Stocks are in the process of consolidating after the big gains over the last week or so. So far, the October sell-off has led to a recovery of about half of what was lost. In the two months ahead, we should see even further gains.

 

No matter how much we would like it to, the stock market rarely goes straight up. It is one reason why I constantly advise clients not to check their portfolios on a daily, weekly, or even monthly basis. And never check them in down markets. Why put yourself through that emotional turmoil — especially when you have no intention of using the money anytime soon.

 

As we now know, the Democrats regained the House this week. As I, and everyone else on Wall Street predicted, the Republicans maintained their hold on the Senate. Some races, such as Florida, are still too close to call. But the results were predictable enough for the markets to rally over 2 percent the day after the results.

 

Since then, traders have been selling. That's natural. Once they bank some profits, and some of the overbought technical conditions as well as investment sentiment is reduced, stocks will find their footing and advance once again. In the meantime, get ready for the political noise that will most assuredly begin emanating from Washington.

 

President Trump, at long last, has fired his attorney general, Jeff Sessions. It won't matter who he appoints in his stead, in my opinion, because nothing will stop the Mueller investigation and its findings from being disseminated. The Democrats will see to that.

 

The question that the markets will ask is:

 

"Who, if anyone, did anything wrong?"

 

Chances are it won't be Donald Trump, if history is any guide. Rarely does the captain go down with the ship in politics.  His first mate, bosun, and any number of sailors might drown, but unless he has been stupid and failed in some way to cover his trail, the president will come out blameless. In which case, the markets will celebrate that victory.

 

My column yesterday pointed out that little, if anything, can be expected in the way of legislation over the next two years. That removes an unknown variable from the financial markets. What's left?

 

Trump's trade war and rising interest rates. Both will receive undue attention from investors. Trade will likely take a back-seat until Trump meets his Chinese counterpart this month, which leaves interest rates.

 

Throughout their careers, few of Wall Street's professionals have ever experienced a rising interest rate environment. Most are too young to remember. Many were not even born during the era of the oil embargo, double-digit interest rates and inflation. To them, this is all theoretical and not anchored in experience.

 

Therefore, they won't know when and how rising interest rates may trigger a recession. What's worse, they also won't know when too much inflation, versus too little inflation, is good (or bad) for the stock markets. As such, most of the investment community will live in a state of perpetual jumpiness. Jumpiness is a state of nervousness marked by sudden jerky movements. We just had such a day on Friday.

 

The Fed met this week and simply repeated what the markets already knew: that a rate hike was in the offing next month and further hikes should be expected next year. The only "new" comment was a sentence indicating that business investment seemed to be moderating slightly. Nonetheless, global markets fell on Thursday night and into Friday because many felt disappointment that the Fed was still on course.

 

 My belief is that kind of overreaction may continue to occur. When few in the markets understands the natural process of a growing economy, rising interest rates, and over (versus under) heating, any hike in interest rates is automatically considered negative for stocks.

 

It is not, but one must live through the experience of rising interest rates in order to understand them and to take the process in stride. Unfortunately, our "professionals" are all on a learning curve. What is theory and what is true will only be realized in hindsight. This is the world we live in, so expect more jumpiness in the foreseeable future.  

 

 

True to form, the opposition party regained control of the House, while the ruling party, in this case the GOP, retained control of the Senate. If history is any guide, this means that little in the way of legislation will be coming out of Congress for the next two years.

 

In the past, investors and the stock market alike did better than you might expect under this kind of political paralysis. That's because financial markets abhor the unknown. Given the unpredictability of politics and legislation, investors are far more content with inaction than action, unless of course, those actions are favorable to the markets or the economy.

 

Take for example, the tax cut of 2018. That sent the markets higher because most investors expected the cut would fuel additional growth in the economy.  In turn, that would generate higher earnings for public companies and provide a reason to bid the stock market up even higher.

 

While expectations for any additional tax cuts over the next two years are remote, there could be some surprises. There is some conjecture that the Federal government could undo parts of the tax cut. They could reinstate, for example, the federal tax deductibility of those states with an income tax. In exchange, the corporate tax rate might be raised a few percentage points. Of course, it's early days and any quid pro quo negotiation on taxes between the two houses and the president could drag out until 2020. 

 

The unfolding disaster that is the Affordable Care Act (ACA) over the first two years of Republican rule was not lost on voters. Health care was identified as one of the greatest concerns among voters in exit polls across the nation. That doesn't mean that the legislatures will suddenly be able to come together and fix a health care system that has run amuck.

 

 If the GOP, which had control of the executive branch and both Houses of Congress, could not come up with a plan to replace the AFC, why would we expect a divided Congress to do any better? At most, we may see drug pricing initiatives, but the passage of even that effort is doubtful.

 

The common wisdom of most political pundits is that the Democrats will launch investigation after investigation into the perceived wrong-doings of the president, his cabinet members, and anyone else they can target among the GOP. As a result, no one in power will have the time or energy to contemplate any new legislation. Most of their efforts will be tied up in defending themselves.

 

One area that might see the light of day might be infrastructure spending. Both parties have been talking about that since the early days of the Obama Administration. At that time, Republicans considered themselves deficit hawks and did not want to spend the money necessary to fund a multi-trillion-dollar spending program.

 

Today, however, Republicans, with few exceptions, have taken on the mantle of big government spenders. Democrats, at least since the days of Franklin Roosevelt and the New Deal, have always been saddled with that reputation. It is conceivable that enough elements of both parties could see their way into a compromise infrastructure spending bill. The caveat here is that the deficit itself could become an explosive issue next year as interest rates (and debt payments) continue to rise. In which case, neither party may be willing to add to the nation's debt for any reason.

 

In my opinion, the direction of the stock market will be far more dependent on how fast and how high-interest rates will rise. The outcome depends on the Federal Reserve Bank and not politicians in Washington, D.C.

 

There is one worry, however, that does continue to haunt the markets. President Trump's on-going trade war could ultimately sink both the economy and the stock market. The Democrats in the past, having been no friend of free trade, believe strongly that America has not been treated fairly by our trading partners. Given that the president and the Democrats may see eye-to-eye on this issue, it may embolden Trump to escalate his tariffs and other demands on our trading partners.

 

 

It is a good time to take a reality check on how aggressively you are invested. The 6.9 percent decline in the S&P 500 Index over October was gut-wrenching. But entirely within the realm of probability given the historical data. Here are some questions to ask.

 

Did you find yourself checking your investment portfolios every day? How about every hour? Did you have trouble focusing on other, possibly more important, things like your job, or your family and friends? Was it more difficult to sleep at night, or did you lay awake worrying about the markets?

 

How much time did you spend checking the averages and listening to the talking heads on television or in the print media? Did you call your broker or investment advisor and, if so, how many times? Did you want to blame someone for the market's decline? Did you need that money for something immediate?

 

If you answered yes to any of the above questions, you have probably invested too aggressively. That's not to say that a sell-off is in any way pleasant. Everyone feels the disappointment, the pain of losing money, and the fear that tomorrow will bring more of the same.  And even though your losses are only on paper, you still feel some anxiety. The question is how you handle it.

 

By now, most of my readers understand that the stock market is not a one-way street. Investors should expect at least three declines of around 5 percent and one decline of 10 percent per year in the stock market. That's on average. There have been plenty of times when the averages have declined more than that. Over the course of the last several years that has occurred consistently, and it will continue to do so for the next several decades into the future.  

 

And one's risk tolerance is both personal and financial. Only you can tell yourself what it is or should be.  And the risk is not static. It changes over time. How much risk you are willing to take depends on many things; some, such as your health or your job are different than when you will need the money in your investment accounts.

 

Geopolitical events such as Brexit, the Trump election, North Korean conflict, stock market valuations, and the next recession will also impact your attitude about risk. None of the above remain static. What was a negative development last year (like the Trump vs. Kim double dog dare) may be a positive this year, such as North Korean nuclear disarmament.

 

We can try to break risk down into two concepts: risk tolerance and your capacity for risks. Capacity for risk is how much you can afford to lose. That is measurable and involves time and finances. If you are saving for retirement, which is decades away, you can afford to lose more in the short-term, because you won't need the money anytime soon. Over time, the stock market has been shown to be a good investment and will make up your losses and then some if you remain patient and don't panic.

 

For example, the pain and fear are real for someone in their forties or fifties, who holds a $5 million portfolio, which loses $500,000 in a 10 percent correction, over the course of two months. Yet, if that person plans to retire 20 years from now and has a good paying job that is secure, then they have the capacity to hang in there, even buy more, because they won't be needing to tap those funds for decades.

 

On the other hand, if that money were needed to pay next month's mortgage or car payment, the purchase of a house in two weeks, the first semester's payment on their kid's college education, then that capacity for risk is far lower.

 

Risk tolerance is far more connected with your emotions; fear and greed among the most prevalent. It is greed that drives an investor's desire to "beat the market," something that is as hopeless as winning consistently at the slot machines. Fear is what drives you to sell at the top (fairly easy) but also destroys your ability to buy at the bottom (almost impossible).

 

So how do you determine these risks and when they change? It's not easy. Start with the questions I asked, and if you answered yes to any of them, review your risk appetite, preferably with someone like an advisor or financial planner. I found that it is far easier to examine your risk tolerance after a market sell-off when the pain is still fresh than when the markets are roaring.

 

It happened like clockwork. Earlier in the week, all three main U.S. averages re-tested their lows and then proceeded to bounce back, only to give it all back. That's what happens during corrections, but it is not over yet.  After all, it is October.

 

Readers will recall that last week I wrote that nine out of 10 times markets will re-test their recent lows. Naturally, this is more of an art than a science, so prices can bottom somewhat above or below those lows. In this case, the Dow hit its lowest level in four months. The S&P 500 Index slipped below its recent lows while NASDAQ got hit the worst, wracking up a total 10percent decline from its highs.

 

This is how it should be since all year long the markets have been led by the advances in the tech-heavy NASDAQ. And by the way, there was no new news on Tuesday. There was no event that anyone can point to for the decline. That also makes total sense when you understand that this entire pullback has been technically-driven. 

 

And it isn't over yet. We still have five days left in October and another six until the mid-term elections. The way the market has been acting this week, we could continue to see 1-2 percentage point-sized swings daily.

 

The fuel for these pyrotechnics is earnings results. Remember my warnings that earnings this quarter, although good, would not be "as good" as the past few quarterly results? As an example, Thursday evening, two of the big FANG stocks, Amazon and Google, reported after the close. Their top line revenue growth was less than expected, which came as a bit of a surprise to investors. No never mind that profits beat expectations since these days profits can be manipulated easily by simply buying back additional shares.

 

Index futures Thursday night dropped like a rock as a result, and Friday morning the Dow dropped 300 points on the opening. Earlier in the week, companies like Caterpillar and Boeing reported. Their announcements were enough to move the markets (up in the case of Boeing, and down on Caterpillar's results). Why, you might ask, do individual company results suddenly have the power to move markets like this?

 

It's all about expectations. Investors have been fretting about Trump's trade war all year. So far, the fallout has only impacted a few areas. Farming, for one, and maybe some companies in the steel business. The fear is that over time more and more companies will pull back investments, lose sales, or be damaged by these tariffs. And what may happen to one, may happen to all.

 

If you believed, as I do, that this is an inaccurate and rather simplistic view of the world than the fact that one company might see some fallout if tariffs are imposed does not warrant taking an entire sector, or in this case, an entire market down with it. However, markets are not rational at times. This is one of those times.

 

Friday, it was announced that the country's economy grew by 3.5 percent in the third quarter, which was faster than expected. Fearful investors barely paid attention to the news. That should come as no surprise. You can search to doomsday for a solid fundamental reason why we are experiencing this sell-off. You won't find one. Bottom line: the markets were overbought and in need of a healthy pullback. Don't over think this one and stay invested.

 

Forget the stock market, internet, and whatever you might think is worth investing in. The good old college textbook beats them all. 

 

That boring first-semester hardcover and similar books have risen over 1,000 percent in price since 1977. Textbooks are a big business. Estimates for the total value of the textbook industry range from $7 billion to $9 billion. And just a handful of companies sell them. The five largest publishers are: Pearson Education, McGraw-Hill Education, Scholastic, Cengage Learning and Houghton Mifflin Harcourt. They have been around a long time, carry deep pockets and usually acquire any startups or smaller competitors in quick order. Some analysts compare them to drug companies because they have similar economics.

 

In the pharmaceutical sales model, for example, drugs are marketed to the decision makers — doctors, hospital pharmacies and the like. The patient, at least those with health insurance, end up paying the price, but much of those costs are paid for by the insurance company or Medicare. Medical decision makers' criteria are usually not how cheap or expensive a drug might be; instead, they select those drugs that are the most efficacious with the least number of side effects for their patients.

 

In the textbook industry, teachers (mostly professors), are the decision makers at colleges, and like doctors, could care less about the costs of a textbook to the student. They demand the most up-to-date educational information possible since they strive for academic excellence in the classroom.

 

It doesn’t help that today the information advances occur at such a rapid pace that most books are out of date by the time they are printed and in the hands of students.

 

There is another wrinkle that boosts the price of textbooks. Today, one in four colleges bundle their textbooks with an access code, which expires at the end of each semester. All the materials that a given student needs to participate in the classroom are put behind this access code paywall. Once you pay for the access code, you get your login ID. In return, the student gains access to workbooks and tests, in addition to the new textbook. It becomes essential to have this access in order to pass the course.

 

Fast forward to the next semester. For a new student beginning that same course, all the materials will have changed again, along with a new access code. The student looking to resell their old course material is out of luck. There is no re-sale market. It is simply useless. Many of the introductory courses that are part of the general education requirements for all students function in this way. These codes force students to buy books at retail prices at campus bookstores while walling off any chance to recoup part of the costs through resale.

 

Textbook prices have increased four times faster than the rate of inflation since 2006. At least 30 percent of post-secondary students buy their textbooks with financial aid money. Community college students are twice as likely to buy textbooks in the same manner.

 

Today, the average costs of textbooks per year, per student is $1,168. It is a pinch shared by public, primary and secondary education as well. Books have begun to be a major expense for every grade level. The costs are even worse for low-income school districts since standardized test requirements are based on these private-label, high-priced textbooks.

 

How does that work? It is a vicious circle: the school can’t afford the newest books, so students don’t get the information needed to pass standardized tests. As a result, the school gets lower funding because of poor test scores, keeping the new textbooks unaffordable. And on goes the cycle. It would be hilarious if we, the taxpayers, were not paying the bills.

 

Some say the system needs to be changed. As it is, the end user remains the student who bears the brunt of the cost. But since the buyer is the institution or instructor, all the book publishers need to do is maintain a good reputation, a cozy relationship with the teacher, and comparatively up-to-date new textbook editions.

 

Textbook companies, therefore, can continue to act as a quasi-cartel, if the formula of higher textbook prices is based on expanding college attendance and thus increasing demand for textbooks. Price really doesn’t come into it.