Market & Economy

This is the month volatility roared back into the stock market, sparking a tumultuous week of trading that included two drops of more than 1,000 points each in the widely followed Dow Jones Industrial Average. Many pinned the blame on the unwinding of a popular strategy that bet on volatility remaining low. Computers also took a lot of the blame. But many market strategists said the sell-off appeared technical in nature and that the factors that have supported a record rise in the market in the last year haven't changed. Corporate earnings are rising, economies globally are growing, and central banks are inching their way to returning interest rates to more normalized levels. The S&P 500 was down 3.75% on Thursday but up 16.9% over one year. Every sector was down in the latest market rout, led by financials, information technology and consumer discretionary stocks.

Some positive numbers:

1. With half the S&P 500 reporting fourth quarter results by the end of the day Feb. 2, earnings are up 15% and more companies are beating estimates than usual and beating those estimates by a bigger margin.
2. January was the strongest month for hiring since May, LinkedIn said, up 13% from a year earlier and 10% from December.
3. Average pay rose by more than 3% in at least half of U.S. states last year and there was a jump in the number of states where the jobless rate was near record lows, according to Reuters.
4. The economy's service sector grew in January after slowing down late last year. The Institute of Supply Management said non-manufacturing activity hit 59.9, up from 55.9 in December.

Some not-so-positive numbers:

1. The Commerce Department said the U.S. trade gap increased 5% to $53 billion, the highest since October 2008.
2. Senate Democrats, criticizing the GOP tax cuts, released a report that said companies have announced $97 billion in share buybacks since the start of the year.
3. Mortgage application volume stalled in the first week of February as interest rates rose to the highest level in four years. Home prices are high and there is record low supply of homes for sale in most major markets.

Recommended Reading

Anxiety about a market correction had been growing in the first weeks of the new year. With double digit gains in 2017 and another 8% climb in January, the expectation was that it couldn't last forever. While the tax cuts passed last year are widely viewed as helping to boost company spending and profit, they also run the risk of generating so much growth that the market gets overheated. Interest rates are already rising, and a strong jobs report that showed wages were also rising stoked inflation fears and sent the stock market into a tumble. Here are some blog posts and articles in case you missed them.

FOMO investing Contrary to popular opinion, long bull markets aren't the easiest for money managers, according to Bloomberg. Investors feel shame when they buy high and watch as the market trades lower. Read more

Tax plans Natixis chief economist Joseph LaVorgna says the new tax law will give S&P companies a 7% to 8% boost in EPS because they will be spending more on each other. In one example, Kimberly Clark is going to buy hundreds of millions of dollars of new equipment. Read more

Diversify risks Nobel Prize winner Robert Shiller says it's not the "Trump effect" or the tax cuts that have been driving up stock valuations but more likely the higher rate of share repurchases or even the fear of jobs being replaced by machines. The fact that markets have been so highly valued should caution investors to diversify. Read more Burton Malkiel, author of A Random Walk Down Wall Street, said diversification and rebalancing are the best ways to control risk. Read more

Perfect calm The near-perfect investing environment may be nearing an end but take a look at what it has been like: from 2000 to 2017, holding the latest 10-year Treasury and reinvesting coupons returned 155%, the S&P 500 is up 158% and a 60-40 equity bond portfolio beat both. Read more

Building bubble? Homebuilder stocks were on fire last year, outperforming all other groups after an up-tick in first time home buying, but some are predicting a pre-bubble is forming. Read more

Blow off Bridgewater's Ray Dalio, attending the World Economic Conference in Davos, Switzerland, last month, said the tax cuts would lead to big gains for the U.S. stock market and predicted a market "blow off." Read more

Seeking skill Investors tend to focus on a manager's 1, 3 and 5-year returns, but those short time horizons leave plenty of room for luck to overtake the manager's actual skill in picking stocks. There's more to picking a successful manager. Read more

No recession DoubleLine's Jeffrey Gundlach sees a lower S&P 500 this year but not a recession. Factory orders are booming and consumer confidence (at least before the stock market volatility this week) is high. Commodities are poised to rally. Read more

Bear hunting Long-short hedge funds are eagerly awaiting the next bear market, when they can finally make money again. Read more Hedge funds have had trouble keeping pace with the market and some managers have returned money, closed or cut fees. Read more

Since our last newsletter, the S&P 500 returned -9.1%, while the Hot List returned -11.6%. So far in 2018, the portfolio has returned -11.7% vs. -3.5% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 221.0% vs. the S&P's 158.0% gain.

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Three Mantras for Investors

This week was definitive proof that volatility has roared back into the stock market after a year of calm, causing wild swings and heavy trading volume. It is scary to watch the indexes plunge and then recover only to fall again, but these tulmutuous days are also an opportunity for investors to take a step back and remember why they have money invested in the markets in the first place.

A day-trader would justifiably be nervous about a 1,597-point drop in the Dow Jones industrial average, even if it lasted only a couple of minutes. On multiple occasions this week, the Dow has whipsawed up 500 or more points only to lose it all and then fall to a negative 500 before rebounding. This is not the type of market to try to market-time. But this type of volatility is just the thing to rattle investors and knock them off track. It significantly elevates emotions and opens the door to poor decision-making.

With that said, it's probably a good time to bring up three mantras to investors to repeat:

• Investing in the stock market is a long-term activity. Stocks have beaten all other asset classes over time. They beat bonds, commodities and even cash and gold. But "long-term" isn't measured in days, months or even years. It's measured over decades. That is why stocks are riskier than other assets. They can and will - and have - have massive, gut-wrenching declines. Before this week, that was a difficult lesson to teach because so many investors had been lulled by a stunning nine-year bull run. People forget that this bull began in March 2009, at a time when stocks had bottomed out after a harrowing late fall and winter 2008. The bear only hibernates for so long.

Out of 20 bear markets in the last 100 years, 15 happened before 1970. There have only been three in recent years, including 1987, when computerized trading was blamed for the Dow's biggest one-day fall ever, the dot-com bubble bursting in 2000, and the beginning of the financial crisis in 2007. Each time the S&P 500 fell at least 20% over an extended period of months before recovering. The bear market that began in 2007 and ran to March 2009 was the worst since the Great Depression.

How investors react during these periods of decline is what separates the successful from the merely disappointed. It is worth remembering that to get to the long-term you have to endure short-term pain. But behavior finance shows the psychology of loss makes this difficult. The human brain simply suffers the effects of loss more than it derives pleasure from an equal amount of gain.

• Last year was an anomaly. There hasn't ever been a year like 2017, when the S&P 500 rose each month. Volatility as measured by the Cboe Volatility index, a basket of options that acts as a measure of trader expectations for a big change in the market over the next 30 days, touched all-time lows. That meant traders had low expectations for volatility. Markets were steadily rising and no one was worried about them reversing.

But historically there is a 38% chance that a month will turn negative for the S&P at any given time. And there's nearly a 50% chance that the market will be down on any given day.

Last year was not normal, in other words, even though it felt more normal than this week's dizzying swings. But investors tend to believe that the most recent results are what will happen in the future. They like to chase hot stocks and shun persistent underperformers even though some of the world's most famous investors have tended to behave in the opposite way.

Warren Buffett has famously said investors should be "fearful when others are greedy and greedy when others are fearful." Billionaires can afford to take more risks than normal people, but his point is that long-term investing requires discipline and commitment. Don't chase hot stocks and don't sell everything when times get bad.

• Stick to your strategy. Yes, that isn't as easy as it sounds, especially given the temptations and fears confronting investors on a daily basis. And yet, studies and the behavior of some of the most successful investors shows it's the most important factor in achieving long-term goals. Believing in your strategy means you will abide it through tough times and not stray from it during good times. There's no point to following a strategy you aren't able or willing to embrace with conviction, either.

Investors who have confidence in their strategies are also more inclined to take advantage of opportunities when other people are fleeing in fear - what Buffett said about being greedy when others are fearful.

As another 1,000-plus drop in the Dow on Thursday just days after a 1,175 point drop marked the biggest one-day point drop in its history shows, this week's market tumult is far from over. But what happens in the span of a week or a month is only a tiny blip on the screen for an investor in the market for decades. Being consistent and sticking with your strategy is what will matter over that long-term.

Newcomers to the Hot List

Alliance Data Systems Corporation (ADS)

A provider of loyalty and marketing services, including credit cards and loyalty programs. It passes the tests of gurus Warren Buffet, Peter Lynch and Martin Zweig.

UnitedHealth Group (UNH)

The managed health care company, providing health care products and insurance. It passes our growth stock screen and fits the strategies of Martin Zweig, Warren Buffett and

Schneider National (SNDR)

Provider of truckload, intermodal and logistics services. It passes the models tracking Peter Lynch, and our screens tracking growth/value and momentum stocks.

Paycom Software (PAYC)

A provider of online payroll and human resource technology services. It passes the tests of our momentum stock screening model and the model tracking the style of the Motley Fool.

ManpowerGroup Corporation (MAN)

An international staffing and temporary services provider. It passes the tests of Peter Lynch, Kenneth Fisher and James O'Shaughnessy.

Lear Corporation (LEA).

A maker of automotive seating and electrical distribution systems. It passes the tests of our growth/value, P/E growth investor, momentum models.

News on Hot List Stocks

Cooper Tire & Rubber is opening a 1 million square foot warehouse in Mississippi, which will be its largest in the U.S., and create approximately 100 jobs.

ManpowerGroup said year-over-year revenue and profit growth was health and sales in the fourth quarter exceeded the estimate.

Paycom said its fourth quarter results also beat estimates, and its shares have surged 90.7% in the last year.

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