Market Commentary Ignore the Volatility (Again)

 

Nobody likes volatility. It can scare the heck out of the best of us, and certainly can prompt any of us to second-guess ourselves. We’ve written that before, and it bears repeating today.

We’ll have more detail on the markets and the economy in another commentary, but for now, we wanted to lend some much-needed perspective on the last several days of stock market losses.

The S&P 500 has lost, as of this writing, 5% since last month’s record high. Nonetheless, it is still up roughly 4% from the beginning of the year. Whether we remain in positive territory on a year-to-date basis is anyone’s guess, but even then these moves remain more the product of fear than substance.

The economy is not faltering; the market is not in need of a massive correction, and there is certainly nothing to suggest right now that we have an imminent recession.

The reason for the drop is a combination of news reports citing Fed tightening, increases in interest rates, trade war worries and the civil unrest which grips Washington D.C. right now. They all contribute to a general sense of unease, and that can easily translate – as we believe it has now – into some emotional sell-offs in stocks.

Here’s how we see things now – both the tactical stuff and the more long-term directions.

Bond yields are still unusually low. The Fed is not even close to choking off the recovery.

Real borrowing costs (interest rate less the rate of inflation) are still almost zero.
Interest rate increases are a sign of a healthy economy. They communicate both the Fed’s confidence they can get back to more normal levels without hurting the economy and bond sellers’ need to raise rates to attract people to buy bonds instead of moving into stocks.

Corporate profits are still very strong – likely to grow 20% this year and another 10% next year – that’s why the herd has been moving into stocks.

U.S. unemployment has declined to the lowest level in almost 50 years.

Job growth is still high, and wage growth has not yet risen to the level which would even suggest that employment is peaking.
The market is not over-priced. Using current corporate profit levels, it would take a 3.7% 10-year yield to make equities “fairly” priced. There is no evidence they are over-valued. And if you factor in the 10% to 20% growth in profits we anticipate, the market is far from showing irrational exuberance.

Threats of a trade war are serious stuff, and we won’t sugar coat that. But threats are different than the actual occurrence of a trade war. The tariffs are at this point a headwind, not a game changer for the economy. They have more the feel of negotiating tactics than long-term strategy or policy. They can also be withdrawn just as quickly as they are imposed, so there is a self-corrective component to the authority which has been granted to the President.

On that front, we must also factor in the positive trade steps taken with Mexico and Canada. Both were threatened with high tariffs, markets reacted negatively, and ultimately trade agreements were signed; and the market recovered easily.

We feel that China will take longer, but that the ultimate outcome will be the same: lots of saber rattling and posturing (certainly in public) with more realistic negotiations and results behind the scenes.

The fact remains China has taken advantage of the U.S. for several years. That needs to change, and we believe it will. If a trade war is actually started with China, there will be dislocations (and we are not fans of trade wars; they do not help either country), but they will not hurt the U.S. as much as some pundits are predicting. We believe the downside would not be a major recession, but instead a decrease in our economy’s growth rate.

Right now, this is just another panic attack. We’ve seen lots of these, and the market always recovers. We seem to forget the previous ones the minute the new panic grips the front page. Old Wall Street traders coined a term long ago, “the stock market climbs successive walls of worry”, to explain this phenomenon.

We hope this helps lend some perspective. We will add more in the days/weeks to come if necessary, but for now, there is still a bright future ahead. In the meantime, we will watch the trade negotiations closely in case anything substantial changes there.

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