Anyone paying attention to the market lately may have had a case of indigestion at their Thanksgiving meal yesterday. Equities continued the sell-off that began in October as worried investors sold shares fearing the world’s economies are slowing in the wake of trade concerns, rising interest rates, rising inflation, and a strong U.S. dollar. To no one’s surprise, the sector that had run up the most, technology, has taken the biggest hit, and no group of companies has felt the pain more than the FAANG stocks. FAANG is an acronym for Facebook, Apple, Amazon, Netflix, and Google, the companies that helped revolutionize the products and services on which the world’s consumers have become so dependent. Overly optimistic investors bid up FAANG share prices to levels that allowed little margin for error when it came to meeting lofty growth expectations. It always helps to keep things in perspective when going through periods of market turbulence, so let’s review the economic and market environment and our possible responses to it.
The economy is currently enjoying the second longest expansion on record and concurrent with it - a bull market in equities. The Federal Reserve began an aggressive campaign of monetary stimulus in the wake of the Great Recession that began in 2007. It lowered the fed funds rate from 5.25% to zero and implemented three rounds of quantitative easing (QE I, II, & III) in which it bought trillions of dollars in government and mortgage bonds. As conditions improved it slowly began to reverse the process trying to normalize interest rates. Market rates responded with short-term rates moving up faster than longer term rates resulting in a flattening of the yield curve, often a pre-cursor to recession. However, for the fed to have raised rates eight times in three years is an indication of its confidence in the economy’s durability. The fed must cautiously weigh every policy decision because if it moves interest rates up too fast it can choke off growth, risking a recession and if it moves too slowly, inflation can get out of hand. Signs of an eminent recession are not yet on the horizon and inflation is running close to the Fed’s 2% target range, partially due to wage pressures from 3.7% unemployment and increased production costs from trade tariffs.
Economic growth, as measured by GDP (Gross Domestic Product) is significantly above recent years’ levels, coming in at 3.5% in 3Q18 after a blistering 4.2% annual rate in 2Q18. Growth is projected to slow next year as the stimulus effects from the tax bill fade. Interest rates, while higher than the rock-bottom lows hit in 2016, are still at very low levels. Us baby boomers, who readily recall the days of 15% mortgage rates, think anything below 5% is still one heck of a deal. Our global trading partners are, as usual, reporting mixed results and each country’s fortunes will depend on numerous variables such as exchange rates and oil prices. However, at the end of the day what happens here at home will heavily influence world economies because we are the world’s largest consumer.
When considering any company or group of companies’ valuation, the factors that matter most are earnings, dividends, interest rates, and inflation. FactSet estimates third quarter, year-over-year earnings growth of 25.7% which would be the highest rate since 3Q-2010. This rate is up from a September 30th estimate of 19.3%. According to FactSet, all eleven S&P sectors have higher growth rates today (compared to September 30) due to positive EPS surprises and upward revisions to EPS estimates. Much of that growth is a result of tax reform and reduced regulations and is obviously unsustainable, so any slowdown in earnings should come as no surprise. The question is at what rate companies will continue to grow before any significant retrenchment and what value will investors place on that growth. Historically, U.S. companies grow their earnings around 6-8% annually. Add to that dividends of 2-3% and you get the 9-10% average annual return produced by common stocks since 1926 – some years more, some less, some none. If interest rates and inflation are rising it can create a re-valuation in share prices because fixed-income investments are an alternative to equities and because investors demand an inflation premium to compensate for the loss of purchasing power. Now with additional concerns over a possible global economic slowdown, it is easy to see how stock prices can retreat from recent record highs.
So what should be our response to current conditions? From our perspective, investors have three choices - sell, buy more or stay their current course. Since buying or selling in response to market conditions is a form of market-timing, something we adamantly oppose, we would not recommend either. Our preferred option is door # 3 - stay the course. The decision to stay the course presumes that there is a course. A course that has been mapped out after a detailed analysis of your goals and objectives, present and future resources, risk tolerance and risk capacity, and anticipated longevity. A course that incorporates the historical risks and returns from the various investment options available to you, and one that anticipates market conditions just like the present and conditions even more severe.
That course is the result of your goals-based financial plan, something the professionals at Wealthview Capital are dedicated to helping our clients create so that they may become better financial stewards. Without the clarity and peace of mind that comes from such planning efforts investors will be left to their own intuition, or worse – taking advice from the doom-saying financial media whose job is to scare you out of a good night’s sleep and financial security.
Stay the course, be patient, persevere.