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VOL. 128 | NO. 119 | Wednesday, June 19, 2013

David Waddell

King Kong Versus Godzilla

By David Waddell

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Among attentive investors the recent bout of market volatility has reprised fears of country, currency, economic decline and general market collapse. When global macro-market events occur, large trading positions that have been spooling quickly unspool, leading to jarring movements like those we are witnessing in Japan. These environments become a bit of a predator’s ball, as short-term traders feast on volatility, which only amplifies volatility further.

For longer-term investors, the right question to ask is whether the fundamentals have suddenly changed. Is the global economy still slowly growing? Yes. Are we still burning off high pre-crisis debt levels? Yes. Are inflation expectations still contained? Yes. Are central banks still providing crisis insurance? Yes. Are equity valuations worldwide still reasonable? Yes. Are employment, consumption, housing and investment trends still constructive? Yes. Is the yield curve still positively sloped? Yes.

Having answered yes to these questions does not tell you whether the stock market will rise or fall tomorrow, but it does gird the intermediate-term outlook. Longer-term investors should watch these periods of high volatility with interest, but should not be lured into the technical trading battle royale between New York and Tokyo. The cops that tried to intervene in the battle between King Kong and Godzilla always ended up flattened. Investors should stay indoors.

What’s happening?

Domestically, the Fed gestured that it might begin reducing the amount of its monthly bond purchases. The 10-year Treasury bond has moved from 1.62 percent to a high of 2.28 percent over the last month. Internationally, the Japanese have set expectations that they will flood the market with fresh yen. Since announcing such intentions in November, the Japanese stock market surged nearly 80 percent before correcting 20 percent. Large moves such as these expose holders to large losses, initiating chain reactions. Gold, currency, stocks, commodities, other bonds, etc., will feel downward pressure as sellers raise liquidity to cover losses.

A large move in a macro market will create disruption akin to an earthquake for traders, and the ripples will fan across every asset classes … even if intuitively they appear unrelated. In the past month, the Japanese yen has gained 8 percent (this is bad), the Japanese stock market has fallen 16 percent, the U.S. dollar has fallen 4 percent, the 10-year Treasury has fallen 2 percent, gold has fallen 3 percent, and the S&P 500 has fallen 2 percent. These assets do not traditionally move in unison. Just to confuse things further, the Euro has gained 3 percent.

My advice is to sit out the current trader battle between King Kong and Godzilla. Keep in mind that the U.S. market has advanced 14 percent this year without a meaningful pullback. Should the second half of the year mimic the first half, stocks will advance 30 percent. More likely, the second half of the year will contain more volatility and less return. Don’t fret. Volatility-free markets that rise continuously ultimately collapse from engendered excess. The current moment of doubt will improve the marketplace by exposing and evicting the weaker hands, which may have been precisely their intent.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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