we witnessed in 2008. The best approach is to focus on a long-term plan, and try not to be overly influenced by market volatility. 29
