Markets Are Allowed To Go Down 10/19/18

Well that was not much fun was it?

Last week saw the most volatility we have seen in a while. As a matter of fact, the last time I felt that way was at the beginning of the year during ‘Vomageddon’.  Things have settled down a bit but once again the talking heads were scrambling for answers. Of course my phone was ringing off the hook with interview requests from New Zealand to New Brunswick. They all wanted to know why the market was doing what it was doing. I thought it would be interesting to put down all the things that I heard and read about last week that were getting all the attention as to why the market was going down.

Firstly, we need to get one thing straight – markets are allowed to go down. Fox quoted me on a tweet last week when I said that ‘I am more worried about a market that goes up for no reason than a market that goes down for a few good reasons’. That is absolutely the case in this scenario. The market was not getting any respect. I hear a lot of the time that this is the most hated bull rally in a long time meaning that a lot of investors have missed out on the 40+% move higher in stocks since President Trump was elected. Not only was it the most hated, it was also not getting its deserved respect. That is sometimes what happens when things are quiet for a while and investors start getting careless and forget that the market can go down as well as up. Usually it goes down a lot faster than it goes up hence the saying, escalator on the way up, elevator on the way down. I think with things settling down here so far this week the respect has made a reappearance.

As for last week’s list of excuses, let’s begin with China. The initial reports were that finally the China tariff tantrum was coming to fruition. All of the things we were supposed to be worried about had reared their ugly heads all at once. The drag on the global economy was going to affect global growth (nothing new there) and that this tiff will last longer than most think. All are plausible but all old excuses. This didn’t strike me as the ‘ah ha’ moment that investors woke up to. The second China story was that the Chinese, long time buyers of our bonds, were going to step away from the auctions causing our borrowing costs to rise. The worries made the rounds as yields crept higher with even more scare stories doing the rounds of the 10 year yield hitting 4% or even 4.5%. Not so fast captain. Yields can definitely rise and probably will but with inflation still subdued and a Fed that realizes that they are usually the ones that ruin the party, I think Powell will play this one pretty safely – regardless of that the President says. There is some truth to what he says about the Fed being one of the two reasons for a recession (the other being inflation) but with our inflation situation and economic health, it is not something that I am worried about at this time. On to the nest reason…

We had some that were touting the fact that the bull run was over.  If you were a retiree or about to retire, you had to make sure that you were taking at least a little profit off the table. Remember, we had been up almost 45% from the election and had you known that at the time you would not have believed it. Sometimes the human condition can get greedy and that is why markets sometimes act the way they do. If you follow the basic investing advice of ‘however old you are is the percentage of what you should have safely invested (ie bonds) in your portfolio. So a person that is 65 years old better have at least 65% of their portfolio in bonds. This is not a hard and fast rule but for a long time a lot of personal investment advisors followed this theory. Might a lot of those baby boomers gotten out of bed last week and decided to take some profits and rebalance all at the same time? Maybe but I think that is highly unlikely. Next reason please…

The interest rate rises were now starting to compete with equity yields. This has the most legs out of all the reasons/excuses that I heard last week. The 2 year yield was approaching 3% and with that yield, investors may switch out of stocks and into shorter dated bonds. That is already starting to happen but reports are that they are not happening as much as our imagination might think so. A safe yield of 3% is going to be attractive but mainly to those that I have reference above – retirees and those about to retire. I think it is something to keep our eyes on as this is going to be more in play as the shorter term rates rise some more.

Another excuse was that tech was beginning to lose some steam. I believe that this is also the case but maybe not as much as the media had lain out. Obviously, tech has led us higher and been a big reason as to why we have seen the returns to date. This excuse is too broad and needs further attention. I am a big fan of tech and feel as though that sector can still lead but will need some new players to take it to the next level.

The last reason was that although earning s could be good, forward guidance could hurt. Again, this is in my mind another example of how your imagination is your own worst enemy.

So here we sit, the market has shaken off its jitters, at least in the short term. The earnings so far are good and maybe the worst is behind us. That is not for me to say but when I need answers I turn to the numbers, 4.2% growth, 3.7% unemployment rate etc. etc. As long as earnings are still good, and forward guidance is not trashed, the US economy still looks to be in good shape.

About Scott Shellady

Mr. Shellady has a broad and strong range of technical and trade experience in both commodities and financial products in the three main geographies of North America, Europe and Asia.