Portuguese bank drama. Regional conflicts in Ukraine/Iraq. Falling US GDP. Slowing eurozone growth. All drew sensationalistic headlines claiming here—HERE!—was the trigger for negative volatility so overdue for stocks. Yet to date, markets have defied them. But lest you think this would change the skeptics’ song and dance, now they have a new target: Weak earnings growth is the next alleged correction catalyst. Yet this seems to us more like yet another example of the remaining skeptics showing their stripes before they again marvel at this bull market’s “resiliency.”
What’s left out of this picture is the simple fact the economic and market cycle swamps such “events” routinely. This is normal bull market behavior, not exceptional. Folks hunt for bear catalysts and presume Event X equals Result Y, forgetting markets move most on the gap between expectations and reality. Ironically, the hunt for downturn catalysts implies folks just don’t get that the cycle vastly overpowers them. They don’t appreciate that while US GDP was bad in Q1, it’s also over and the cycle churned on. They don’t get that Portugal didn’t cease the bull in 2010, 2011 or 2012—and this concern is even less powerful today. These are great eyeball-grabbing headline tools, and they could cause near-term wiggles here and there. (Or not!) But the longer-term direction is unlikely to be swayed much by events you heard of on TV. Why? Chances are high you weren’t the only person tuned in. (And, by the way, someone had to tell the reporter that news, the channel may have been late to the party, and so on.) Markets are really just a collaboration of people (and machines programmed by people). If those people heard the news when you did—or earlier—they probably already acted on it, making their opinions and assumptions already reflected in current prices. While not perfectly so, markets are pretty darn efficient!
If most expect markets to zig based on all these “catalysts,” those expectations are quickly discounted, and stocks often do something different. For example, zag. But markets won’t necessarily do the opposite of the consensus—veering to the polar opposite merely because it is the consensus isn’t a winning strategy: This is not a case of the false either/or argument. Because Event X doesn’t automatically mean Result Y should not be taken to mean Event X always yields Result Z. It might mean Result .[i] It might mean nothing. You cannot memorize a list of rules and memes and forever invest successfully. Nor can you just do the opposite of what you think the crowd is doing to achieve success. It’s helpful in this probabilities business to know what the crowd thinks, but all that tells you is what isn’t likely to happen.
In 2013, forecasters in Barron’s “Roundtable” predicted a “year of modest gains for US stocks.” That was the crowd. The contrarians would likely have thought, “down.” The S&P 500 Total Return Index finished up 32.4% for 2013.[ii] . In late 2013, forecasters that were polled in a similar roundtable predicted mid-single digit stock returns for 2014. (The S&P 500 has risen 7.1% in 2014’s first half.[iii]) In June, that same group of forecasters provided an update on their 2014 S&P 500 forecasts in Barron’s “Midyear Roundtable.” Now, the bullish forecasters are predicting … drumroll … a “meager” 5% gain through the rest of the year. And the bearish ones are predicting stocks might end 10% lower. These forecasts equal the zig and zag. More research than this is required to gauge future market direction.
Bears saying stocks must fall seem to forget it is normal for stocks to rise even if the world looks weak. Stocks have a long, long history of brushing off widely assumed negatives. For instance, stocks were up for the year during both the 1991 Gulf War and the 2003 Iraq War. And during this expansion, we’ve already seen a negative dip in GDP (Q1 2011), but the bull kept chugging along. As for the latest feared catalyst—even if earnings growth were to slow down a tad in Q2, it doesn’t necessarily portend poor stock market returns. During the 1990s bull, earnings growth gradually decelerated after its initial jump, but stocks still continued to push higher throughout. Plus, Q2 2014 estimated earnings growth is still positive. (Oh, and we just saw this movie in Q1.)
Yes, there can be sense in looking for negative catalysts. Just don’t blind yourself to the strength of the cycle in the process. The key is just to be aware the hunt goes on—and that so long as most are hunting for the next bear’s trigger, it’s unlikely that bear is imminent.
[i] This is a wingding. We don’t know why they created wingdings, nor have we ever published one before. We guess there is a first time for everything.
[iii] FactSet, as of 07/08/2014. S&P 500 Index returns, 12/31/2013-06/30/2014.