It is always hard to tell what will actually trigger a correction. This week it seems like Cyprus is the culprit. The story out of Cyprus is almost surreal; the thought that the government could just come in and take ten percent or more of your savings is bizarre to our ears. In an almost comical twist, these events have Vladimir Putin pontificating on the importance of individual property rights.
In truth the story is more complicated than it seems. The so-called tax is really an attempt to have depositors, many of whom in this case are frankly unsavory characters involved in laundering money gained by ill-gotten means, to share in the cost of saving the banks. If these banks are not saved, depositors stand a likely chance of losing most, if not all, of their savings. Of course the tragedy in this case is the perfectly innocent smaller depositors, and sympathy for them is what has caused the political crisis.
However, one must ask if Cyprus is really meaningful enough to warrant such a market reaction. My guess is that this mini-crisis is more of an excuse than a reason for markets reversing course this week. I would argue that the correction had already begun when Cyprus hit the news.
Individual investors have a very harmful habit of looking only at the most publicized market indices, usually the Dow Jones because the Dow’s ups and downs are reported every day among mass media. Looking only at the total results from a broad index and not what is happening underneath the surface can be very misleading. The index could be up even when the majority of stocks in it are down, or vice versa. This happens when only a few sectors or perhaps even a handful of darling companies are doing fantastically while the rest of the world does nothing or even loses ground. Paying attention to what is happening under the surface is really more important in the long run, as these dislocations have a way of fixing themselves over time.
In this latest rally, for example, the stocks of technology companies have largely been left behind. On the other hand one of the hottest areas of the market has been oil refineries and drilling companies that are benefitting from North America’s energy boom. Over the last ten days or so we have begun to see these energy companies come off their highs, with a few already hitting the ten percent drop in price that is defined as a correction. In the meantime there appear to be some signs of life on the technology front. This type of rotation is often an early sign that the correction is happening. The broader markets may not drop the usual ten percent before regaining upward momentum. While many commentators try to sound authoritative, the truth is no one knows exactly what the market will do in the short run.
In the long run equities remain the most attractive asset class, and that will remain true as long as interest rates stay this low. Any correction – whether in the broad market or just underneath the surface – should be used as an opportunity to rebalance, which is exactly what we will do.
Chuck Osborne, CFA