The Grinches that Stole Christmas 2018

Chris Perras: This is Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. Welcome to the Christmas Eve edition of Keeping You connected to Your Money. Each week we try to recap events in the market and share with you our views on what we believe will transpire in the weeks and months ahead. This week, I’m going to title this one, the Grinch that stole Christmas and my stock market gains for the last 18 months.

After another volatile week last week in the market, that we saw most stock indexes move closer to bear market declines, US stocks extended their December losses on Friday, amid a dramatically higher short-term volatility. In fact, a volatility which was 10 back in January, hit 30 to 31 on Friday. Slow in global growth attributed to this decline, partial government shutdown looming, Trump wanting $5 billion for his border wall, and then the resignation of the Defense Secretary James Mattis, which was unforeseen by pretty much everyone, happened on Friday.

Most importantly, with regards to the financial markets, federal reserve who continues to see a stronger economic growth than really the markets and the data series that we look at are providing. Year to date, as I said, market volatility has increased dramatically. It was less than 10 in January, which was historic lows. It hit 30 on Friday. We’re at the very end of the year, there’s generally no liquidity at this time of the year. People are out there right now, I think, tax-law selling. We saw upwards of $90 billion with a B dollars exit the market over the prior two weeks. That’s a historic high.

Usually, a great indicator in market sentiment, money flooding out of the market at the lows, money coming into the market like January when $55 billion came in at the highs. The increased volatility, the reasons as we’ve talked about in the past, trade tensions between the US and China, those have been going on pretty much all year. They started right after the tax plan was passed way back in January. That has led to a bunch of estimate cuts for the second half of 2018, largely due to three items which we’ve referred to in the past as the Goldilocks items.

They’ve been all negative for earnings for the second half of 2018. The dollar has been rising. That’s negative term for earnings. Oil has been falling, another negative for most the energy sector and earnings and the yield curve has been flattening, which is negative for the banking industry. You’ve been having estimate cuts pretty much throughout the second half of 2018. Been tighter financial additions due to the federal reserve raising rates all year at an accelerated rate. They went up a four times in interest rate increases at the short end of the yield curve.

At the same time, they’re letting their balance sheet runoff at the end of the year here and not reinvesting their balance sheet. Peak-to-trough since the late summer highs, the Dow Jones industrial is off a little over 16% from its high. The S&P 500 is off a little over, I believe 17% from its high, the NASDAQ, which is more volatile 22% since it’s high. The small-cap indices, which have the most growth on the upside and the most volatility on the downside down around 25% since their highs, which in layman’s terms puts the indices back to where they were almost 18 months ago in the second and third quarter of 2017.

People have asked is it 2008 again? We don’t believe so. Highly unlikely, financial markets have a lot more balance sheet strength behind them. In the banking system, we’ve actually seen these kinds of declines a number of times. The cycle for the bull market in 2011, the market was down 21.6% from peak-to-trough. Then it was down another 2% right after that. It went down almost 23% in about a six-month window, and we resumed the bull market the next year, and the market’s up well over 50% since then.

In 2015 in the fourth quarter of 2015, the first quarter of 2016, the S&P 500 was down over 15.5% in a four to six-month window. The Federal reserve came out in mid-January of 2016 and said they’re going to slow their rate of increase interest rates. Market went down for about another two weeks. Then promptly turned around at the end of January, beginning of February of 2016, and went up considerably over the next 18 months. From a fundamental perspective, valuations in the market have gotten extremely attractive now.

At the beginning of the year, we were looking at over 21, 22 times earnings. The forward PE multiple now on the S&P 500 is around 14 times, which is very reasonable, very attractive given, we see low inflation and continued low overall interest rates over the next three to five years. Addressing the issues that are on TV and in the markets, government shut down which is going on right now have been only short-term events in the past have caused volatility for a number of weeks, but have not caused issues with regards to earnings in the market over longer periods of time.

Interest rates and yield curves. While the yield curve has flattened year to date, and everyone is talking about it for the last three to six months, it’s actually been going on over three years. The normal lag from a yield curve flattening to a recession is between 18 and 24 months. These things don’t happen immediately. As good of a predictor as a flattening yield curve has been, it takes the yield curve being inverted for a sustained period of time for the markets to get concerned about recession. Not to mention that a recession in the stock market, and we mentioned this in the past, is typically about minus 30% from peak-to-trough.

The S&P 500 is already down from the very peak about 17.5%, and that it took three months to happen. Even if you believe there’s a recession coming, the market declines are well over half over probably closer to two thirds over. As we’ve said throughout our educational process, the market takes a stair-step up and then takes the elevator down. It’s very slow to move up and there’s very fast as emotions take over and falls very quickly. The third issue that’s out there the US-China trade negotiations ongoing, there’s a March 1st deadline, as far as the truce that’s currently going on.

If you have any belief that president Trump wants any hope of getting re-elected, he’s going to get a deal done in the first quarter. He has to pretty much get a deal done by the end of the first quarter because if he doesn’t, this issue is going to linger and there’s little to no chance he has any chance of getting reelected. Now, I don’t know if he wants to try to get reelected, or he just wants to be a one term president, but most presidents want a second term.

He is going to have to shift his focus from China and that issue, to trying to improve the economy and focus on domestic issues. Right now the stock market is clearly worrying him. He was trying to take all the credit for the stock market going up. Right now he seem to be trying to blame everyone else for the stock market going down, but he is part of the problem, obviously. Consideration for long-term investors, downturns are always unnerving and emotional, but remember your investing principles shouldn’t change. We don’t change our investor principles because the market is down.

You shouldn’t change yours either. We have the core four here at Oak Harvest. We set out your financial plan into different categories. There’s the safe category which is generally cash short-term bonds, annuities, if you have them, insurance products, these assets do not fluctuate much with the market at all. The annuities and investments, insurance products, and tools that we use don’t fluctuate day to day. You can’t pull them up and see them going up and down. They’re stable. The real estate portion of your portfolio and asset allocation does go up and down a little bit. Usually, with interest rates provides a higher dividend yield than the a third category. If you have single stocks, they’re dividend stocks, dividends are no guarantee but they do provide a safety net and a compounding effect over long periods of time. We take those dividends, if you need them for current income, we use them for current income. Otherwise, we reinvest them with the company’s compound returns. Then the fourth category is another risk category, which are diversified low-cost, ETFs and mutual funds.

A lot of the down move in the market right now are being caused by index funds and ETFs. As we’ve discussed in the past, a lot of investors now are using these passive tools, but they’re using them actively. When money comes into these indexes and ETFs, they are priced agnostic. They buy the market or baskets of stocks that are in the index or ETF without regard to price. You saw that in January. I think we’ve talked in the past, Boeing went up $3 a day, $5 a day, then 7 and 12, just because these indexes were buying it.

They did not care what the price of Boeing was. What’s happened the last two to three weeks is a lot of money has gone out of ETFs, gone out of indexes, and those same tools are being used to sell stocks and they are price agnostic on the way down, which is why there hasn’t been many bounces intraday. These funds come in and they have $5 billion per sale. They literally just sell, sell, sell until they’re done selling.

It’s just the tools that are in the market now. It is nearly impossible to correctly time the market. We’ve spoken about that in the past. Is generally healthier for your portfolio if you resist the urge to sell based solely on recent market moves. Since 1974, there have been 10 times when the S&P 500 dropped well over 16%, between 16 and 18% from its peak. Six of those times a bear market and recession didn’t happen.

Most recently was the fourth quarter of 2015, the first quarter of 2016, which was a very similar period economically, as far as coming off a pretty high growth rate at the beginning of 15, federal reserves was raising rates, slow the economy, people thought we’d go into recession. The federal reserve slowed down their interest rates increases at the beginning of 2016. Volatility remained for another two to four weeks, at very high levels and its volatility declined most of the second quarter of 2016, right up until the election.

Remember the most valuable investment advice we can give you is to remain disciplined and try to remove emotions from the investment process. If you already have a financial plans with Oak Harvest Financial Group, and you want us to review it and make sure it still matches your investment goals and objectives, give us a call, and let’s meet in the beginning of 2019. If you don’t have a plan with us, or if you’re looking for a second opinion on a plan that you have with someone else, give us a call and let’s schedule a meeting with our planning group in the first quarter.

Let us review that or set you up with a new plan. Once again, this is Chris Perras with Oak Harvest Group, keeping you connected to your money, many blessings, and Merry Christmas.