Every year or so, we expect the stock market to drop 10-15%, and view this as a healthy exhale or pause within a longer-term secular bull market. But when the market dips, how do we know the bull market is still alive and the drop is not the beginning of our next sustained bear market? For the stock market to enter prolonged bear territory, the underlying economy must first enter recession. Two things happen in advance of a recession: the yield curve flattens and inverts, and the Leading Economic Indicators drop.
The chart below shows the yield curve on U.S. treasury bonds from two different time periods – today, and late 2006. The vertical axis on the chart shows yield, and the horizontal axis shows maturity. The green line at the bottom shows yields from today. An upward-sloping yield curve where short-term rates are lower than long-term rates is referred to as “normal” in shape. The blue line at the top of the chart shows a curve that has flattened and actually inverted, where short-term rates have risen above long-term rates. This inverted curve from late 2006 was predictive of the recessionary period that started in 2007.
The Leading Economic index is a basket of data designed to signal the direction of the economy 6-12 months in the future. In the chart below, the two most recent recessionary periods are represented by the shaded grey bars, and the blue line represents the Leading Economic Index, or LEI’s. The blue line dips down several months in advance of the recessionary periods, signaling the economic slowdowns.
The next time the market swoons, drop us a line to find out if the yield curve has inverted and/or the LEI’s have dropped so you can respond accordingly to protect your stock portfolio!
Source: U.S. Treasury, © 2016 Pawleys Investment Advisors, LLC. All rights reserved.
The Pawleys Dividend Fund has been long Home Depot stock since late 2010. For the past four years, the total return figures for HD have been dizzying: +22% in 2011, +50% in 2012, +36% in 2013, and +30% in 2014. It was the top performing holding for the Pawleys Dividend Fund in only one of those years – 2012. Yet HD has been a solid contributor to the overall portfolio returns, and has helped keep our gross return figures ahead of the DJIA for each year. We decided to break down the HD numbers on a daily basis to see if we could learn anything more.
For each year, the price movement on the stock generated the entire yearly gain in just a select number of trading days. Traders moving in and out of the stock who were not long on those select days would have the return on their HD position reduced to zero. What did we learn? In 2011, the DJIA annualized total return was only 5%, while HD delivered +22%. The entire total return could be attributed to just 6 trading days. The markets were more robust during the other years, and the HD gains were a result of several days, not just a few. Stock picking and extended holding periods become even more critical to delivering good performance in lackluster markets.
If we continue to hold HD during the next recession and stock market downturn – which we may or may not – we will crunch the numbers again to see how the daily returns break down in falling markets. Stay tuned for more from the beautiful beaches of South Carolina!
Source: Yahoo! Finance
© 2015 Pawleys Investment Advisors, LLC. All rights reserved.
Nothing like coming in hot to 2015. Mid-December Federal Open Market Committee comments about monetary policy included the word “patient,” which caused a stir akin to that created by Santa on the rooftop. The Leading Economic Indicators for the U.S. came in at +0.6% for November, further solidifying their upward march. Investors of all faiths found peace with this, and the equity markets rocketed upwards like a sleigh with launchers.
Entering the last week of trading for the year, the major areas of the markets rang in joyous annual total return figures. Major indices and exchanges delivered holiday cheer across the board with solid double-digit returns. The Dow Jones Industrial Average gave investors +11.47%, the Standard & Poors 500 +15.3%, and NASDAQ +15.09%. Sector winners were topped by Utilities and Healthcare, with both posting total return figures over 30% for the year. Other sectors followed suit. The only naughty sector for equity investors was Energy, which lost as much as 10-20% depending on capitalization. The year also saw differentiation by style, as growth orientation outpaced value for 2014 by about 3%.
Now off to celebrate a Happy New Year and a fabulous 2015!
© 2014-2015 Pawleys Capital Management, LLC. All rights reserved.