Top-down versus bottom-up. That's an eternal debate among equity portfolio managers, our equivalent of Miller's legendary "tastes great versus less filling" ads.
This market correction has been driven by factors that would fall into the top-down category, most notably the flattening and partial inversion of the yield curve. That is not only a classic recession signal, but it also pressures net interest margins at banks. Veteran market pundits--regardless of adherence to top-down or bottom-up investment philosophies--invariably state "you can't have a healthy market in stocks without leadership from the financials."
Well, a quick look at the stock charts of Goldman Sachs (GS) , Morgan Stanley (MS) , Bank of America (BAC) and Wells Fargo (WFC) shows them all at or near 52-week lows in today's trading. There's a bit of dumpster fire going among the financials, and even shares of best-in-class JPMorgan (JPM) are about a dollar away from hitting a 52-week low today.
As these institutions fund every other sector's growth their relative health is vital to the strength of the economy. A cursory look at the September 30 balance sheets of any of the big banks would show loan loss ratios at minuscule levels and healthy capital ratios by any measure, Basel III or otherwise. As I mentioned in my RM piece last week even Deutsche Bank (DB) , which seems to have found a permanent place in institutional investors' dumpsters, had a very strong balance sheet as of Sept. 30 and thus is an attractive credit play. But I am not buying the stock even as slides to all-time low levels.
I will keep writing this until my fingers fall off--stocks are forward-looking discounting mechanisms. Mr. Market is telling you that things for the banks are going to get worse, even if those banks' balance sheets told a completely different story as of September 30, 2018.
"As good as it gets" is a very, very powerful theme in investing, and that is more relevant for top-downers than bottom-uppers. I certainly don't remember any individual stock analysts screaming "this is as good as it gets" for Amazon (AMZN) , for instance, when it hit $2,050 per share on September 4. As I have frequently mentioned in my RM columns, I was a sell-side analyst for 11 years. When following a name that is skyrocketing, as AMZN was this summer, the choice between downgrading on the achievement of your price target or just raising that price target is a very, very easy one.
That's the fundamental difference between top-down and bottom-up and the reason that the market's move to an ETF-driven agglomeration is so important. ETFs that track indices buy more of stocks that move those indices. This natural self-selection is what brought you AAPL at $220, Facebook (FB) at $215 and Netflix (NFLX) at $415--yes, only five months ago NFLX shares were trading at that level. That same self-selection is why I don't remember a single analyst on CNBC saying "this is too much; FAANG is ahead of itself" on CNBC this summer. It is possible that there was such a person and I missed him or her, but, really, the zeitgeist of "go,go,go" was in full effect as recently as Labor Day. I know you remember that.
The only force more powerful than the ETF-drive of the stock market is the interest-rate vigilantism of the bond market driven by its master, the Federal Reserve's Federal Open Market Committee.
The FOMC has the power to make the humans who created the monstrous mutual fund complexes shift more into cash. That means equity positions must be reduced, and thus the largest ETFs--starved of growth capital--will naturally shrink.
That is a factor completely independent of how many subscribers Netflix has, iPhones Apple sells, Christmas presents Amazon delivers (on time, thankfully,) etc. That is why individual fundamentals can and are overwhelmed by interest rate worries. That is the phenomenon we saw in October and then again in November, and it is clearly impacting markets again this week.
Bottom line: Wake up and smell what the Fed is cookin' and lower the amount of your portfolio allocated to stocks. The top-down pressure is too great to ignore, and with a flat yield curve there is no room for that pressure to escape other than in lower valuations for equities.