Jul 5, 2014

What Goes Up Must Come Down..

Sir Issac Newton
"Whats goes up must come down"

This quote by Issac Newton describe one of the important physical phenomena on Earth and it is also an accurate of any financial markets. However, the US stock market in recent days, seems to be defying this basic law of financial markets.

The S&P500 has been correction free for the last 1000 days (A correction is a fall of more than 10%). To put into context, the US stock market falls more than 10% on average every 115 days (Data since 1900). In summary, it has been a very long long time since the US stock market has any significant pullback and this makes me very very worried.  




Type of declineAverage frequencyAverage lengthLast occurrencePrevious occurrence
–5% or more
About 3 times a year47 daysOctober 2013August 2013
–10% or more
About once a year115 daysOctober 2011July 2010
–15% or more
About once every 2 years216 daysOctober 2011March 2009
–20% or more
About once every 3 ½ years338 daysMarch 2009October 2002
Source: Capital Research and Management Company. Data based on 31 Dec 2013

So what is the explanation for this long run? Two Words

Central Bankers

The historical low interest rates around the world has fueled a rush of cheap money chasing for returns. Central bankers believes that it is still too premature to raise interest rates as they believe that inflation is still benign and an accommodating monetary policy is needed to ensure that the world doesn't lapse into another crisis. However, if history is of any guide, central bankers are often slow to act when inflation starts hitting the headlines and a bubble is usually formed as a result of that. With the complacent index at its 2007 level, it is hard not to believe that the financial market is ahead of its fundamentals at this point of time. 
Looking at the chart of the average no of days before a major correction I will say that we are statistically due for a 10% correction. In fact, I won't be surprised even if the market falls by 20%.
Chaos in Middle East
Two major events occurred during June. The first event is the incursion of ISIS (Islamic State of Iraq and Syria) into the northern parts of Iraq and occupying the country's second largest city. The second event is a major correction of the Dubai stock market resulting in losses of up to 31%.
An image uploaded on June 14, 2014 on the jihadist website Welayat Salahuddin
allegedly shows militants of the Islamic State of Iraq and the Levant (ISIL)
driving on a street at unknown location in the Salaheddin province. (AFP Photo)
 The incursion of ISIS lead to a spike in oil prices, and gave the international financial markets a scare. There are fears that the rise in the oil prices will lead to increased inflation, indirectly leading to a rise in interest rates. The fears died down as their advance slowed and the financial markets returned to normalcy. 
The crash of the Dubai stock market was little known to the rest of the world and was more or less ignored. The Dubai stock market was the best performing market in the last 2 years and at the heart of the rise, are United Arab Emirates' property companies. It is a familiar stock market story, whereby the market went up too fast too high and came crashing down at the first hint of negative rumors. 
Is there an opportunity to get into the Middle East market? I believe there is. However, I will want to observe the market a bit more and not jump into it prematurely like what I did for Turkey and Thailand. If you recall, I moved a part of the portfolio into Thailand and turkey after a 15% correction. However, these two markets fell another 15% and I have to cut loss on the position. Since than, the stock markets of these two countries have recovered to its previous high and are two of the better performing markets for 2014. 
Portfolio Strategy

The global financial market is grinding slowly upwards making small incremental returns each month. The US and Emerging Markets performed the best, while Europe underperformed. 

Essentially, the 3 regions are taking turns to perform in the last 6 months. It seems like international investors are just rotating their funds among the 3 regions, trying to squeeze out as much return as possible. It will be futile at this moment in time to predict which of the 3 regions will outperform, so a shotgun method of allocating an equal share to each of the region seems like a sound strategy for now.
Meanwhile, I intend to continue to wait for a more meaningful correction before moving in. Never forget the number 1 rule in investing. Capital Preservation! 

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