The markets did not react well to this week’s Federal Reserve meeting announcement and Fed Chair Jerome Powell’s press conference. The Fed raised overnight rates 0.25% to 2.25-2.50% and have now raised rates three times this year. Going forward they did cut their estimate on rate hikes in 2019 to two from three and emphasized a commitment to data dependency on further hikes. This effectively means they raised the bar somewhat on what would get them to raise rates in 2019. [i]
Markets were hoping they would be even more cautious in their statement about the prospect of future hikes.
Another aspect of Fed policy is the Fed balance sheet — the Fed started buying many billions of government and mortgage bonds during the 2008 financial crisis to pump cash into the economy. They are now letting those bonds mature and are not reinvesting the proceeds, essentially draining huge amounts of money from the economy.
The S&P 500 fell 1.5% on the day yesterday after it absorbed the Fed news.
Instead of a year-end rally, December has been very rough so far with the S&P 500 down 9.1% since November 30. The S&P is now down 4.4% for the year and 13.8% since the all-time high on October 3. [ii]
Smart investing takes a lot of counterintuitive discipline. The old adage of ‘buy low, sell high’ is easy to say but often difficult to implement.
Back in January expectations for profitability were high, good news was embraced, valuations were expanding, and investor sentiment was very positive. Now in December we are experiencing the mirror image of January. [iii] Valuations have compressed (from an 18 forward price-to-earnings ratio in January to 14.5 now). [iv] Investor sentiment surveys are negative, and positive news is ignored and everyone is worried.
Earnings estimates are coming down but not dramatically. The trade tensions with China continue, but at least the two sides are talking for the next two months and clearly both sides are incentivized to figure out a breakthrough that can avoid further tariffs. [v] From our perspective, the two biggest concerns of 2018 — Fed rate hikes and China trade — are at least now looking less ominous as we begin the new year.
With the recent market action, valuations are at the lowest point in five years, and investor pessimism is at a 2 1/2 year high.[vi] You are relying on us to get you through the emotional challenges of market downturns and to fully participate in the investment opportunities that are all around us. We seek to do this consistent with your financial goals and asset allocation plans, as we avoid overreacting to short term issues. Holding on and adding to equities (rebalancing) is, in our opinion, the right but difficult thing to do — remember ‘buy low, sell high.’
We intend to keep on plan by rebalancing portfolios and harvesting losses for tax purposes. Long-term investing requires patience and discipline; every extended market sell-off tests investor fortitude. We will diligently and thoughtfully work through this downturn with you as we have others in the past. We believe our investment program has demonstrated its durability over the last twenty years, and our confidence in it remains as strong as ever.
Happy Holidays! We look forward to communicating often in 2019.
John M. Bussel
Chief Investment Officer
[i] “Federal Reserve Issues FOMC Statement.” The Fed – Money Stock and Debt Measures – H.6 Release – April 26, 2018, Board of Governors of the Federal Reserve System (U.S.), www.federalreserve.gov/newsevents/pressreleases/monetary20181219a.htm [Accessed 20 Dec. 2018].
[ii] Source: Morningstar Direct
[iii] Bird, Mike. “The Great Cheapening of 2018: Global Stock Valuations Now at Five-Year Lows.” The Wall Street Journal, Dow Jones & Company, 12 Dec. 2018, www.wsj.com/articles/the-great-cheapening-of-2018-global-stock- valuations-now-at-five-year-lows-11544587538.
[iv] Yardeni, Edward, et al. Stock Market Briefing: S&P 500 Sectors & Industries Forward P/Es. 19 Dec. 2018, www.yardeni.com/pub/mktbriefsppesecind.pdf. [Accessed 20 Dec. 2018].
[v] Mian, Sheraz. “How Low Can Earnings Estimates Go?” Zacks Investment Research, Zacks Investment Research, 20 Dec. 2018, www.zacks.com/commentary/197994/how-low-can-earnings-estimates-go [Accessed 20 Dec. 2018].
[vi] Bespoke Investment Group. “Individual Investor Sentiment Hits Multi-Year Records.” Seeking Alpha, Seeking Alpha, 14 Dec. 2018, https://seekingalpha.com/article/4228269-individual-investor-sentiment-hits-multi-year-records [Accessed 20 Dec. 2018].
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