301 North Main,
Pardon the length, but much to be said.
Holidays are over, the Egg Nog out of our system, and a month, nay a quarter, nay the year is done. Good riddance. If there is anything good that came out of December and the 2018 calendar year it was the great reminder that investing in companies where we can see every day what an investor will pay for those shares can be volatile. Also, it is a good reminder that policy from the Fed, White House drama, and oil prices still can encapsulate the rational and many times irrational behavior of investors. December was a month filled with political activity, economic activity, and market activity. First the good news (don’t get too excited): bonds. Last month’s bond market (US Aggregate Bond index) had the second best month in the last decade at +1.84%! So we can pat ourselves on the back that the bond market index returned us a wonderful +0.01% for 2018. Meaning if we hadn’t had the second best day in the last decade in that index, we would have ended 2018 negative with bonds. If you had fewer treasuries in your inventory then your bond returns were much worse. The S&P 500 ended the month -9.03%, small cap companies (Russell 2000) ended the month -11.88% and there was less than substantial difference between value verses growth stocks with returns of -9.60% and -8.60% respectively. The not-so-shiny silver lining was that international stocks (MSCI ACWI ex US) returned only -4.53% for the month. So yes, we can officially say this was the worst December recorded since the Great Depression.
So where was Santa!? Every year (or most of them to be sure) we get to take comfort in knowing that the “Santa Claus Rally” is there to tuck us in at night while we rest on vacation for a year well-worked. We take off work a bit early or extend our vacation a bit late into the New Year with the assurance of knowing Santa will deliver his final gift of Christmas to our 401ks and other portfolios. So what gives? Well, The Santa Claus Rally by definition is the last 5 trading days of December followed by the first two trading days of January. No one can pinpoint why this time period is so good. Maybe it’s because we all invest our bonuses for the year. Maybe it’s because the selling pressure of early December to harvest tax losses is over so there are more buyers in the market. Maybe it’s because the pessimists go on vacation so there are once again more buyers in these low volume trading days. Maybe people like to purchase stock before the stock prices increase in January with what is referred to as the January Effect. Regardless of the reason, it may have felt like Santa fell asleep at the sleigh.
But did he? In no attempt to make you feel any better, Santa actually showed up this year on schedule. The returns of the S&P 500, Russell 2000, and MSCI ACWI ex US indices from 12/24/2018 – 01/03/2019 were +1.37%, +3.10%, and +0.20% respectively. That is how bad the other 15 trading days were last month.
So what was the cause? Why did we all lose so much money in our stock positions last month and (because of that month) all last year? While I cannot attribute all of the selling pressure for the month, I can give some major events that happened that aided in the spiral. First, we all began to breathe a short sigh of relief after the dinner between President Trump and Xi where they announced a tariff “cease fire” for 90 days…however that quickly turned around in our face with the “Tariff Man” tweet by our POTUS a few days later. Additionally we had a rate hike by the Fed with an ensuing press conference that did not live up to the expectations of the market’s overall negative sentiment. Jerome Powell’s dovish rhetoric, while well-received, was apparently not dovish enough. Another economic factor that I believe played into the hands of our dooms-day-ers was the inversion of part of the yield curve. Since World War II a prolonged inverted yield curve (where shorter-term treasuries are paying more than longer-term ones) has been a strong signal of a coming recession. However I’ve written on this indicator many times before and still believe that the inversion seen in December is a false signal; not to mention that even if it was a true signal, the average months before a recession is measured by years, not months. And then we had oils prices dip below $50/barrel from its mid-70s high in October.
So there were many things to fear in the world and I didn’t even include the volatile Brexit talks, the government shutdown, pulling out of Syria and many other “smaller” newsworthy events.
Here is the real silver lining: Fundamentals. When we look at long-term measures of our markets and economies what we should fear are the following: accelerating inflation, accelerating wage cost, credit bubbles, over-extended market valuations, and a 65,000 to 75,000 year over year decline in the monthly jobs report. Those things tell you more about the true health of the economy than they are currently getting credit for. And all of those things are peachy.
Estimates for 4th quarter GDP have risen to 2.8% - driven by consumer spending and private fixed investments. Home-buying is becoming cool again, and 2018 auto sales show that people are not losing their ability to purchase goods and services. Household leverage is declining. Most recently, the jobs report for December came in at 312,000 and 58,000 jobs were revised upwards for past months. Wages increased at a steady, manageable pace, and our manufacturing index, while lower, is still signaling an expanding economy. December’s reading of 54.1 is far from the 3 index readings that lead the last three recessions starting July 1990, March 2001, and December 2007. Those readings were 46.6, 43.1, and 50.1 respectively. Finally, the US Dollar continues to flat-line and show relative weakness. I believe this continues into next year given our Fed becoming more dovish and other central banks becoming more hawkish (thinking mainly of Europe).
Additionally, 2019 estimates of S&P 500 earnings is roughly $174. The long-term average of what an investor is willing to pay for those earnings is 16.1x expected earnings, putting an intrinsic value to the S&P 500 at 2,801.40. From the close of business on 01/08/2019, that would put a 9% return easily in reach over the next 6 to 12 months. We started 2018 willing to pay 18x earnings, which is common before investors begin thinking the market is too over-priced. If that kind of optimism came back in the markets, that would push the S&P 500 up another 21%. So it’s hard say we are currently overpaying for our market right now and if you look beyond the S&P 500 to small cap, developed countries and emerging countries, the discounts seem even brighter.
I am optimistic that the January Effect (where investors re-invest their tax loss harvesting proceeds from December) will help the first month of 2019 end strong. I promise I am not an Always Optimist. I understand that the weight of our tariffs, our government shutdown, growth worries in China, the EU saga and other meaningful issues can be real problems. I don’t think this economic expansion will last forever. I believe we will see a recession in the next 2 to 5 years. But now is not the time to give in to the emotional reaction a disappointing month like December can bring. When we see fundamentals begin breaking down, we will start sounding the alarms. But until then, stay the course. Invest in stocks as a long-term investor. Don’t make a reactionary decision, and I’m hopeful you will find that the grass is greener on the other side of 6 to 12 months.
We will soon be sending invitations out to discuss our 2019 outlook so be looking for that email.
A reminder, if you have missed any of our Month-In-Reviews you can find them archived on our website at https://www.aghwealth.com/p/month-in-review.
Thank you for your trust and confidence.
LPL Financial Advisor
Vice President, AGH Wealth Management
DISCLOSURES: Indices discussed above were analyzed on Morningstar Direct™. The indices included the S&P 500 Index, Russell 2000 Index, Russell 1000 Growth Index, Russell 1000 Value Index, MSCI ACWI ex US Index, and BBgBarc US Agg Bond Index. The US Dollar Index was measured from the Trade Weighted U.S. Dollar Index: Major Currencies (DTWEXM) Index. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the loss of principal. The content in this letter is developed from sources believed to be providing accurate information.