Market Update March 1st, 2019

Following the worst December since 1931, the U.S. stock market just had its best first two months to start a year in 28 years. That is extreme volatility, even by this bull market’s standards. The 19.8% market decline from the September 20th peak to the Christmas Eve low was the most severe correction yet during this bull market (narrowly surpassing 2011’s 19.4% correction), and was the eighth correction of 9.8% or greater since this bull market began in 2009.

Through Friday, the S&P 500 index has rallied 19.3% from the Christmas Eve low, so thank you to everyone for hanging in there during such a difficult correction. Especially as a constant stream of smart people in the press breathlessly warned of an imminent recession and full-blown market crash. The media almost talked Americans into a recession in December, but we stayed calm and focused on what the big picture was telling us.

We believe the masses still suffer from some “post traumatic 2008 syndrome” and “economic hypochondria”, as they continually try to foresee and get out of the way of “another 2008”. This has helped keep investor sentiment overly cautious and most equity valuations attractive, which is rare at this stage of a cyclical bull market, but not unprecedented. And it is one of the reasons we have believed that the challenge for equity investors has not been in finding a way to eliminate volatility from their portfolios, but in developing a mental approach to dealing with it. Yet there are massive industries that make tremendous profits by convincing investors that they need to avoid stock market volatility. Whether it be hybrid products and annuities laden with fees, or trading programs, financial media and brokerage firms encouraging active trading, or far too low of interest rates offered in exchange for no volatility risk.

In our opinion not much has changed this last few months to have caused such a massive stock market swing. Yes the Fed has softened its message regarding future monetary policy, and investors are more optimistic about a new trade agreement with China. We just don’t know why so many seemed to think the opposite back in December. As if the Fed wouldn’t react and adjust as new data came in, and as if all incentives for both the U.S. and China didn’t clearly align in favor of trade resolution.

Looking forward, it would be rare not to get some degree of market pullback after ten straight up weeks, and we may see some more significant market turbulence around upcoming Brexit developments. Neither should be reasons to get too worried in our opinion, but this may be a good time to raise some extra cash. Especially if you have upcoming commitments later this year or next, or if the recent severe correction just made you too uncomfortable. Now is probably a good time for us to make those types of adjustments.

We are closely watching the recent economic slowing in China, Europe and Japan. While we think this is most likely a temporary soft patch that should soon start to stabilize, they could certainly get worse before they get better, and negatively impact global stock markets. We will keep you updated. Especially if this or other issues take a turn for the worse. Otherwise we remain positive regarding the economy and U.S. and most global stock markets.

Yes the rate of corporate earnings growth will slow, but should not go backwards anytime soon. Corporate earnings grew over 20% in 2018 as already strong earnings growth was further boosted by the large cut in the corporate tax rate, which provided a one-time additional boost to year-over-year earnings growth rates. But don’t think all of this “peak earnings” talk means earnings are going to decrease any time soon. We think pre-tax corporate earnings are likely to continue to grow at a healthy clip again this year, similar to last year.

A couple of words on Brexit and our national debt now that the debt ceiling and Brexit deadlines are fast approaching:

Brexit: Prognosticators continue to fret about a “Hard Brexit” as the clock winds down on the UK’s negotiations with the European Union. They fear that the UK will plunge into chaos if they crash out of the EU without a trade agreement, throwing the UK into recession, and taking global equity prices down steeply. This seems to assume there would be little or no trade between the UK and the EU after a Hard Brexit. But as economist Brian Wesbury recently pointed out, trade rules would simply shift to the rules that apply between the EU and other countries under the World Trade Organization, like those that apply to EU/US trade or between the EU and China or Japan. And, the rest of the European Union runs a roughly $90 billion trade surplus with the UK, so if a Hard Brexit makes it difficult for the rest of the EU to export to the UK, every EU member country would suffer more than the UK, placing tremendous pressure on the EU to lower tariffs and cut new trade deals with the UK. We therefore don’t believe Brexit should cause sustained economic or market disruptions, despite the hype of the press and the EU’s rhetoric and threats.

The National Debt: “Christmas is the time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell government what they want and their kids pay for it.” – Richard Lamm

We have been surprised at how little attention the national debt and deficit received during the presidential and mid-term elections, and still receive to this day. With our national debt skyrocketing to a current $22 trillion, and our annual budget deficit approaching $1 trillion, many people wonder how concerned they should be, and what if anything they should do to protect themselves.

Our politicians will all but ignore the debt and deficit for long periods, as if they aren’t a problem, and then periodically sound the alarm as if they are the greatest current risk to our country, especially when it comes time to agree on a budget or raise the debt ceiling. So which is it? Could our exponentially-growing debt become a major problem in the future? Absolutely. Is it a major problem to worry about today? Probably not when put in the proper perspective. The reason being, U.S. private assets and the economy are growing as fast, or faster, than the debt for now. And the cost of servicing that debt is currently about 1.5% of our GDP. In the ‘80’s and ‘90’s our cost of servicing the national debt was 3% of GDP. But as interest rates rise in the future, the risks will intensify. Especially during future recessions.

Non-government assets in the U.S. today are estimated at around $300 trillion. Our national annual GDP is about $20 trillion, and our national debt is $22 trillion. Here is another way to look at it by removing a bunch of zeros. Imagine you inherited a building from your uncle worth $300,000 that generated annual income of $20,000 and had debt of $22,000. Would you be worried about the solvency of this investment that you inherited? No. Would you like to start paying that debt down with some of that income? Probably. But overall it is a solid asset with attractive investment returns and reasonable debt that could be easily paid down if that were a priority. However, in 20 or 30 years the situation could be very different, which is why we would like to see a balanced budget achieved during strong economic periods like this.

That’s it for now.

Have a great weekend!