By Professor Patrick O'Halloran
NYC College of Technology (City Tech)
We made it through the predicted Mayan apocalypse and the transition from the fourth "sun" to a fifth. But now scientists are warning that the sun is out to get us. According to NASA, the sun's current cycle, known as Solar Cycle 24, is expected to reach its peak in early to mid 2013. Powerful solar flares have begun to have a significant effect on Earth. They can cause long lasting radiation storms in the atmosphere disrupting electrical infrastructure and temporarily rendering cell phones useless.
But can they cause stock market pullbacks? The most notable stock market pullbacks of the past two years coincided with spikes in solar activity. In particular, recent stock market pullbacks have coincided with solar flares: August 2011, November 2011, May 2012, and October 2012. However, it was not the consequent electromagnetic storms that disrupted the stock market. Instead, it was flare-ups of a different sort: the debt ceiling debacle (August 2011), the European financial crisis (October/ November 2012).
The potential flare ups we are monitoring this year are:
European Crisis: The Scandal in Spain plaguing Prime Minister Mariano Rajoy, the deadlocked election outcome in Italy that puts economic reforms at risk, and the unwillingness of Germany to approve more aid ahead of the fall elections in that country all raise risks. It was events in Europe that pulled stocks down 10 percent or more as measured by the S&P 500 in the spring of each of the past few years, we should be watching things closely for a repeat.
Spending sequester: The Congressional Budget Office estimates that the fiscal drag from the sequester in 2013 would be about $85 billion, or about 0.5 percent of gross domestic product (GDP). This adds to the roughly 1.5 percent drag on the economy from the fiscal cliff tax increases that went into place January 1, 2013. That is a materially negative impact for an economy that registered a contraction in the fourth quarter and is on track for only sluggish growth in the current one.
Quantitative easing: The Fed is likely to begin to slow or stop the current bond buying program known as quantitative easing (QE), later in 2013 or very early in 2014. These steps toward a return to a more normal monetary environment are likely to lead to higher interest rates and tighter credit conditions for borrowers that can weigh on the stock market. Changes to Fed programs or even deliberations months ahead of the potential end of a program or start of a new one have punctuated the volatile moves in the market over the past five years.
Exacerbating these potential flare ups, currently high energy prices can make the economy and markets more vulnerable to a negative that drives stocks lower. Ever 10 cents gasoline prices rise takes more than $10 billion out of U.S consumer' pockets over the course of a year.
However it is important to note that potential negative impact of these risks is limited by the fact that they have been known for some time. Though they may contribute to market volatility this year, the forewarning of them makes a bear market unlikely.
Bull markets do not tend to end with the S&P 500 stocks valued as low as they are today, which is the lowest price to earnings ratio at a bull market peak since World War II. Therefore, based upon these factors, while ups and down may continue, I believe the bull market is unlikely to be over.
In an up and down market environment, investors may seek to benefit from volatility in several ways, including:
Buying the dips: Buying makes sense in fundamentally improving areas such as housing and manufacturing.
Seeking yield: Focusing on the yield of an investment rather than solely on prices appreciation may potentially enhance total returns.
Going active: According to my research, using active management rather than passive indexing strategies may enhance returns as active managers tend to outperform their indexes when volatility rises.
Despite these flare-ups, I believe the sun will still be shining by year end, and stocks and bonds may deliver modest gains for investors in 2013.
* The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
* Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Professor Patrick O'Halloran teaches at New York City College of Technology in Brooklyn. His latest book is titled Detailed Job Descriptions in the Hospitality Industry. His email address is [email protected]
New York City College of Technology (City Tech) of the City University of New York (CUNY) is the largest public college of technology in New York State. Located at 300 Jay St. in Downtown Brooklyn, the college enrolls more than 14,000 in 60 baccalaureates, associate and specialized certificate programs. An additional 15,000 annually enroll in Continuing Education and Workforce Development Programs.