Gill Capital Partners December 2018 Market Commentary
First and foremost, we would like to wish all of our clients, friends, and partners Happy Holidays and Merry Christmas. We are thankful for the privilege of working with each and every one of you.
As we approach the end of 2018, the exuberant investor sentiment of the past couple of years, spurred by strong corporate profits, restrained inflation, and continued global growth, gave way to caution and investor fear in the fourth quarter of 2018. Has the fundamental economic picture eroded so materially, so quickly, that investors need to reassess their investment strategy? Or is this a normal, albeit unsettling, market correction? Let start with looking at the current bout of volatility and how it compares to other historical periods.
Market Volatility Is Normal
Stock market corrections happen fairly often. Since 1980, on average, corrections in excess of 10% have occurred every 357 days, or about once per year. As shown in the chart below, the S&P 500 has been positive 32 out of the 38 years since 1980. This is despite a 10%+ correction occurring, on average, once per year. In fact, the average intra-year decline since 1980 has been 13%. While these declines have always been unsettling for investors, historically the markets have recovered from intra-year declines and provided positive returns for investors.
Furthermore, market corrections do not tend to last very long, with an average duration of 71.6 trading days, or roughly 14 weeks. How does this correction stack up? As of this writing, the S&P 500 is down 10.16% (peak to trough) and the correction has lasted 59 days.
While there is no question that volatility can be unnerving, we know that corrections are a normal part of investing and a good time to make sure that your portfolio is properly diversified, rebalanced, and in line with your long-term plan. That is where we come in.
Macro Update –Fundamentals, The Fed, & Trade
As we moved into the fourth quarter this year, investor sentiment shifted dramatically. The prospect of higher interest rates in 2019, combined with the fear of decelerating corporate profits and escalating trade tensions, have investors hitting the pause button. Is the base fundamental growth case still intact? Let’s briefly dig into each of the important components mentioned above.
Interest Rates and The Fed –The consensus conclusion coming in to the quarter that the Federal Reserve would continue to methodically hike interest rates stoked fears that monetary policy would quickly (or had already) become restrictive. Consensus forecasts called for the Fed hiking rates 3-4 times in 2019 on top of a widely anticipated rate hike this month. What a difference a few weeks makes. The market is reassessing this consensus and is now forecasting a far less aggressive Federal Reserve in 2019, with much lower interest rate forecasts.
Our View – We do not believe that the Federal Reserve will be able to hike 3-4 times next year given falling commodity prices, the type of stock market volatility we are experiencing, and the ongoing trade disputes. We expect the Fed to take a much softer tone, and we expect this to be a renewed tailwind for stocks.
Corporate Earnings – We saw year-over-year corporate earnings and revenue grow by 27% and 12% respectively in Q3. The bottom line earnings numbers were astounding, though revenue growth as a whole was softer than expected. Tax reform was a significant contributing factor, but a large part of the expansion has occurred in pre-tax margins, as pre-tax earnings grew by 14% year-over-year through the first three quarters of 2018. Investors looked at softer revenue numbers, combined with declining earnings growth forecasts, and became concerned that corporate profitability will be decelerating.
Our View – The spike in corporate earnings may have been exaggerated thanks to tax reform, but corporate earnings are still growing, albeit at a slower pace. We would anticipate muted corporate earnings growth in the mid-to high single digits next year, as wage pressures and trade tensions will pressure margins. Please note, we are not calling for negative earnings, just a slower pace of growth.
Trade Tensions – Trade tensions with China continue to act as a drag on markets as uncertainty and sabre rattling have sent jitters into the financial markets. For now, it appears that both sides are committed to reinvigorated talk over the next 90 days.
Our View – Trade is the single biggest wild card. A positive resolution would surely send markets higher, particularly international markets, while a devolving solution could likely have the opposite impact. Both sides want a deal, which is encouraging, but it is unclear if a deal is within reach. We know Trump will want to make a deal, and we still suspect he will be able to claim a “victory” here. The question is, will he get it done before too much damage has already been done?
We believe the fundamental economic picture is changing, though not as negatively as the markets are interpreting right now. We still see economic growth next year, albeit a bit more subdued. The labor market is still robust, corporate earnings are still growing, and Federal Reserve policy may now become a positive for stock investors.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.