By Joseph Y. Calhoun
Stocks managed to finish the week on a positive note after a volatile ride that seemed to be based mostly on the changing geopolitical situation. Stocks fell with the imposition of retaliatory sanctions from Russia and rose as Putin seemed to back off at the end of the week. Thrown into the mix was an escalation of US involvement in Iraq bringing to mind Michael Corleone's lament in Godfather III. What is it about this mess of a country that just keeps pulling us back in? And after the close Friday, President Obama let us know that our involvement there will not be quick, that it will likely be months (years?) rather than days or weeks before we accomplish our goals, whatever they may be beyond trying to rescue a group of people no one had heard of before last week. (That isn't to say we shouldn't be helping the Yazidi people but one does wonder why them but not the innocents in Syria or Libya or other hotspots around the world.)
Alongside the geopolitical machinations were earnings reports that have been better than expected (and pretty good generally) and a continuing improvement in the short term economic indicators. The non-manufacturing ISM report, like its manufacturing counterpart last week, was quite a bit better than expected, factory orders were solid and jobless claims hit new lows for the cycle. Those positive reports were balanced by another drop in mortgage purchase applications, a trade report showing a contraction in the deficit unfortunately led by a drop in imports (and no it wasn't all oil), a dispiriting report on productivity, a drop in Gallup's economic confidence index and a more modest rise in inventories than expected.
Contradictions abound within markets too. Against a backdrop of generally positive economic news, Treasury bonds continued to rally with rates for the 10 year Treasury falling, at one point, to a new low for the year. Junk bonds, meanwhile, found a bit of a bid mid-week but continue to look rather sickly compared to their no risk Treasury cousins. Commodity prices, which would seem a logical place for economic bulls to place their bets, continued their ragged performance. Even oil prices, which one would expect to respond positively to the geopolitical turmoil, spent the entire week on the back foot, trading below the 200 day moving average all week. About the only commodity that acted as expected was gold which played its typical safe haven role and rose on the week.
In addition to the current geopolitical and economic uncertainty, we are entering the election season which will add one more element of uncertainty to an already confusing market. The typical pattern in a mid-term election year is for the market to trade down into the election and rally after the uncertainty is relieved in November. I have my doubts about that pattern holding up this year as the gridlock that has served markets so well seems unlikely to be impaired by an election where none of the above would seem the best voter choice. Even a change in control of the Senate, which seems fairly likely at this point, would make little difference since President Obama won't be losing his veto pen for another couple of years.
The contradictions extend to the sentiment indicators where the AAII poll last week registered more bears than bulls for the first time in months while Investor's Intelligence and Consensus continue to show elevated levels of bullishness among advisers. And while the AAII poll respondents put on their bear hats, they are also holding the lowest levels of cash ever. We've also seen a recent spike in the VIX alongside still subdued levels of put buying in indexes and individual equities.
We even have contradictory opinions within our own shop with Doug Terry, who tracks the incoming data, seeing a positive divergence, while Jeff Snider, who takes a longer-term view of economic performance, sees little evidence of acceleration outside the reduced expectations of the post crisis period. That doesn't have to be contradictory as there can be positive divergences within the context of the long-term problems that continue to plague our economy.
I think what all these contradictory items represent, more than anything, is an exhaustion on the part of investors and their advisers. I know and talk to a lot of advisers around the country and the overwhelming sense I get from them is that they and their clients are tired of the grind of trying to invest in this environment. They know that the economy isn't very good but they also know they need returns and so feel obligated to participate in a market they no longer trust. They know that a change in economic policy could produce a more robust economy but have given up hope of seeing any change in the status quo. They know the Fed has distorted prices - in bond markets, stock markets and the economy at large - but are tired of trying to outguess the FOMC on the direction of policy. And they are increasingly nervous about the outcome of the end of the Fed's extraordinary policy of QE and ZIRP. While they wait for resolution, they are sitting on their hands, doing as little as possible for fear of making a mistake.
There is a tension between the need to protect the gains of the last few years and the desire to participate in more upside. In other words, the competing forces of fear and greed are at a stalemate with the news flow determining the winner on any given day. Good economic news leads to fear of an accelerated Fed tightening cycle but also greed in the form of potentially higher earnings. The situation in the Middle East is ignored in one moment as nothing different than what we've seen for decades and in another as completely different and terrifying. The mess in the Ukraine has a clear villain in Vladimir Putin but seemingly lacks any heroes on the other side and the only thing most people can conclude is that the big loser appears to be Europe in general and Germany specifically, which of course affects the view of future global growth and impacts investment decisions from China to Latin America to the US.
Investors always face an uncertain future when trying to make investment decisions but the level of uncertainty today seems unusually high and the outcomes fraught with extreme consequences. I don't know how the contradictions will be resolved but I think a more subdued approach to investing is required until some of them are. That means trading less and not making any big bets in either direction. It also means holding more cash than normal and respecting the increased odds of a mistake within the fog of war. It means staying flexible and not reacting to every tweet out of Russia or Iraq. Put your portfolio in a comfortable position, one that will allow you to survive whatever the outcome and wait for trends to develop. This is no time for heroes.