Holiday cheer fades as markets deliver a reality check

The first real stock and bond market tumult since the fourth quarter of 2015 has grabbed media attention and put investors on edge. After rising nearly 10% through September, the S&P 500 entered “correction” territory, ultimately returning a negative 4.4% for the year 2018. There are numerous rationales for the swoon, with number one being fear that the U.S. Federal Reserve has lost track of the proper level of interest rates. After 2 years of steady, gradual and well-signaled increases in short term rates, markets are rioting due to fear that Federal Reserve Chair Jay Powell may have raised them a notch too high. Layer in concerns over China/U.S. trade and flagging overseas growth, and you have a recipe for market angst.

Outside of weakness in housing and autos, however, the U.S. economy has yet to show real stress. Job growth, wages and consumer demand remain healthy. Markets are worried that a decade of steady (if mediocre) economic growth will come to an end as the monetary spigot is turned off. We don’t know if the U.S. is about to enter recession or not, but we’re certain none of the extreme excesses that knocked the entire financial system for a loop a decade ago are present today. Yes, corporate credit has pushed the edges of the “quality” envelope over the past 18 months or so, and foreign banks continue to be undercapitalized, but neither of these issues is anywhere near the magnitude or severity of the U.S. mortgage crash of 2008.

We’re therefore viewing the current market decline as a standard feature of a normal, cyclical stock market. It just “feels” more severe due to the nearly linear rise in share prices since the last recession. Before the 2018 decline, the S&P 500 had not had a down calendar year since 2008. Investors, particularly less experienced investors, became used to a stock market which rebounded quickly after a setback and marched steadily higher. This may be the wished for “new normal”, but it doesn’t reflect economic reality. Two or three years out of ten, markets and the economy stumble. Investors who understand this fact build “all weather” portfolios that work over a full cycle. After a decade of fair weather, it’s important to own businesses built for the bad times as well as the good. Avoid too much debt. Avoid the extreme valuations of companies priced at more than 30 times current earnings. Most importantly, be prepared to see the share price of any business you own, particularly a cyclical one, decline by 30% (or more) in a bear market.

Bottom line: Human emotion overlaid on an economic soft patch can be an expensive mix. Market declines are inevitable, and investors who let their emotions rule in a down market miss out on the long-term compounding machine that is the U.S. stock market. We don’t try to “sidestep” market declines. After decades of managing money, we’ve learned that timing the market can’t be done successfully. You pay us to help you think like a business owner instead of a speculator – to keep you on course in periods such as this – and that’s what we’ll do. In the meantime, we’ll provide further updates on economic and market news as events warrant.

Nathan Boxx, Bradley Newman, Jason Seltzer

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