STA Weekly Report – The End of Easy Money
INSIDE THIS EDITION:
The End of Easy Money
American Consumers Remain Bullish
Weekly Technical Comment
Portfolio Stress Test
401k Plan Manager
While last week was a difficult week for stocks, yesterday major stock indexes lost more than all last week. For context, last week the large stocks of the S&P 500 lost ground and fell 3.8%. Smaller companies of the Russell 2000 fell 3.7%.
In last week’s report, we closed the first section of the report “Presently we are suggesting caution”. In our January 23rd report, entitled “Events Worth Watching”, we highlighted over enthusiasm in the market, yields, inflationary pressure, economic growth, the federal reserve and national debt. These factors came into play last week and on Monday.
In our January 16th report, entitled “On the Lookout for a Break in the Markets” we highlighted that technical indicators appeared overbought in the shorter-term and we had real concern regarding the lack of fear in the marketplace.
In our January 9th report, entitled “Stocks Start year with a Bang…Proceed with Caution” we highlighted the valuations and historically high margin debt indicating overly bullish sentiment in this market.
I point this out not to suggest we have a crystal ball. I do however want to make the point that a multidimensional risk management strategy can increase the probability of minimizing certain risks in the portfolio.
Risk management is about identifying potential problems. Then positioning portfolios so that the effects of those problems are minimized. We believe our job as wealth managers is to work out what may go wrong, and NOT do as most others and “hope for the best”. Hope is great but not a sound investing method. Investors have enjoyed a prolonged period of calm one-way action (in which we experienced an unprecedented period without even a minor setback – 311 sessions without so much as a 3% decline; 405 days without a 5% decline). This seemingly unstoppable ascent gave rise to heady optimism, and sentiment was so one-sided. With all the warning signs of an overextended market, investors chased the market when it had staged its latest push higher and plowed $45.6 billion into stock funds last week, and a record $100 billion for the month of January. That is sad, but not surprising.
In context, the market slide should be viewed in the context of a Dow that surged 25% in 2017 and more than doubled earnings growth. From election day, the blue-chip index is still up 33%. The bottom line is that we are long overdue for a correction to occur. Look, markets don’t go straight up. The economy is showing some signs of improvement, but just know that this was the only time we have ever seen the S&P 500 rally at a 17% annual rate with real GDP growth barely above a 2% pace.
We still have a market that looks oversold on a near-term basis, finding technical support at the 100-day moving average (2,634 on the S&P 500) – a test of the 200-day moving average would mean a move to 2,534.
What makes this latest selloff different than most is that there was no flight to the safety of bonds. Stocks and bonds have appeared to become correlated, which may not seem important. Bonds have generally zigged when stocks zagged, which has made fixed income a valuable hedge for stock portfolios. At least in this latest selloff, the negative correlation appears to be ending. This means that this is not “event” driven. This is about the markets fear of the Federal Reserve game of liquidity-drainage, pure and simple.
Monetary policy of global central banks has mutated the DNA of the global economy. Now, the Fed has begun the process of reversing its post-financial crisis stimulus. Overseas, the European Central Bank is expected to begin to reduce its 60 billion euro ($74.77 billion) monthly bond purchases. The Bank of Japan has continued its asset purchases, but last week, Japanese 10-year government bond yields began to rise anyway. From the onset of the 2008-9 financial crisis to 2017 the central banks of the Federal Reserve, European Central Bank and Bank of Japan expanded their balance sheets by $8 trillion and the global economy expanded by $2 trillion. One could argue that there is approximately $6 trillion in excess liquidity. We should not be surprised by market reactions to this change in policy.
In other words, risk assets may not be able to rely on the Central Banks or a drop in yields to provide a cushion when prices sell off. That’s because the Federal Reserve is on a path to move short-term rates steadily higher, given that it has nearly met its dual mandate of maximum unemployment and stable inflation.
The January unemployment report released on Friday morning gave further indication, and helped kick of the sessions sell-off. Nonfarm payrolls expanded 200,000 last month, a bit higher that the 180,000 consensus estimate. What really got the markets spooked was a 0.3% jump in average hourly earnings, which translated into a 2.9% year-over-year rate, the highest since June 2009. This worried investors about the onset of inflation, and Fed policy to deal with it. I will just say here, that inflation has been below the Federal Reserve’s target for ten years now, and I believe will remain so. Therefore, the Fed will be slow and reluctant to “normalize” interest rates.
This pullback should not be surprising as investors wonder whether transiting from easy monetary policy to economic growth will be a smooth one. While the answer to that remains to be seen, this is not a time to panic. The underlying conditions of the economy and markets do not warrant significant portfolio changes if you have been following our thoughts, and as we mentioned in last week’s report…proceed with caution.
Despite the recent sell off in markets over the last couple of days, American consumers haven’t been as bullish since before the financial crisis and for good reason. The labor market is strong. Nonfarm payrolls just added another 200k jobs in February. The unemployment rate, at 4.1%, continues trending lower and is currently at its lowest reading since 2000.
Wage growth is accelerating. Wage growth has been modest throughout the current business cycle, owing to aging demographics, disruptive technology, and globalization. However, a tight labor market has now made it difficult to find qualified workers, which, in turn, has put pressure on employers to raise pay at a faster pace.
Financial assets have swelled. One of the longest bull markets in history has not only made investors feel wealthy, but has also boosted their confidence that the rally can last longer. Prior to this week’s market decline, the percentage of Americans who held bullish views of the market was at the highest level since 1987.
American consumers remain optimistic. The combination of a healthy economy, job security, and growing personal wealth has pushed U.S. consumer confidence to its highest level in almost 17 years.
Weekly Technical Comment
S&P 500 Fall Below 50-Day Average
Stocks had a terrible day yesterday. Major stock indexes in the U.S. lost about 4% in one day. And some chart damage was done. The daily bars in Chart 1 show the S&P 500 falling well below its 50-day average. Its next potential support is the rising trendline drawn under its November 2016 and August 2017 lows near 2600. That would bring the S&P 500 down close to 10% which hasn’t been seen in two years. If that doesn’t hold, the 200-day moving average could be next. Some good news may be that the 14-day RSI line (top of chart) slipped below 30 today which puts it in oversold territory for the first time since late 2016. Market breadth was weak and volume was heavy. All market sectors suffered big losses as did stocks all over the world. Volatility soared. Chart 2 shows the CBOE Volatility (VIX) Index more than doubling in value to the highest level since 2015. The only good there is that the three previous moves above 40 coincided with market bottoms. Safe havens gained some ground, but not much.
Weekly Snapshot of Global Asset Class Performance
If you have any questions, please feel free to email me at email@example.com.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
STA Wealth Management – Portfolio Stress Test
By Scott Bishop, MBA, CPA/PFS, CFP®
Partner and Executive VP of Financial Planning
In November of 2017, I wrote the article suggesting that it may be time for you to perform a “Portfolio Stress Test”. Many of our newsletter readers were a little worried that the Bull Market run was getting ahead of itself, and I was suggesting that there was no better time than during a bull run to review your portfolio strategy and susceptibility to market risk and volatility…Similar to how you would rather have a treadmill stress test to check your heart health BEFORE you have a heart attack.
In the last few days, the market has erased all the gains for 2018. If that makes you nervous or worried, do not make a decision to “sell and go to cash” based on emotion. Get some data to make an informed decision. You should ask yourself these questions:
- Is my portfolio keeping me up at night?
- Do I feel that portfolio is being managed optimally?
- If it goes down further, can I handle it (both emotionally and in terms of your financial plan)?
- Will a market correction derail my retirement (check out our Retirement Survival Guide to see more on this)?
- Do I have any tools or components in my portfolio or portfolio management strategy to reduce or mitigate risk if the markets start falling fast?
If you don’t know the answer, I would suggest that it is time to review your strategy or at least get a stress test to see how it will react if this negative market trend continues. During one of the recent market pull-backs in 2014, I was asked by CNBC to write two articles that may be worth revisiting now:
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