Market Alert – “The Politics That Stole Christmas”

Uncle Sam stole the year-end Santa rally.  The worst December since 1931 and the worst Christmas Eve stock market performance of all time occurred this year.  From my perspective, it is all politics this December.  Yes, our great Uncle Sam “Scrooge” stole Christmas and a small positive investment performance for 2018.  It traces to bad politics coming together in a “perfect storm.”  A “perfect political storm” is the coming together of at least 2 bad events at the same time.  We count at least 3 negative political charges right now: the Fed, Tariffs, and government shutdown (budget).

Recall, we wrote several times that “tariffs will shake the market; but interest rates (the Fed) can break the market.”  Indeed, tariff talk with China continues to shake the markets.  But tightening interest rate policy, executed by the Fed raising rates 4 times this year and for the last 2 years along with allowing their balance sheet to shrink, is the “last straw, breaking the proverbial camel’s back.”  It is too much for investors to take; it’s the unwanted “lump of coal” for being “bad” in 2018.

Because of these negative political situations, algorithm computer program trading activated in early December, initiating a message to the Fed that they were doing too much tightening.  In our view, the market was saying another increase in the Fed Funds rate was inappropriate at this time.  The stock and bond market message was “slow down;” “you are out of runway;” “stop, wait and watch.”  Last week, Fed Chairman Powell announced the 4th rate increase in 2018 with a poorly presented explanation.  In essence the market interpreted his comments, “We are following our plan; we will raise rates, and politics will not influence our process.”

Tariff talk with China is also slow moving.  It could very well be drawn out.  For business leaders, this process creates uncertainty about the “rules of the game.”  For many, it is better to place business investment on hold pending better understanding of how tariff taxes will affect product pricing and profits.  They are guarded about spending cash flow on additional plant and equipment, even though they would benefit from immediate expensing from the 2017 tax law changes.  When the rules are uncertain, business plans and outlook become uncertain.  Don’t forget, higher interest rates also mean higher borrowing costs.

Government shutdowns usually do not affect the markets much.  And this shutdown would not by itself cause market damage like present.  Yet, at the moment, it adds additional negativity to the market storm underway by underscoring the root cause: government ineptitude at virtually every level.  Politics are …too much!

The Fed is the key catalyst in this current event.  History shares that a change in liquidity conditions can front-run a change in the market trend.  When the Fed does too much too fast given underlying conditions, this change in liquidity conditions changes the investment backdrop; and the market can become unsettled for a time.  The Fed’s political posture is the “Scrooge” stealing this Christmas and year-end cheer.

Add one more dimension.  As is required by tax code, many mutual funds are forced to distribute large capital gains.  These capital gains are taxable in personal brokerage (not retirement) accounts.  Their timing is always bad; at year-end.  This year, it is especially exasperating because no-one likes to pay taxes on capital gains when the market is generating negative performance results.  Managing client investments involves being tax aware because taxes consume client wealth.  We do not like to make investment decisions based on taxes – it is said, “Don’t let the tax tail wag the investment dog.”  But another investment experience advocates, “The market provides opportunity, even in down markets.”  Investors must make changes as the market provides.  Thus, we are making some fund changes, using the current market weakness to improve tax efficiency.  Following capital gain distributions by some funds, if the share price following the distribution is lower, we can capture a loss to offset some or much of the distributed capital gain, and thereby reduce/lower a tax liability due April 2019.  Taxes erode client wealth, and current trades being made are pursued to reduce capital gains.  Be aware, we are probably not alone harvesting losses to offset gains.  This 10-year old current bull market (which may now be over), did not offer many losses to capture, until now.  Thus, as investors conclude this last week of 2018, expect additional market volatility as tax loss harvesting is underway because of this “perfect political storm.”

When will this drawdown end?  How will it end?  The market convergence hurts – all stocks moving down in similar fashion.  It is this action that brings about a bottom to the drawdown.  Share valuations are at near-recession levels, which are disconnected from present economic reality; prices are consistent with severe growth scares.  The US economy is likely to slow in 2019; but a recession is not part of the forecast.  We are certain the Fed is closely aware that their policy steps could lead to error.  They should pause, wait, and watch, then respond.  This is a likely better path the Fed will follow in 2019.  Tariff talk will continue to shake the market (increase volatility).  The administration follows the stock market closely, and is strongly motivated to complete a deal with China.  This too should provide investors with a better economic backdrop for 2019.

We know this drawdown will end.  Price action is overdone, and likely close to its bottom.  We also know it is important to endure time and monitor the changing investor sentiment.  Over coming weeks (time), the markets should attempt to rally but may settle back to test current lows.  Time is critical to repairing recent damage.  It is during this process, that investor sentiment changes, with many becoming fearful about investing.  Sentiment reveals its low when “panic” selling occurs (and there is already strong evidence of that occurring); it appears through an attitude of “sell everything; just sell.”

Not to be Pollyanna, …”We all move through a mysterious universe.  Stout hearts can fly away from strange, unfamiliar fears, which haunt and darken our mood.”  Be extremely careful during such times of great fear because emotions can promote wrong action.  Paradoxical statements are wonderful to consider.  Someone said “We are often the most certain about the ultimate, when we are most uncertain about the immediate.”  When bear market shadows appear, it is easy to allow current events to alter time proven facts.  It is always best to know what you know, before acting on emotion.

After 40+ years of investing, I know that not all market experiences are the same; they are different.  Not all investors respond the same either.  But, financial markets will always rise and fall.  The rise is always slower and longer than the fall, which is often fast and short.  The cycle is fully a part of investing occurring many many times during one’s life of investing.  You could say it is analogous to growing the size of a portfolio – slow upward growth over time (from deposits and returns), but quick to drawdown (most often due to large withdrawals).  The successful investor does not try to jump in/out, as they understand their timing will never be rewarded.  Life is always an up/down experience, and investing is true to this as well.  For all investors, key to long-term investment success relates to two things – time in the market, and compounding returns.  Both provide surprising experiences.  Please don’t forget, if we were together thoughtful when establishing your investment objectives and asset allocation, your portfolio owns “buckets of time” aligned with the time horizon for when you anticipate potential needs for money – money market funds, bonds and stocks.  We can provide funds from your portfolio because it owns portfolio flexibility – we do not need to sell stocks during a storm; but can draw upon money market funds and bonds.  This process offers time while the stock market moves into a new time of sunny days.  It is always best to consider key facts of investing, before acting on current emotional conclusions.

We welcome your thoughts.  Call or email us about your investment worries/fears.  We can coordinate a time to visit together.  Enjoy a Happy New Year – there should be many sunny days ahead!!


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