At the end of October, one could almost gather that a some modest relief was returning to the financial markets as the ugly but much anticipated US midterm election drew near and uncertainty over its outcome would be no more. As it turned out, election day generally went as predicted by political pundits – that Democrats would take back the house, but Republicans could hold their majority in the Senate. The fracture of Republican control renews what is often referred to as political gridlock. Citizens will often complain about gridlock or political dysfunction, but investors see it more favorably because the probability of significant policy changes are perceived lower when political parties are at odds with each other. In this day, it also mostly removes the possibility of Democrats pursuing impeachment of Trump or a wholesale rollback of policies implemented during his first two years (which would not in any way be market friendly). On the split-power result, US equities enjoyed a strong start to the week and post-election bounce on Wednesday. That bounce, which led some to cheer that a hoped-for 4Q rally might now get underway, were cooled Thursday and Friday as the Federal reserve reiterated its intent to continue raising interest rates. Still, the strength by markets early in the week was enough to help the S&P500 conclude firmly in positive territory for the week with an advance of +2.2% on the S&P500.
Shake or bake; not! Shake and/or Break is a fitting title for the frightful market action in October. Markets may “shake” because of tariffs. But, the Fed can cause the market “break.”
Much of the blame for October is aimed at President Trump and/or Federal Reserve Chairman Powell. Investors are concerned that the Fed remains inclined to raise interest rates further – 1 more hike in December, and presently communicates 3 additional times in 2019. There are even forecasts of one more rate increase planned in 2020. Investors are also concerned about tariffs because they are like a tax to American citizens. Both issues are viewed as punitive to economic growth over the next 12 months. Some wonder if the recent economic strength is “as good as it gets.” That suggests that economic and business growth will be shifting into slow expansion again (even though this expansion will become the longest running in US history next year). The economy is probably able to handle slow rising interest rates, to a point. But the stock market will show stress earlier, as witnessed by action in October. In essence, the market tone was altered due to these two concerns. Again, markets may “shake” because of tariffs; but markets could “break” because of the Fed.
In recent days we executed several tactical adjustments in the fixed-income sleeve of client portfolios. We sold or reduced exposure to short-maturity bond funds and reinvested proceeds into position-traded money funds. These adjustments take advantage of attractive yields available on short-term money funds relative to the variable return potential on short-maturity bonds in a rising interest rate environment.
One word comes to mind when thinking of the drawdown endured in October: relentless. It was the worst month for US investors years with 16 of the 23 trading sessions during the month being negative. Worse than that, since the S&P500 made its last all-time high on September 20, 75% of all trading days were negative and the major US stock indexes flirted with technical correction – a term defined by a drawdown of -10% or more. The retreat was most severe in those areas of the stock market that to this point, performed the strongest. “FAANG” names (Facebook, Amazon, Apple, Netflix, and Google) were punished one after the next for either softer-than-hoped quarterly earnings or more sober forecasts of quarters to come. As bad as it was, perhaps the most discouraging development was that diversification provided almost no relief. Even the safest of bonds, which historically offered investors a destination of safety and could be counted on to rise during times of severe market stress, also forfeited ground during the month muting their benefit. International equities, of course more risky than bonds but experiencing troubled times throughout most of 2018 fared even worse than domestic (how much further can they fall?!). One story appearing in the Wall Street Journal went so far as to call diversification “dead”.
We last wrote a “Market Alert” about large stock market movements on August 24, 2015. That fact in itself highlights that it’s been an infrequent occurrence over much of the past two years that investors felt much discomfort. Large market swings or accelerated volatility in stock prices is never a welcome experience – even if we admit they are more common than witnessed throughout much of 2016 or all of 2017. Even long-term investors who are aggressive, maybe opportunistic, and sitting on a lot of cash to invest do not welcome market drawdowns. Yet, market downturns provide opportunity to invest when companies are on sale.
The weakness that began to unfold in early October continues on is arguably intensifying as the month matures. As noted in our update earlier this week investors increasingly seem acutely focused on the well discussed risks rather than what can or is still going right (seemingly old, boring news). In recognition that our notes earlier this week (notes for week ended 10/19) and in the prior (Halloween Arrives Early) did a fairly comprehensive job of highlighting those key fundamentals and risks the market is weighing, the bottom line is that we believe as this pullback matures it is increasingly of technical nature. Said differently, it is decoupling from fundamentals and being fueled off what is mostly technical behavior. This includes program/computer/algorithmic trading; the type of trading that causes “babies to be thrown out with bathwater” (or all stocks trading similarly, despite unique business characteristics of each company). Being that it increasingly appears a technical pullback, it seems appropriate to highlight some technical signposts of what to look for when trying to understand how much longer weakness may persist – a question likely on most everyone’s mind following a session like today.
Despite continued skittish trading behavior and large daily gyrations, shares of US equities concluded the week ending October 19 roughly unchanged from where they began. The S&P500 finished less than -0.01% lower while the more concentrated Dow Jones Industrial Average added +0.4%; perhaps the broadest domestic measuring stick, the Wilshire 5000, also concluded essentially flat for the week, but is off -5.5% month-to-date and brings the year-to-date performance to a very scant +2.8%. With the reality that markets look dramatically more concerned than just 3 weeks ago (at September 30), the most natural question one might ponder is, “what is so different to justify the dramatic tone change?”
What a difference 8 days can make! After turning in the best quarterly performance in several years, the new month and start of 4Q has been no friend to investors. If you’ve been following the financial media at all in the last week or so, you are aware that the recent market stress is being attributed to a swift upward adjustment in bond yields. Most notably, yields on US Treasuries (particularly the 10 year) have quickly increased as the bond market seems to finally be responding to the stronger than trend economic growth in progress. This strength, when coupled with unemployment hitting its
lowest rate in 49 years (recent tick 3.7%) is being extrapolated to mean more robust wage growth is on the short horizon, and wage growth is historically the primary driver of broad-based inflation. And, if Continue reading
In our quarterly newsletter that follows, the two feature articles are titled: “A Great Story Never Told” and “Flying on One Engine”. The first discusses the prevailing skepticism, or even outright pessimism, that may best characterize the consensus of investors’ psychological mindset relating to what is now the longest bull market in US history. The second article explores what are the polarized and opposing views of how the economic and corporate fundamental “tea leaves” are being interpreted and highlights what we see are the biggest risks threatening to halt the progressing bull market. We encourage you to review the full articles contained in our quarterly newsletter below. The full printer-friendly document can be downloaded here: NVEST NSIGHTS 3Q
A GREAT STORY NEVER TOLD
Following a tug-of-war market experience during the first 6 months of 2018, stocks surged ahead during the 3Q with the S&P500 up +7.2%. It was the fastest advance since late 2013. Combined with the first half, the accumulation brings the YTD rise to just over +10%. Company earnings and economic growth are rising at the fastest pace of this current cycle and expanding the current Bull Market run, yet these facts remain a great story never told. Few want to acknowledge this Bull Market is now the longest running ever. Also, few will acknowledge that the current economic rebound will shortly become the longest running ever. This current run approaching 10 years remains unloved for a variety of reasons, including the fact that many investors experienced 2 Bear Markets in 15 years. Those two experiences eroded investor portfolio values and family wealth, and wreaked havoc with investor confidence. In reality, the only situation where the length of this economic rebound and/or market advance is cited is when stating its age as a compelling reason to anticipate the current trends must soon end. Many continue to hold a keen aversion to owning risk assets even today.
It’s often said that “no matter how carefully something is planned, things may still go awry”. The saying is adapted from a well-known line in the Poem “To a Mouse” by Robert Burns. Perhaps Mr. Burns was in the process of retirement planning when crafting this poem? Regardless, its cautionary tone can be applied. As we work with clients helping them articulate and achieve financial goals, there are a number of areas that can be underestimated relative to actual spending.