Holiday Funk - A Blue Water Investment Committee Commentary

Tom Brown |

Investors are wondering what in the world is going on with the stock markets that have turned the holidays into a sea of red?  And we’re not talking about Santa’s coat or the color of your holiday light display; rather it’s the stream of red ticker tape on Wall Street!  This holiday season has come and gone with investors’ agonizing over witnessing the stock market careen around like a ship in troubled waters. 

The oft referred to “Santa Clause rally” in the markets has not only failed to materialize in December but the results have been quite the opposite; a horrendous display of returns that are the worst since 2008.  As of the writing of this missive, the Standard & Poor’s 500 Index, a measure of performance of the five hundred largest companies in the U.S., is down almost 19% since the beginning of the fourth quarter beginning October 1st and is down almost 15% for the month of December alone. Overall, for 2018, the S&P 500 Index is down over 10% as of December 24th

Other markets are no better.  International stocks, as a collective and measured by the MSCI EAFE (Europe, Asia and Far East) Index, are down 18% in 2018 through December 25th, however, “only” 7% in December.  While recent International losses were much lighter compared to the S&P’s loss of 15% so far in December, their stocks were already behind the eight ball as they were poor performers during the first nine months of the year, losing 3.8% while the S&P 500 was up over 10%! 

 

Why has the market behaved so badly?

Clearly, there is something wrong with the economy, right?  This is simply not the case if you look at the facts.  The economy has been humming along at a healthy clip with strong employment and corporate earnings growth.  U.S. Gross Domestic Product (GDP), a measure of the value of all goods and services produced in the U.S., rose 3.4% in the 3rd quarter and 4.1% in the 2nd quarter marking the best two quarter stretch in the last four years.  

Will the economy slow down for the rest of 2018 and into 2019?  It certainly can and probably will.  Economists’ forecast GDP growth of 2.7% to 3.1% in the fourth quarter, a healthy rate on a historical basis, and slower economic growth in 2019.  The economy is in the late stages of this current “business cycle” (i.e. the planned the ups and downs of the economy) and two-thirds of economists are forecasting a recession will not occur until 2021 or later.

But no one really knows.  The National Bureau of Economic Statistics (NBER), the authority on dating U.S. recessions, typically don’t even call a recession until after its already over.  Another common statistical determination of a recession is two consecutive quarters of negative economic growth.  Clearly, we are not near that type of slow down yet.

 

We’ve seen this movie before; the market’s history of short-term overreaction

Even during the bull market run that started at the beginning of 2009, we have seen periods of sharp declines and volatility.  Below is a selected sample of periods over the last several years where the S&P 500 Index has declined precipitously due only to have rebounded sharply afterwards when stability returned:

Decline Period                                   % Decline             Rebound Period        % Gain

1/26/18 to 2/8/18                                 -11.3%                  2/9/18 to 2/26/18         +8.0%

3/9/18 to 4/2/18                                   -9.1%                    4/3/18 to 6/12/18         +8.9%

11/2/15 to 2/8/16                                 -16.9%                  2/9/16 to 4/18/16         +14.3%

7/18/11 to 8/15/11                               -20.0%                  8/16/11 to 3/12/12       +20.9%

 

Are there potholes in the road for the U.S. Economy?

The reality is that the while the timing of an economic downturn may be in dispute, many economists agree that the headwinds facing the U.S. economy are growing stronger and more numerous.  Interest rates keep rising, making borrowing costs more expensive for consumers and companies; trade tariffs are increasing, in large part due to aggressive U.S. negotiating tactics; and Wall Street analysts are growing concerned that earnings growth has peaked as the bull market enters its tenth year. 

However, if there is some measure of relief in the form of a positive resolution to the ongoing trade tensions with China, the market may react just as fast and furious taking stock prices back up as it has in taking them down.  

 

Where do we go from here?

We believe the market has overshot with this most recent painful decline and while mindful of evaluating what steps we can take to positively impact client portfolio’s, prudent investing guides us not to over react and make significant course altering adjustments at this time.  It would be detrimental to make significant changes that could risk permanently losing money for you; losses that are only on paper at this point.

Rather, we are evaluating changes that will prepare for the seeming eventuality of an economic slowdown we will not be making a drastic bet that would reflect what we feel is a lower probability; a dire outcome for the U.S. economy and stock markets. 

Please know we that we are dedicated to investing your hard-earned money wisely and understand the emotional havoc market turmoil can wreak.  But we are in place to provide the guidance and experienced management that is consistent with a longer-term investment perspective to avoid making harmful mistakes that almost always come from making emotional decisions in volatile markets.