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THE WEEKLY GUIDE TO MANAGING YOUR MONEY
It’s Getting Scary
Bears Stalk the
‘Goldilocks’ Market
BY TOM LAURICELLA
Dow Mauled
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The Dow Jones
Industrial Average
fell 2.7% last week,
its third consecutive
down week. The
Average has fallen
4.3% since its
September high and
is now down 0.2%
for all of 2014.
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Oct. 6
long-term bull market “is not
over,” she says. But selloffs like
the current one, which have
brought the S&P 500 down 5.2%
from its most recent high, “are
going to be a bit more par for
the course,” she says. “It’s very
normal at this stage…to get multiple pullbacks.”
That would be a change for investors. For five and half years
stocks have been in a bull market, and in the past two years declines have been shallow and
short-lived. It’s been two years
since the last “correction”—a 10%
decline or more—in the S&P 500.
The biggest decline this year was
a three-week selloff totaling 5.8%
that began in mid-January.
As recently as last month, the
Dow and the S&P 500 were carving out fresh record highs. But
the Dow finished last week down
0.2% for the year while the S&P
is up a bare 3.1%.
Driving share prices steadily
higher has been the combination
of an improving U.S. economy
and jobs market, strong corporate earnings and the Fed’s easymoney policies. There have been
trouble spots, such as weak wage
growth, high long-term unemployment and a stalling real-estate recovery.
But broadly, most investors
say that absent a shock to the
1250
1200
Small-cap companies with
market values under
$2 billion led the bull market
up and are now leading it
down. The Russell 2000
small-cap index closed Friday
down 12.8% from its July
high—official “correction”
territory, and then some.
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1050
Friday: 1053.32
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F M A M J J
Source: FactSet
1
Miracle on 34th St.:
Amazon.com plans to
open a store in the
middle of New York City,
according to people familiar with the plans, the first
brick-and-mortar outlet in
its 20-year history and an
experiment to provide the
type of face-to-face experience found at traditional
retailers. The site is set to
open in time for the holiday
shopping season on the
same busy street as Macy’s.
2
Taylor Hill
Autopilot: Tesla Motors, after weeks of
speculation,
unveiled
an automated
driving
system designed to
enhance
Tesla CEO
visibility,
prevent ac- Elon Musk
cidents
and even allow vehicles to
park themselves.
A S O
The Wall Street Journal
3
Save Money: Wal-Mart
Stores is cutting health
insurance for another
30,000 part-time workers and
raising premiums for its
other employees, as U.S. corporations push to contain
health-care costs.
4
Flat Rate: Most Medicare beneficiaries will
pay monthly premiums
of $104.90 for 2015, the same
as this year and last year,
while cost-sharing for hospital and skilled nursing stays
will increase slightly, the
Obama administration said.
5
Back to the Office: As
it pulls the plug on
hedge funds, the California Public Employees’ Retirement System, the country’s biggest public pension,
plans to increase its allocation to commercial real estate by 27% from the present
$26 billion—giving Calpers
with its largest property
holdings since before the financial crisis.
The Numbers
Percent change for the week
2.4%
GOLD
4.4%
OIL
9
10
The Wall Street Journal
economy, there’s no danger of a
recession that would send stocks
into a prolonged decline.
“The economic fundamentals
still are in a Goldilocks” environment, says Ms. Sonders. She
points to the September employment report, which showed a
healthy 248,000 new jobs created during the month.
Meanwhile, corporate earnings have defied expectations of
a slowdown. During the second
quarter, companies in the S&P
500 posted a better-than-forecast 7.5% rise from a year earlier,
according to FactSet. And with
third-quarter earnings season
having just kicked off, profits are
expected to show a 4.6% rise.
But worries about global
growth threaten to crimp some
of that growth. “The U.S. economy is not immune,” especially
among larger companies, says
Joseph Amato, chief investment
officer at money-management
firm Neuberger Berman, which
oversees $257 billion.
S&P 500 companies generated
46% of their sales outside of the
U.S. as of June 2013 , according
to S&P Dow Jones Indices. Europe accounted for roughly 7%.
Slowing growth in Europe
“will make earnings estimates a
little more vulnerable than they
were six months ago,” says Wil-
BY DANIEL HUANG
1150
950
8
Tax Breaks
Recent Grads
Overlook
NEED TO KNOW
Small-Cap
Correction
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Source: SIX Financial
0.9%
2.3%
10 YR
WSJ
DOLLAR INDEX TREASURY YIELD
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WSJ.com/Sunday
Recent college graduates,
overloaded with debt, tend to
skimp in any way possible. Yet
many overlook features in the
tax code that offer substantial
savings. Here are a few:
Student-loan interest deduction: As graduates start earning
and paying off debt, they can
slash their taxable income by up
to $2,500 for interest paid on
both federal and private student
loans, says the Internal Revenue
Service.
Most borrowers who are single filers and have adjusted
gross income of less than
$60,000 are eligible for the full
deduction. Those with AGI between $60,000 and $75,000 are
eligible for a reduced one.
Lifetime learning credit:
This is worth up to $2,000 for
those paying qualified expenses
for postsecondary education, or
paying them for an eligible student. You need to have been in
school at least part of the relevant year to claim it.
The credit is a “nonrefundable” dollar-for-dollar reduction
of one’s tax bill, says the IRS. If
the tax owed is less than $2,000,
for example, the credit will reduce the sum to zero but won’t
refund the difference. The
amount of the credit phases out
at an AGI of $53,000 to $63,000.
Students who graduated in
May this year, or are still in college, also could be eligible for
the American Opportunity Tax
Credit—a $2,500 nonrefundable
credit available for the first four
years of postsecondary education.
Moving-expenses deduction:
Reasonable moving expenses
covered by the deduction include packing and traveling
costs, but not meals or costs related to car maintenance or depreciation.
Eligible expenses are those
incurred six months before or
after the first day of work, says
the IRS. The employee also must
work full time for at least 39
weeks during the first 12 months
after arriving in the general area
of the new workplace.
Tax-smart saving strategies:
The first place many young
workers should start saving is in
their employer-sponsored 401(k)
plan. Contributions are pretax,
meaning that taxes aren’t paid
until the funds are withdrawn.
Many companies match part of
your contributions.
Oscar Ramos
Investors were taken on another white-knuckle ride last
week, as stocks posted wide
back-to-back gains and losses.
Unexpectedly weak economic
news out of Germany helped pull
the Dow Jones Industrial Average down 1.6% on Tuesday, its
sharpest one-day decline since
July. Then on Wednesday the
Dow rocketed back 1.6%—its biggest gain of the year—on news
suggesting that worries about
Europe and a stronger dollar
could lead the Federal Reserve to
raise rates slower than some had
expected. Just when the coast
seemed clear, the Dow tumbled
2% on Thursday, before falling
another 0.69% on Friday.
When the dust had settled,
the Dow had lost all of its gains
for 2014.
For several years, it’s been a
Goldilocks stock market. Now,
some investors wonder if an economic slowdown overseas and
the Federal Reserve will spoil the
fairy tale. Most think the bull
market will endure, but investors
should expect a bumpy ride.
Concerns are building that a
renewed weakening of economies in Europe, at a time when
Japan remains in the doldrums
and China’s massive economy is
slowing, could spill over to the
U.S. economy.
At the same time, the Fed is
signaling that it expects next
year to begin raising short-term
interest rates, which have been
locked near zero since the financial crisis. Though most investors expect the Fed to move
slowly and carefully, many also
think uncertainty about its timing will make stocks more prone
to sharp swings.
Liz Ann Sonders, chief investment strategist at Charles
Schwab, had been a steady bull
on stocks, but in recent months
she’s become more cautious. The
WSJ.com/Sunday
liam Kennedy, manager of the $11.1 billion
Fidelity International
Discovery fund.
It’s not just
the pace of
growth in Europe
that raises concerns. It’s also been
the 9% rise in the value of the
dollar against the euro since its
2014 low in March. That makes
U.S. goods more expensive overseas and reduces the value of
profits earned abroad. This swift
rally follows a long period of dollar weakness that had helped
U.S. exporters.
“What had been a tailwind...has now reversed,” says
Mr. Kennedy.
Still, he doesn’t expect the
bull market to be derailed. “As
you recalibrate expectations,
clearly there are some individual
stocks that will not perform as
well,” says Mr. Kennedy. “But
just because Europe is slow it
doesn’t mean the story is over
for the next three to five years.”
For many fund managers, the
primary question is whether
eventual rate increases by the
Fed will mean an end to the Goldilocks environment for stocks.
On the positive side for the
broad stock market, the strong
dollar can keep inflation in
check, allowing the Fed to raise
rates slowly. A strong dollar
damps inflation in part by lowering the cost of imported goods—
good news for retailers, in particular. In addition, many
globally produced commodities,
such as oil, are priced in dollars.
As the dollar rises, those commodity prices drop.
Crude-oil prices have fallen
more than 20% from September
2013, to $85 a barrel. That, in
turn, is leading gas prices lower.
The average price for a gallon of
gas as of
midweek
was $3.24,
according to
AAA, down from
$3.43 a month ago.
At Neuberger, Mr. Amato is among those thinking the
Fed’s eventual rate increases will
lead to more volatility, and a potential change in leadership
among top-performing stocks.
Many of the best-performing
stocks, he says, have been companies with high debt levels and
weaker balance sheets. Those
companies have benefited from
the Fed’s cheap money policies.
But as the cost of borrowing
rises, the advantage should shift
to “higher quality” companies
with stronger cash flows, lower
debt levels and more dominant
market positions.
“A move to a more normalized monetary policy is a good
thing” he said, adding it’s just
“never fun when you’re going
through it.”
Email: tom.lauricella@wsj.com
JONATHAN CLEMENTS
The Hazards of Overreach
Leverage and Other Tactics That Can Put You in a Hole
During a
stock-market decline,
there are
those who
panic and
sell. And then there are
those who don’t have any
choice.
In late 2008 and early
2009, I remember talking
to many investors who lost
their nerve as share prices
plummeted. Some of those
who dumped stocks were
folks I considered to be
seasoned investors.
But today’s column is
aimed at a different group:
those who set themselves
up for failure before share
prices even decline—by
pursuing high-risk investment strategies that just
don’t make sense for the
typical investor.
Flirting With Zero
Let’s say you take out a
margin loan, which involves borrowing against
your portfolio’s value. You
then use that money to
buy additional shares, so
you end up owning, say,
twice as much stock as you
could otherwise afford.
That leverage should
prove mighty rewarding if
shares rally from here. But
if, instead, stocks tumble,
you could get a margin call
demanding that you repay
part of the loan. At that
point, you might be forced
to sell shares and give up
all chance of recouping
your losses. In a sign of
the market’s frothiness,
margin borrowing has doubled since the start of
2010.
Selling put options can
also lead to permanent
losses. When you sell a
put, you receive a premium
from the option’s buyer. In
return, you give the buyer
the right to sell you shares
at a specified price. If the
stock falls far below that
price, you will lose a fistful
of money—and the premium received will be
scant compensation.
You could also suffer
large, permanent losses if
you bet heavily on a few
stocks. While it’s reasonable to expect the broad
market to rebound from a
severe decline, there are
plenty of individual stocks
that plunge and never recover. Just think about all
the dot-com companies
that went out of business
during the 2000-02 bear
market.
In addition, I would be
leery of leveraged stock
funds. For instance,
ProShares Ultra S&P 500,
an exchange-traded fund
that aims to deliver twice
the daily return of the S&P
500-stock index, lost an
eye-popping 84.7% from
2007’s market peak to
2009’s trough, according
to Chicago investment researcher Morningstar.
Amazingly, the fund
eventually recouped that
loss, though it’s hard to
imagine many shareholders
toughed it out through the
entire roller-coaster ride.
cause you have a plain-vanilla diversified stock portfolio. Still, you too could
suffer permanent losses
during a bear market—if
you’re forced to sell stocks
to pay for upcoming goals.
Give It Five Years
As a rule, money you
plan to spend in the next
five years should be out of
stocks and in more conservative investments, like
certificates of deposit and
short-term bonds. Why
this caution? Even with a
five-year time horizon, you
could lose money with a
diversified stock portfolio.
Consider the S&P 500’s
performance since yearend 1925, which includes
84 rolling five-calendaryear periods. Morningstar
calculates that stocks lost
money in 12 of those fiveyear stretches, or 14% of
Some people set themselves up for failure
before share prices even decline, by pursuing
high-risk strategies that make no sense for
the typical investor—things like margin loans
and leveraged funds.
Keep in mind that such
brutal losses aren’t just a
bear-market phenomenon.
In a rising market, there
are other strategies that
also offer the prospect of
staggering losses. Suppose
you borrow shares and
then sell them short, in a
bet that they’ll fall in
value. If, instead, the stock
rallies, there’s no limit to
your potential loss.
Similarly, in a rising
market, you can face hefty
losses if you sell so-called
naked call options. Buyers
of these call options have
the right to purchase the
underlying stock from you
at a specified price. But
because you don’t own the
stock—hence the term “naked”—you could lose big
money if the shares climb
sharply.
All this talk of buying on
margin and selling options
might seem irrelevant, be-
the time. This performance
includes reinvested dividends.
What if you look at 10year stretches? The S&P
500 lost money in four of
the 79 rolling 10-year periods, or 5% of the time.
Let’s say you have
money you plan to spend
in the years ahead on retirement living expenses,
college costs or a house
down payment. Once your
goal is five years away, you
should look to move the
money involved out of
stocks. If shares are currently in a funk, you might
hold off selling and see if
the market recovers.
But if stock prices are at
or close to their highs—
which is where we are today—consider shifting the
money into conservative
investments, so you avoid
the risk of selling shares at
fire-sale prices.