Cause to Worry? (Oct 10, 2018)

Feb 22, 2019 | So Wealth Management Group


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Here is an update on the current pulse of the market.

We wanted to give you an update on the current 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.  The concern is as follows: if rates go up, consumers are negatively impacted, and then they will spend/consume less. The other concern is that rising rates could cause the housing market to go down (or continue to slow down).  This would cause consumer confidence to decrease, as people realize that their house (their largest asset) has come down in value, and hence people spend/consume less.  This is, rightly or wrongly, how the markets think and this has been the narrative for the last two 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 could keep people on the sidelines:

  1. Rates are increasing– will it negatively pressure corporate earnings as borrowing costs increase?
  2. Higher raw materials costs – will these costs reduce profit margins or were they successfully passed to the consumer?
  3. Weaker foreign currencies – will this impact those multinational companies that do business globally?
  4. Tariffs / weaker China demand – will this affect the future guidance on earnings?

If you combine the above factors with the fact that mid-term elections in the US are just a month away, you can understand that this uncertainty has led some traders to sell ahead of the earnings season.

Although investors should not ignore these headlines, we believe that the strong fundamentals of the market and economy should serve as their overall anchor.  We will 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, with 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 has 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.

It is important to continue to monitor recessionary risks, which are the biggest determining factors 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 continues to be low.  The following are two examples of recessionary indicators that we look for: 1) seeing “inverted yield curves” (the long term government interest rates fall below the short term rates), and 2) if we see interest rates rise above Nominal GDP. If the aforementioned occurs, then we will likely change our tune and reassess recessionary risks.

Interestingly, 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.  Currently, we do not see a big rush into these assets. Gold is fractionally higher, bonds are flat or slightly negative, and “safe” utility and consumer staple stocks are also down.  This tells us 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, and 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 that 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.

The big question is… is this a buying opportunity? We believe that 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 some cash.  You can then use this to finally start building that one or two positions in companies that just seemed too expensive to buy two weeks ago.