Christmas came late! After a volatile gut-clenching end to 2018, when markets finished with a dramatic correction, the year’s first quarter delivered a happy rebound. All market sectors turned strongly GREEN, leaving last year’s champion, Cash, in their dust. It just goes to say, what goes up must come down, and vice versa. In the Game of Investing, Cash was dethroned.
Moving forward, equities continue upward in pursuit of the prior year’s highs. In spite of rising angst by market pundits and predictions of impending recession by some economists, matters seem well in hand. The economy remains steady, unemployment at multi-decade lows, and 30-year mortgages again below 4 percent. It can be reasonably expected there will be a pause in all of this good news, but it’s difficult to see any of the same conditions which preceded the severity of the events of 11 years ago.
The rest of the world is experiencing more difficult challenges, and international markets reflect this. There are increasing signs of a turnaround, however, as China seems to be strengthening and the various central banks have, once again, opened the money spigots. A resolution of trade issues would be of great assistance.
So are we back to the perennial question of whether markets are too hot, just right, or about to get very cold. We suspect markets are in a neutral goldilocks zone, with increasing levels of volatility for the rest of the year – much like last year. If equity prices were too elevated in the middle of 2018, they may once again be getting ahead of themselves. In the event of any market moving event, equities could move abruptly down, only to bounce back as cash rolls in for lack of any better investing alternative. And you may expect foreign funds to continue to roll into the US whenever German ten-year bonds drop back into negative interest territory.
The final Christmas raise of the Federal Funds rate has allowed returns on cash and short-term investment to rise to the 2.5 – 3.5% level. With 10 year treasuries trading solidly in the middle of this range, it continues to make limited sense to buy longer-dated fixed income instruments. Why take the principal risk, especially if you live in Germany or Japan?
Further complicating the bond world is what happens if the inevitable recession does arrive? We have had 10 years of sustained expansion, so a recession is anticipated, perhaps in 2020. The usual tools for dealing with this are to 1) lower interest rates, 2) increase spending, and 3) lower taxes.
Unfortunately, these tools are of limited availability today, as all three are already at recession fighting levels. If there is anything to keep a portfolio manager up at night it is thinking about rising deficits, powered by a tsunami of federal debt in the next five years that is driven by entitlement and interest expenses plus the inability of politicians to control discretionary spending.
Believe it or not, current levels of volatility are normal. As the Bull market runs out of legs, the Bear will take over (for a while), and then matters will reverse. What we know is that we don’t know when this will happen.
It is reasonable to believe that as long as this expansion has lasted, a bear market becomes more inevitable. 10 years of outperformance by growth stocks will be superseded by so-called value stocks. Mean reversion will occur:
This chart shows that for eight years after the tech/growth stock bubble popped in 2000, value stocks ruled. This reversed in 2007, and we now have an extended run when growth stocks have outperformed. If history holds true, a bear market will reverse this trend.
Our strategies have always had a value bias, which we have reduced as the growth phase extended. In recognition of changing global economic trends toward slower growth, we will marginally shift the growth/value balance back to value.
It remains important to remember that your long term investment planning should not be changed because of events such as the Christmas Eve correction. Selling into a panic at that point would have missed out on the double-digit returns of the rebound. Stay focused on your long term objectives, cash planning, and “ability to sleep well” through volatility.
Anticipating long term trend changes is important, but trying to time abrupt shifts is almost always a loser’s game.
Panic is not Preparation. The long-term trend is up.
And Congratulations to my alma mater, Virginia, on a great basketball season! Wahoowa!
Nothing contained in this publication is intended to constitute legal, tax, securities or investment advice, nor an opinion concerning the appropriateness of any investment, nor a solicitation of any type and does not guarantee future results. The information contained in this publication should not be acted upon without specific legal, tax and investment advice from a licensed professional. Past results are not indicative of future performance.