Why is the Market Down?

The stock market had a good year in 2014, at least the medium and large U.S. stocks did. However, international stocks over the last 12 months dropped -6.7%, US small stocks were up only 3.5% and the Barclays US Govt/Corp [bond] trust returned just 3%.

Now, at the end of the year and first few days of the new year, a traditionally very good time for stocks known as the “Santa Claus rally,” our stocks have been sharply lower. So is this the start of a big correction and a bad 2015?

Bears say:

1) International markets, especially Europe, are dragging the US. down. When the first half of each day is down and an hour or so after the European close, our markets spend the rest of the day moving up, that is a clear signal that Europeans are selling the US. European stocks are cheap and US large stocks are pricier and easier to sell.

Europeans are selling because:

a) Fears are rising in Europe as Greece and Italy are increasingly chafing against the austerity measures put in place by their northern European lenders. In actuality, those restrictions are light and reasonable. But, it is easier to blame someone else for your problems, especially if your problems involve bloated and often corrupt government, terribly heavy reguation, high taxes and cultural attitudes, all of which are very difficult to change.

b) Germany is getting tired of Greece and is reportedly less worried about them leaving the Eurozone, which some people see as the first is a series of dominoes.

c) Mario Draghi, the ECB president in whom investors placed a lot of faith is considering resigning to run for president of Italy. Even if he stays, some are wondering if the ECB (European Central Bank) can really pull off the money-printing stimulus that Draghi has promised.

2) Large pensions and other large investors often have to rebalance their portfolios to get back in line with their long-term allocations. So, when one asset class outperforms the others, they must sell it to get back in balance and that often happens in January.

3) Many on Wall St. are extremely short-term-oriented and if things are going down they will jump in and sell just as they bought in when things were going up. They add fuel to the fire.

4) Economic reports out of China have been disappointing lately. So, China is slowing down, Japan is in recession, European problems are back and Europe is still on the edge of recession.

5) The price of oil is crashing, now down to $49 from over $100 in June. While that’s great for consumers, it is bad for the energy industry and all who are related to it, including industrial engineering and construction firms, shippers and others. It also makes people wonder if oil is not the canary in the coal mine, signaling unforeseen trouble ahead.

6) The Federal Reserve is seen raising interest rates later this year

Bulls say:

1) Declining oil prices put more spendable cash in consumer pockets, and spending it is a stimulant to the economy

2) US economic reports have been consistently stonger over the last few months

3) Interest rates are dropping even lower. That’s also an economic stimulant.

4) It would be hard to imagine a Federal Reserve more accomodating and less willing to raise interest rates if can find any reason not to.

5) Periodic pullbacks are always sharp and scary but are actually good for the market because they drain over-enthusiasm

6) There are no major bubbles out there to burst as we had in 1999 and 2007. Valuations are not very far from average.

I’ve been diversifying client accounts into partnerships not connected to stocks, into less volatile, higher-income paying stocks, into stocks with strong growth selling at reasonable prices and keeping some bonds in most accounts. So, I’m not that worried.

If you like a company’s long-term outlook, a pullback is a good thing because you can buy more cheaply. Warren Buffett and others have become wealthy with that kind of strategy.

Dave Hoshour