Gift Exchange – Dow Roars to Largest Daily Gain in History

Market Commentary – December 27, 2018

“Happy Birthday.” That was the text that I sent to our former CEO yesterday (Wednesday) morning. Our recently retired and level-headed partner responded, “Thanks. A thousand-point rally would be a nice present.” I responded, “I’ll get to work on that.” Much later after the market closed, I texted again with tongue in cheek, “Got you 1,086. We will work on it again tomorrow. You’re welcome.”  

As background, the markets have been nothing short of challenging. Continuing with a gift analogy, the gift of 1,086 points on the Dow Jones Industrial Average (Up 4.98%) yesterday was a belated Christmas gift that many would like to exchange for all of December (and more). The similarly impressive gain of 4.96% for the S&P 500 yesterday kept it from hitting bear market territory (i.e., down 20% from recent high). The following is based largely on a note that I penned to our employees on Christmas Eve, which was titled “Coal for Christmas”. I’ve updated some sections for relevancy.

How Bad Has It Been?

  • Worst Month Since the Great Depression (1930s) – As of Friday (12/21/18), the S&P 500 was down 12.35% for the month. At this rate, it will be the worst month since the Great Depression.
  • Worst Quarter Since the Great Recession (2008) – S&P 500 was down 16.67%. Data as of 12/21/18.
  • First Time in 27 years – Providing global stocks and bonds end down for the year, it will be the first time in 27 years this has occurred.
  • Silver Lining Prelude – The broad bond market was up 1.37% month-to-date and 1.17% quarter-to-date. Data as of 12/21/18.

With yesterday’s (12/26/18) historic rally, the S&P 500 is still down 5.91% year-to-date, while international stocks have been performing better than domestic stocks of late they are down 15.53% for the same time period. The general bond market is down 0.50% year-to-date after a significant risk-off rally has rewarded U.S Treasury bonds.

Reasons?

The same reasons that we have communicated numerous times recently applies.

  • Fed Rate Hike – Market does not like that fact that the Fed hiked 25 bps last week. The good news that they announced dropping their estimates for hikes next year from three to two was diminished by their comments that the economy has a more balanced set of risks (i.e., softer economy than their comments from months ago).
  • Inverted Yield Curve – The 2-year vs 10-year U.S. Treasury spread has been tightening – a sign the market believes the Fed is wrong. Inverted yield curves often lead to economic recessions.
  • Tariffs – Markets do not like tariffs. It creates winners and losers – usually more losers. It also reduces productivity, increases inflation and slows growth. To that point, the International Monetary Fund (IMF) has reduced global growth rates based primarily on tariffs.

However, there are some new issues to report.

  • Government Shut Down – While government shut-downs aren’t normally a big deal for the economy or markets and this one only impacts 25% of services, the reversal by President Trump that he would sign a bill keeping the government open whipsawed the markets.
  • Lack of Confidence in Government – It is fair to objectively state that the markets are not only worried about the Fed, but that the drama from politicians is wearing nerves thin. And according to Strategas Research Partners, there are now 17 open investigations into Trump in some capacity and Special Counsel Mueller may provide a report in February. As Strategas states, Republicans are now turning on the President and more chaos may develop as Democrats take control of the House in January. The President’s actions make policy decisions even tougher to calculate in 2019. Markets don’t like uncertainty and chaos. The political scene has plenty of both.

Two issues we are watching are the impact of tariffs on corporate earnings and the negative impact of uncertain/negative government comments and decisions on animal spirits. Recent tax reforms created incentives for companies to invest in growth. However, if the environment is too unpredictable for corporations then this could negatively impact their plans, creating a self-fulfilling slow-down.

Silver Linings?

  • Technicals – Markets appear oversold. For example, nearly 50% of S&P 500 stocks traded at a 52-week low on Christmas Eve. Put/call option ratios are at extremes not seen in years. And, just 10% of stocks are trading above their 200-day moving average.
  • Valuations – Valuations appear modestly priced.
  • Framing Actual Returns – It is important to avoid the pitfalls of behavioral finance, including anchoring and recency bias.  For example, the S&P 500 was up nearly 22% in 2017. As of Friday’s close the trailing three-year return is still up 8.3% and international stocks (MSCI ACWI ex US) are up 5.2% during that time.
  • Fiscal Stimulus – Expect lots of positive news on this front globally for 2019.
  • China & Tariffs – China has already made stimulus moves and more are on the way. China cut tariffs on December 23rd on over 700 items, albeit it’s not the major news we are looking for. Here is a link to an article highlighting these actions.  
  • Market Strategists – According to recent Bloomberg survey of market strategists, the average S&P 500 price target for 2019 is 3,052, which represents a 24% return from the December 26th close. I wouldn’t bank on these forecasts. Economists are predictably high and ratchet down over time. However, even if these numbers come down, it could be a better-looking equity runway for 2019.

Reminders

  • Don’t Time the Market – Market volatility can be hard to stomach particularly if you are looking daily. The frequency of reviews often leads to making decisions based on emotions instead of facts. The decision to sell must then be followed by the decision to buy, but when do you do that? Some of the largest market rebounds come on the heels of market sell-offs. The following study from T Rowe Price illustrates that sticking to our financial/investment plan and riding out volatility may prove beneficial.
  • Portfolio Management – We continuously monitor the markets and have been making a variety of de-risking moves over the past 18 months.
  • Financial Planning & Risk Assessments – While we have been immune to volatility in recent years, this environment may provide a good time to review your actual goals-based investment objectives and risk tolerances. After all, investing for goals is more important than chasing or running away from market returns.

Please review our previous Reed Between the Lines publications for related commentary.

We continue to closely monitor the markets and will be providing more commentary in the days and weeks ahead. This will include our Winter Market Commentary where we will discuss many of the fundamentals driving markets, including three key ingredients – valuations, growth rates and sentiment. In the meantime, if you have any questions please don’t hesitate to contact your TC Wealth Partners/Trust Company of Illinois advisor.

Wishing you a Happy New Year!

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