Saying the market hates uncertainty is cliché because uncertainty is the only constant in the market. Otherwise there would be no risk and returns would be miniscule. Lately, though, there have been three sources of outsized uncertainty: US/China trade, Brexit, and the Federal Reserve. October may have been the beginning of the end of these extended episodes of uncertainty, perhaps shifting markets back to normal sources of worry.
After almost two years of tit-for-tat and sometimes tweet-for-tweet sparring over trade, the United States and China may have stumbled upon a framework for resolving the dispute. Instead of one over-arching deal wrapping everything up, a series of agreements seems to be the way forward. Previous rumors of progress have fallen victim to a cycle of: announced progress -> markets rise -> no real progress is made -> one side announces increased tariffs on the other -> market sells off. However, by working in mini-deals perhaps progress can be locked in while the next phase is negotiated.
The S&P 500 is up over 20% through September 30th. Real estate is up almost 28%. Even the Barclays Aggregate Bond Index is up over 8%. Unemployment is incredibly low at 3.7% and wage growth is picking up. Inflation is tame at under 2%. The United States, particularly relative to the rest of the world, is doing well. So why is there so much bad news in the media?
Short-term uncertainties dominate today’s news cycle. These short-term fears are contagious and political. Trade war, Brexit, US elections, and the Middle East defy simple explanation. Even as it brushes new all-time highs, the stock market has only gained about 7% over the last 20 months. Should we be skeptical of the markets going forward?
Midway through August nearly every media outlet posted a RECESSION headline. Even the Cleveland Plain Dealer ran a front-page story. The yield curve had inverted (the yield on shorter maturity bonds was higher than longer maturities), leading some to jump to the conclusion that a recession was imminent. After all, the yield curve has “predicted” every recession since 1980.
Yield curve inversion is a leading indicator in a broad sense, though. The “predicted” recessions followed an inversion by an average of 22 months and the yield curve stayed inverted during most of that time. If the yield curve remains inverted for over a year, maybe it would be time to look for other signs of upcoming recession. According to the St. Louis Federal Reserve, our current situation does not fit this pattern.
With a trade war, the Fed’s rate cut, and election season ramping up (none of the challengers will say anything positive about the economy), you may be forgiven for thinking the investing environment is in shambles. However, even after the rough past week, the S&P 500 remains up nearly 15% year-to-date after being up over 20% through July 31. Inflation is low and money is cheap.
What did things look like in December of 2008, the last time the Federal Reserve cut rates, versus what they look like now?
The last time the Fed cut rates, we were heading into the teeth of the Great Financial Crisis. Unemployment was on its way up to 10%. Concerns over “peak oil” boosted oil prices to almost $150/barrel before crashing into the $30 range.
The stock market is either red-hot, extremely average, or still in recovery depending on your perspective. Let’s torture the data until it tells us what we want to hear.
The red-hot stock market
The S&P 500 is up 18.5% and we’re only halfway through 2019! Unemployment is incredibly low. Inflation can’t seem to stay above 2%. The market expects the Federal Reserve to cut rates and Chairman Powell’s dovish remarks encouraged bulls.
Silicon Valley’s unicorns are frolicking in the public markets. Pinterest, Zoom, and Uber are up from their debuts, but the real story is fake-meat. Beyond Meat, a plant-based meat substitute company has soared since its IPO.
For the third year, Fairway Wealth Management had the privilege of sponsoring the RhizoKids Ohio annual fundraiser on May 11th, 2019 at St. Adalberts in Berea, Ohio. Rhizokids supporters enjoyed a dinner followed by an evening of raffles, horse races, and auctions. The fundraiser was a great success, hosting around 300 attendees and raising more than $40,000 in support of the RhizoKids cause. Fairway was represented at the event by Chris Martin, who has been involved with the organization since 2015.
RhizoKids International is a charitable organization originally established in 2008 to support research in pursuit of a cure for Rhizomelic Chondrodysplasia Punctata (RCDP). Mindy Lee, President of RhizoKids Ohio, established the extension chapter of RhizoKids International in 2008 to further the regional presence of the organization. RCDP, a genetic disorder, is a form of dwarfism that brings with it very serious complications. It is very rare, with fewer than 100 children known to be living with condition worldwide. Currently, there is no treatment and no cure for RCDP. Over the years RhizoKids has grown into an organization that provides vital advocacy and support for families of children with RCDP. Each year, the organization hosts a conference in Alabama to bring together leading doctors in the field with the families of children with RCDP. Additionally, RhizoKids International provides grants for research projects, sponsors the RCDP Registry and A.I. duPont Hospital for Children, and works to bring national awareness.
The month of May was not kind to equity markets as the S&P 500 dropped 6%. International stocks were down for the month, too. The EAFE lost 5% while Emerging Markets were down 7%. Sell in May and go away? We don’t think so. The timing of the drop is luck more than anything else. Fingers have been pointed at the so-called trade war, various tweets, and the ever-present market “jitters”. All of these issues (real or imagined) have been part of the investing environment for over a year.
The truth is that no one really knows why the market moves one way or the other on a day-to-day basis. Bank of America Merrill Lynch’s Global Fund Manager Survey listed the following fears as the biggest tail risks going back to 2011: central bank policy mistakes, political populism, a Chinese hard landing, geopolitical crisis, a different Chinese hard landing, the US fiscal cliff, and EU sovereign debt funding. Despite that, the S&P 500 is up 14% over the last ten years, annualized, and almost 10%, annualized, over the last five years.
Most investors, and certainly all our clients, know that market timing (i.e. trying to move in and out of the stock market based on a prediction of the future) is a bad idea. I recently read an article with some data that really illustrates the risk:
Over the last 92 years (1927-2018), the S&P 500 has returned 10.1%/year
If we remove the best 92 months over that period, the return of the S&P 500 would be almost exactly 0% (0.01% to be precise)
So, if an investor was invested on average 11 out of every 12 months, but happened to miss that one best month, they got no return…while the buy and hold investor got over 10% per year
The numbers were very similar in the international markets as well, with almost all the return coming in short bursts
We’ve recently had what will likely be one of those top 92 months. In the month of January 2019, the S&P 500 returned approximately 8%. Yet according to Morningstar, there were $83B of net outflows from mutual funds and ETFs in December 2018, making it the worst month of net flows since the financial crisis in October 2008. So right before one of those “best” months…and right after the worst quarter since the financial crisis… money was flooding into cash. Ugh!
2019 is off to a hot start as the S&P 500 gained 13.7%. Will the market keep up this pace for the rest of the year? It’s unlikely, but the “pace” is also a bit misleading. We have not yet made up the ground lost in last quarter’s sell-off. This is setting up to be a good calendar year, but the market is at about the same place it was six months ago. On Christmas Eve we were on the cusp of a bear market. Today, the media is back to searching for the downside of an upward trend.
It has been 10 years since the bottom of the Great Financial Crisis. The S&P 500 gained over 400%, including dividends, for an annualized return of 17.6%. The numbers don’t tell the whole story. While the total return sounds great, the first three years of that rally were spent just getting back to zero. The S&P 500 had lost half its value and needed a return of over 100% just to recover. A moderate portfolio would have recovered in about half the time, but the early years of the rally were not easy for anyone, regardless of asset allocation. Negativity was the baseline.
This Commentary Brought to You in Part by Macaroni and Cheese
The latest earnings report for Kraft Heinz was a shocker. Operating results were flat, there was a huge impairment ($15.4 billion) of goodwill, and the dividend was cut by 40%. On top of it all, the SEC is investigating accounting irregularities. The most surprising piece of the story is that Warren Buffett’s Berkshire Hathaway owns a big (26.7%) chunk of Kraft Heinz. This sort of thing isn’t supposed to happen under Uncle Warren’s watchful eye. What happened?
“It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”
Mark Twain’s famous quote may provide all the explanation needed. America’s taste for processed cheese and ketchup just isn’t what it used to be, but investors didn’t catch on (revenues had even been flat for a couple of years). Beyond the numbers, this is also a marking to market of the Kraft Heinz brand. For a deeper dive, I suggest Aswath Damodaran’s write-up. He’s a professor of finance at NYU and has a great way of unwrapping stories like this.