Commentary 10-10-2018

Dec 05, 2018 | So Wealth Management Group


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Hello,

Just wanted to send an update. Please don’t mistake this as a “cause to worry”, but rather our commitment to be pro-active and keep you up-to-date on the pulse of the market.

Today we have above average volatility, with the US market indexes down 2-3% at the time of this writing.

The US Fed Chairman’s path of expected rate increases are being interpreted by investors as too aggressive. Hence… the thought process is as follows… if rates go up, consumers are negatively impacted, and then they will spend/consume less. You also, have the reasoning that…if rates go up, the housing market goes down (or..continues to slow down), then consumer confidence slows as people realize their house (their largest asset) has come down in value, and hence people spend/consume less. This is rightly/wrongly how the markets thinks and this has been the narrative for the last 2 weeks.

You also have investors beginning to put a lot of weight on the upcoming corporate earnings season that is about to start later this month. There is still the expectation that earnings will be good, but there are some factors that keep people on the side lines including:

Rates are going higher – will it negatively pressure corporate earnings as borrowing costs increase?

Higher raw materials costs – will these costs reduce profit margins or were they successfully passed to the consumer?

Weaker foreign currencies – will this impact those multinational companies that do business globally?

Tariffs / weaker China demand – will this affect the future guidance on earnings

To combine the fact that you have mid-term elections in the US just a month away, you can understand that this had led some traders to sell ahead of the earnings season.

Investors should not ignore these headlines, however, the strong fundamentals of the market and economy should serve as their overall anchor. We  remain patient until next week before we consider adding to core positions in our discretionary managed portfolios.  The economy in the US is still roaring with growth last quarter hitting +4.1%, unemployment at record lows and wages for workers starting to rise which boosts consumption in the economy. Moreover, all that money that companies have repatriated from overseas have yet to  be spent or reinvested back into growing their businesses. We also gain confidence when we see companies buy back their own stock whenever you have dips like we have seen this week. We are at record stock buy backs and this provides some degree of support to the market, recognizing that companies are cushioning the downside by buying on the way down.

I think the most important thing to continue to monitor are recessionary risks, which is the biggest determining factor for sustained and hard to recover losses. Currently, with the economy and data points as strong as they are, the likelihood of recession in the next 12 months continue to be low. To give you 2 examples of recessionary indicators that we look for: 1) seeing “inverted yield curves” (the long term government rates fall below short term government rates) and 2) if we see interest rates rise above Nominal GDP. If the aforementioned occurs, then we will be quicker to change our tune and reassess recessionary risks.

What is interesting to observe is that , on down days like today, if the market was indicating or predicting a rotation out of stocks, you would expect safe haven assets to attract significant demand. Interestingly though, we do not see a big rush into these assets. Gold is fractionally higher, bonds are flat or slightly negative, and “safe” utility & consumer staple stocks are also down. What this tells us is that we are simply going through some “good old fashioned” profit taking, and not a wider more alarming rotation. The selling is further compounded by the fact that when investors sell their ETFs and Mutual Funds, all holdings in these products are sold indiscriminately. This is how you get strong companies that are in secular growing technology businesses falling 5-10%. (amazon, salesforce, google are all being sold indiscriminately because they are held widely across all funds).  That being said, I also don’t think we should be too surprised that when the market pulls back, the technology sector gets affected. This should be expected. To put it in perspective, the Nasdaq index has pulled back to where it was in July (far from disastrous). 

To conclude, we believe that we could be in the middle of a healthy correction, similar to one that we saw in February and March earlier this year. We will never belittle a market pullback, however, we do not let it overwhelm us given the fundamentals of the economy and markets are still very strong. Typically, markets will gradually recover from pull back in a few months’ time. However, you could see the recovery occur much earlier if 1) Jerome Powell walks back his aggressive interest rate rhetoric, 2) we have a strong earnings season or 3) if the US gets a trade deal done with China. Therefore, the big question is… is this a buying opportunity? We believe for long term investors (not traders), the answer is yes. However, it does not mean you have to buy today.  New cash should be used to only purchase half (50%) of a new holding, saving some cash for later this month or even next. For those with “play” or “trading” accounts on the side, if you have no cash, it would be advisable to trim any “big winners” (likely from tech stocks) and generate 5% cash. You can then use this to finally start building that one or two positions in companies that just seemed too expensive to buy 2 weeks ago.