The markets bent but did not break yesterday. The Standard & Poor’s 500 (SPX) at its worst declined over 24 points or 1.34%, only to close off 16.4 points or 0.89%. Initially the raison d’etre for the selloff was attributed to earnings and economic data. However, problems in the emerging markets are beginning to bubble up. As a result, we saw a turnaround in futures overnight from slight gains during The Tonight Show to declines during The Today Show. The markets are indicating to decline about 2/3% at the market open.
Anyone who has been involved in the financial markets for at least three decades, as have yours truly, still has scars in their memory from the Latin American Debt and Currency crisis which was at its worst in 1982 -83 and the Emerging Markets Currency and “Asian Contagion” Crisis of 1997-98. Argentina just devalued its peso. The Turkish lira is plunging in the wake of political chaos in that nation. The South African rand is declining. Venezuela devalued its currency earlier in the week. China’s factory order report as well as other economic data in that nation points to a slowing down. The result is that global markets fear another emerging market crisis which will spread across global stock, bond and currency markets.
This is the type of exogenous event that is hard to predict but rather easy to react to. It does not have any root in our domestic economy, hence it is difficult to quantify in the short term, yet it could have secondary domestic implications. The immediate result is a flight to safety, the US Dollar; a bid in gold; and, declining stock markets. That bad news is that we should be prepared for the emerging markets news to spark the long overdue correction in the US stock market. This will be a process and not a one-day one-time event, i.e. sudden market crash. The good news is that we have learned how to combat and react to foreign currency and debt crisis over the course of the last three decades, so there are now built-in monetary and financial markets safeguards and mechanisms which can be used to confront foreign currency and debt problems. This time around, the massive reserves held by China, can be put to work. This was not the case twenty or thirty years ago when China was a sleepy pre-emerging market economy
As it turns out, yesterday, after reading McDonald’s (MCD) earnings report and conference call transcript, we sold out a decade long holding in that restaurant chain. Some newer and small positions for our Low Volatility / High Dividend portfolio were maintained. However those were a small fraction of our holdings as of this time yesterday. To cut to the chase, I have lost faith in McDonald’s management and the company’s ability to look forward. For growth oriented portfolios, it is no longer worth holding onto a company growing at 3% and paying a 3.4% dividend. Hence the stock was jettisoned from our Growth and Food/Restaurant portfolios but maintained in the dividend focused portfolio. As it turns out, McDonald’s growth is coming from emerging markets and that engine is now sputtering.
So, in the final analysis, we don’t want to panic but we do want to act prudently and perhaps, for at least a few weeks put the defensive team on the field. Let’s me be very clear. The SPX is only off just over 1% from its al-time high. We should embrace pullbacks and not fear them. My cash levels have been growing and now stand at about: 3% for the growth portfolios; 6% in the food/restaurant portfolios and 7% for the low volatility/high dividend accounts. If, this emerging markets news continues to impact US markets and a correction ensues, I will raise those cash balances with an eye at putting that cash back to work should the broad market decline, as I expect it might 5 – 10%. So, if you have cash on the sidelines and feel that you missed out on the recent stock market run, you will get another opportunity in the next few weeks. Keep in mind that second chances don’t come all that often. On the other hand, do not rule out the possibility that the pullback is shallow and brief – say, no more than 3 – 5% and just 2 – 3 weeks and you miss a bottom. Hence, you always want to stand ready to act vigilant in the case of a pullback or opportunistic in the case of a rebound.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long MCD — although positions can change at any time.
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