Markets are moving around a lot. After peaking at 12,875 on May 2nd, the Dow Jones Industrial Average cascaded steadily to a nadir of 12,521 on May 5th, only to rebound to a lower high of 12,781 on May 10th. That’s a 614 point roller coaster ride for a net change of only -115. The same suspects (energy, precious metals, basic materials) drove the upside moves. Curiously, those have been the same culprits for the downside days. Volatility concentrated among recent market leaders (highly cyclical stocks that benefit from a strong economic recovery) has left more stable and defensive names out of the fray.
Treasury prices have rallied amid the roil, and the yield on the ten-year dipped below 3.2%. Those calling for an end to the dollar’s status as the world’s reserve currency remain incorrect.
This is what a market turning point looks and feels like. We won’t know for sure whether it is a significant turning point until it unfolds. This is another way of suggesting that a storm is upon us and we can’t assess damages until it has passed.
What we know is that we have enjoyed an unprecedented number of calm, clear days. At a current reading of 16.4, the CBOE SPX Volatility Index, a measure of expected volatility in stocks better known as the VIX, is hovering close to multi-year lows. Since bottoming in March 2009, share prices have doubled. We recall that as share prices were making their lows in 2009, voices of the herd were assuring all available ears that they were absolutely going lower. They didn’t. Nowadays, it is hard to find someone who thinks stocks can go significantly lower.
Voices of the herd have greeted good news and bad news with optimism. In the first four months of 2011, markets have embraced economic crises among several European economies, regime changes and huge instability among oil producing countries, not to mention a massive earthquake, tsunamis, and a nuclear meltdown. We say embraced because all of this news led to markets gains of more than 5%.
John Maynard Keynes said that markets can remain irrational longer than you can remain liquid. With that in mind, we do not believe in market timing, but we recognize the extreme importance of adhering to one’s investment discipline more tightly as the winds howl and boughs break. Winds are picking up.
Finally, we have observed what appears to be the genesis of a rotation into just the sorts of companies we have been advocating for some time. Shares of large multi-national companies with strong balance sheets, ample cash flow, modest debt, and earnings growth are finding buyers. A steady, experienced hand on the tiller is crucial as weather approaches. Our hand is steady, and we advise passengers to breathe deeply and hang on.