(This content was originally published as an Action Alerts PLUS Alert on July 11, 2016. Stock prices, shares held and portfolio positions may have changed.)
Uncertainty. Denial. Fear. Shock. Panic. Capitulation. Dejection. Apathy. Reluctance. Optimism. Excitement. Exuberance.
Such is the cycle of the emotional roller-coaster we call the stock market. We have witnessed this very cycle play out firsthand over the past month in an accelerated fashion. In light of the S&P 500's new highs and ahead of the second quarter (2Q) earnings season -- which kicks off after today's close when Alcoa AA reports its results -- we would like to take a step back in an attempt to place the latest seesaw into historical context.
2009-15: Bull Market Rally
Investors enjoyed a quintessential bull market rally in the six years from its early March 2009 lows to its May 2015 peak. The dejection (and depression) that plagued investor sentiment throughout the brutal crash of 2007-09 was soon replaced by apathy, followed by reluctance, optimism, excitement and ultimately exuberance. Over the course of the six-year honeymoon, wide-eyed investors watched their portfolios multiply (more than triple), with the benchmark S&P 500 index surging over 215% from its early 2009 lows. Sweet dreams indeed.
Enter summer 2015: Greece's long-standing cash shortfalls forced the country to default on an International Monetary Fund (IMF) loan payment June 30. While this emboldened marginal concerns around global market instability, the market stood in relative denial. The decisive trigger that shut the door on the six-year bull market rally was China's stock market crash.
August 2015: The Abyss
Exit dream. Enter nightmare.
In cyclical terms: Exit post-exuberance denial, enter fear. The S&P 500's parabolic rise was disrupted in Icarus-like fashion, with the benchmark index dropping over 12% in a matter of one month (late July through late August 2015), reaching peak panic levels on Aug. 24, a day that drew comparisons to the 1987 stock market crash known as Black Monday.
In the 59 trading days leading up to the Aug. 24 collapse, global markets gave up all gains for the year and shed an estimated $10 trillion in value. Few assets were spared, with commodities such as oil and copper falling to six-year lows and every Asian currency collapsing against the U.S. dollar. The sudden and rapid selloff across global markets was attributed to a confluence of events, led by staggering economic and market fragility in China, with the Shanghai Composite Index falling 40% from its June 2015 highs.
Per an excerpt from one of our myriad bulletins last August (click here to read the full text) "the drastic decline is a product of a confluence of factors, some of which are data-driven (China reported severely disappointing manufacturing data late last week), others of which are political (i.e., the government's decision to devalue the yuan), and the last of which are structural (i.e., the fact that tens of millions of Chinese citizens opened their first trading accounts in each of the past six months while simultaneously taking on considerable leverage). This by no means covers the gamut of reasons, but instead provides a small glimpse into the country's complicated - - sometimes puzzling -- economic fabric."
Concerns about China's ability to be a powerful engine of global economic growth have added to worries about the potential impact of higher interest rates in the United States, driving stocks sharply lower in Asia and Europe. Exacerbating an already fragile situation was the structural breakdown in market machines, leading to the forced sales of stocks bought on credit (known as margin calls).
End of August/Early September 2015: Temporary Swoon
Exit despondence, enter reluctance. U.S. indices rallied after bottoming Aug. 25, with all three benchmarks -- the Dow, NASDAQ and S&P 500 -- rallying 4% in a single day (the Dow's 620-point jump was the third-largest one-day gain in its history). After enduring a three-day rout that erased nearly $3 trillion in value from stocks globally, paralyzing fear gave way to excitement, leapfrogging reluctance and optimism.
Mid-September 2015 Capitulation
Exit excitement, enter fear. On Sept. 18, 2015, the Dow Jones plunged 290 points after the mini-rally. Global markets continued to fall, and the Dow dropped to 16,000 by the end of the month. Fear returns. Panic follows. Capitulation returns. Dejection sets in.
End of 2015
Exit dejection, enter reluctance and modest optimism. U.S. markets begrudgingly recovered into the end of the year -- albeit in volatile fashion -- with the S&P 500 rising 10% above its late-September lows through year-end. The short-term relief rally did not have enough momentum to carry U.S. indices into positive territory for the full year, with the S&P 500 closing down 0.7% and the Dow down 2.2%, the worst year for both since 2008. The exhausting emotional roller-coaster of 2015 -- which saw multiple double-digit selloffs followed by multiple double-digit rallies -- ended without the least bit of excitement: invoking T.S. Eliot, not with a bang but a whimper.
Exit modest optimism, enter fear and ensuing panic. In fact, the first three words in our early January bulletin (click here to read) say it all: "Fear. Panic. Anxiety."
To quote from our note: "These three words define today's market action and, frankly, the first week of the new year. Concerns over the Chinese economy (spurring a structural breakdown in the country's capital markets), currency wars, geopolitical tensions and collapsing commodity prices have sparked a fire under a tank of kerosene, cracking the underlying psychological fortitude of even the strongest- willed investor." The selloff continued throughout the month. Due to crude falling below $27 a barrel on Jan. 20, the Dow fell 565 points intraday. The convergence of fears, led by a commodity collapse and compounded by the aggravating risk factors listed above, led to a continued decline from the first day of trading to early February, with the S&P 500 plunging 13% in the new year's first 25 trading days. Panic gave way to capitulation, followed by dejection and apathy.
February-April 2016: Recovery
Exit apathy, enter reluctance, followed by optimism and mild excitement. From early February through April 20 of this year, U.S. stocks climbed nearly 15%, bringing the benchmark indices out of the trenches and into the green. The "relief rally" was fueled by a turnaround in oil prices, a dovish Federal Reserve and, quite simply, the lack of major negative macroeconomic developments. U.S. stocks appeared safe relative to ultra-low bond yields and perceived visibility into corporate earnings, at least relative to the lack of visibility throughout foreign markets.
Leading Up to Brexit, the Fallout and Redemption
Exit excitement, enter denial. In the weeks leading up to the U.K. referendum (the "leave or stay" vote), markets were volatile as investors digested many competing factors.
First, toward the end May, the Fed was suggesting the possibility for a June rate hike, as highlighted by the release of its April meeting minutes. While the commentary didn't outright indicate a commitment from officials to a June interest- rate hike, it did reveal a decidedly different Federal Reserve from months past. With global economic and political concerns mounting, investors did not take the news lightly and were cautious on equities. As our subscribers know, the Fed eventually reversed course on these hawkish views as May's disappointing jobs report shed light on the vulnerability of our domestic economy, especially in light of growing global risks.
Investor sentiment quickly turned positive, however, as the broader market recalibrated its focus on oil, which bounced over $50 and hit 2016 highs, and rebounded to close out May on an encouraging note. Although we have dealt with various economic and political concerns throughout this year, the one constant factor, other than general uncertainty, has been the market's link to the direction of crude oil prices.
As June moved forward, the looming U.K. referendum emerged from the back of investors' minds and into the spotlight as voting polls began to indicate the potential for a Brexit. Denial bred a seesaw of uncertainty.
In the two weeks heading up to the vote, the S&P 500 fell 2.3%, reflecting the uncertain economic environment that would follow a decision by the U.K. to exit the European Union. With voting polls suggesting a near tie, investors took some profits and built up cash to protect their portfolios. Shortly after, the market bounced off June lows (as has been the way throughout this volatile year) in the week leading up to the vote as growing optimism for the "stay" camp seemed to eliminate at least one element of uncertainty (for the time being). Blind faith and simple denial bred cautious optimism, with investors, voters and outsiders alike seeming to assume "there's no way they will actually leave."
Exit denial, enter fear. Early results from exit poll data on the night of June 23 suggested "leave" had traction. Exit fear, enter panic.
On June 23, U.K. citizens voted to exit the European Union (click here to read our detailed analysis). Panic gave way to shock, which gave way to capitulation as investors sent global stocks on a two-day free-fall. The sting of dejection and myopic apathy proved short-lived, however, as reluctant optimism emerged faster than expected.
S&P 500 quickly rebounded following its 5.3% selloff and has been trending higher ever since, reaching all-time highs in this morning's trading session (up 7% since the post-Brexit lows). Investors clearly took advantage of the short blip as an opportunity to deploy the large cash balances that had been lying dormant on the sidelines into stocks that now sat at relatively more attractive valuations.
A slew of positive news -- including upwardly revised first-quarter GDP estimates; better-than-expected consumer spending figures (suggesting better-than-expected 2Q economic growth); passing grades for banks following stress-test results (click here to read our Alert); capped by a robust June jobs report -- has added to the recent momentum and put Brexit concerns on the back burner, for now.
We believe the market's accelerated gear-shift throughout the carousel of emotions -- zooming from excitement past denial, fear, panic, shock, dejection, apathy, reluctant optimism and currently nascent enthusiasm -- should be carefully considered through the lens of history. We are confident in our holdings yet would be remiss not to respect the high emotional component that drives investor decisions. If we did not already hold a sizable cash position, we would be more inclined to sell winners than buy above our cost basis. Ahead of second-quarter earnings season, we remain content with our recent outperformance yet prefer to keep our cash on the sidelines for now. More specifically, we will be looking to cash out on WhiteWave (WWAV) for a massive gain if a counterbid fails to emerge by the end of the week.