After enjoying unfettered growth in stock prices through much of 2019, the markets took a bit of a breather in January. The earlier part of the month began with optimism on the signing of a ‘Phase One’ trade deal between the U.S. and China. However, concerns over the Coronavirus outbreak put a damper on global optimism while a flare up between the U.S. and Iran led to further heightened volatility.  Many market participants fled to safe haven assets as bonds outperformed equities with government (U.S. and European) bonds performing the best. While the damage from global tensions (U.S./Iran, Brexit, Trade) and the Coronavirus outbreak have gotten much press, there is a little followed catastrophe unfolding in East Africa that has many parallels to our current market.  Currently, the horn of Africa is seeing the worst invasion of desert locusts in 25 years. Kenya is experiencing its worst invasion in 70 years while Pakistan has declared a national emergency in response to its own locust problems. They’re everywhere! Irregular weather and climate conditions are suspected to have contributed to the outbreak.

Swarming Behavior

One can only draw a simple parallel between these desert locusts and the current state of affairs in our stock markets. As locust swarms grow, their insatiable appetite for food can decimate crops and whole communities. For example, a swarm the size of Paris can eat as much food as half the population of France. Which brings us to the current state of affairs in the markets. With the proliferation of information available and the ability to trade (for free) instantaneously, one can only think that market participants are starting to act like locusts. Exhibit A would be the stock price of Tesla (TSLA) but there are many other examples. This analyst is beginning to see this swarming behavior in many places.

Swarming in Markets

The first such place has been the broader market. From January 17 to January 31 the S&P 500 dropped about 104 points, or about 3%. Much of that drop happened over three days, January 23, 24 and 27. Markets recovered a bit only to give back almost 2% in one day (January 31). While moves like these are not unprecedented in the history of markets, this herding behavior of investors hasn’t been seen in some time. The last aggressive move to the downside we experienced like this in the markets was mid-summer 2019. Corrections are a good thing and can help markets remain healthy through a bull market. However, one must be diligent in recognizing a correction versus a change in the “structural sentiment” of the market. While a regular correction maintains the bullish nature of the cycle, a change in structural sentiment can do locust swam-like damage.

Swarming in Stocks

The second place we have seen a slight change in our structural sentiment indicators has been within stocks themselves. For the first time in several quarters earnings reports have begun to matter again. During all of 2019 the market and the stocks that make up the market grew from a purely valuation perspective. That is to say, stock prices went up while the earnings of the companies those stocks represent went nowhere. This happens at times but rarely can persist. At some point the companies whose stock prices have gone up must show that they are growing their businesses. For the past three quarters that has not been the case. If earnings do not grow again in Q4 it will be the first time we have seen 4 straight quarters of earning declines since 2015/2016. During that period equities experienced several large declines in prices (greater than 10%) and an overall market that did not grow.

See, that’s just the thing. Locust swarms are self fulfilling. Locusts begin life as simple grasshoppers and are usually solitary. Yet, under certain circumstances they change their behaviors and habits. After a drought and when vegetation again becomes abundant, the serotonin in their brains triggers changes in their looks, behaviors and habits. They eat everything in their path and move on. They are also highly cannibalistic. When the food runs out they turn on each other.

Economies versus Markets

While markets seem to be swarming, economies around the world are, on average, improving. The U.S. economy continues on solid footing relative to the rest of the world. With 2.1% GDP growth in the fourth quarter of 2019, the U.S. economy seems well poised to weather any storms, locusts or not. China, while combatting the effects of the Coronavirus, is seeing economic stabilization after a period of contraction. The Eurozone growth numbers remain tepid but positive with a health labor market. Manufacturing there saw a significant rebound in the final quarter of the year and could stand to benefit further if the Phase One trade deal improve the fortunes of international trade. Lastly, the UK officially exited the EU at the end of the month. The two parties now enter the trade negotiation phase during the next 11 months of transition. While that soap opera is not over, the economy there seems poised for a rebound as well.

Are we Swarming?

Is the market currently in a swarm phase? Some parts certainly feel like it. As I’ve said before, this earnings season will help clarify whether or not the prior moves in stock prices were warranted or not. Just remember, like the locusts, when it gets ugly investors will begin eating each other. It’s best to be balanced in your approach to investing and reasonable in your expectations for future returns.

If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.