The rapid downswing of Q4 2018 is shaped increasingly by hordes of techno driven trading firms that have no interest in investing. Oceans of rapid paced money seeking an edge pile on to the selling as markets go negative and likely cause huge overshooting of what actual value warrants. Numerous products designed to make money as stock prices fall facilitate the pile-up of “shorts” and other trading pools seeking advantage. The WSJ noted on 12-26-18 : Behind the broad, swift market slide of 2018 is an underlying new reality: Roughly 85% of all trading is on autopilot—controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast….Today, when the computers start buying, everyone buys; when they sell, everyone sells.
Every market era has internal dynamics that have nothing to do with owning good businesses as long-term investors. In the 1960s and 70s it was “The Nifty Fifty” which were a group of stocks that were considered above all the rest. The 1980s had “Portfolio Insurance” that led to the 1987 October downswing. The tech mania of the 1990s is another of many examples that we can learn from. Now the idea that technology is going to wreck the market for everyone will likely get lots of ink and agitated discussion. Fast news wires, technology and teams of math PHDs have been impacting markets for a long time and always will.
Cascading negativity is a psychological phenomenon that is nothing new. The current downswing has arrived after a significant run up in prices that placed the market at extremely vulnerable levels. Prices can only rise if there are new buyers willing to bid. Corrections are a normal part of market systems. The flip side is that the selling generates lots of cash that does not go away. Some successful trades will re-enter at lower prices and some will time it wrong. That is not our concern. But the thought that this is permanent is just an emotional reaction to the negative swing. The cash that goes out with the selling is not going to be buried in the ground, banks paying 2.5% or crypto. It may be back looking to buy what long term investors already own.
Investors do not give away their ownership of a quality asset because business is slow. Think of the restaurant owner troubled by road construction that is inhibiting customers from visiting. Does he rush to sell, to get out while he can? If the owner is confident that his customers will return after the disruption; if she or he believes in the quality of the food, products or services why sell? If you own blue chip dividend paying companies, the economic cycle will ebb and flow as values grow.
During bear markets, many companies continue to pay dividends. The recent environment has shown strong economic growth, but we may see it slow as financial conditions turn volatile. As the economic cycle bottoms the period of dividend reinvestment at lower prices facilitate the recovery of quality portfolios. Pondering “how much have I lost” is a terrible challenge to our process of growing wealth. When you do not sell, no loss is booked. All your shares are intact, and the share balance can even grow if dividends continue. Quality companies will grind and fight and be there when the clouds dissipate.
It sounds hollow to suggest that the only thing to do during these times of volatile and aggressive selling is to remain patient and allow storms to pass. The urge to make changes around the idea of selling until the market calms down is powerful as human emotion overrides the rational mind required for maximizing financial strength over time.
Generally, it is important to consider selling if there is an indication that the fund or manager has shown signs of poor quality or persistent lagging of performance vs its peer group. I work very hard to weed out underperforming funds. Bad environments are usually much less persistent than they threaten to be. My dad used to say that if the market is going down, let it happen fast so you get the decline over with without making a mistake.
Markets generally don’t snap back quickly from these types of sell offs but rather there can be abrupt changes in sentiment. As the broad negativity begins to abate, that is the beginning of the next leg of potential growth. There will be numerous head fakes Along the way and sitting tight may place you in the best position when the recovery begins.
Before discussing policy let me emphasize again that I have no set ideology or hostility to the GOP, Trump, his family or any party whether Democrat or Republican. I strive to see the world in a rational economic based view. I yearn for a time where presidential politics ceases to dominate our public discourse and news flow. This environment is being driven by very unusual people and policy and I need to vent what I see as numerous policy mistakes that are driving this surge in negativity.
The 2016 election shocked the market. The initial market reaction was to sell off. Quickly the psychology turned towards a broad belief in a “pro-business” presidency. Initially these beliefs were reinforced through de-regulation efforts and then followed by a tax cut that featured a big reduction to corporate tax rates. Waves of optimism built on these actions fueled the gains of 2016-17.
Recent gains were built on the idea that the Trump presidency was a relatively standard Republican White House with some populism mixed in. The GOP proceeded as if they could harness the energy to execute a traditional conservative agenda. 2018 saw more volatility as high prices became vulnerable to rising interest rates and lack of additional money to bid equity prices beyond high levels. Pro market / business dynamics were stopped cold by the uncertainty created by incoherent ideas on trade and general antagonism towards much of the post WWII global order. The populist instincts of the President turned out to be of great concern and source of uncertainty. This turns out to be very threatening to commerce and growth.
Shortly after some vague reassurance that came out of a meeting with Chinese leadership, on December 4, 2018 the President of the United States declared “I am a Tariff Man” and the market has proceeded to downswing in one of the worst December’s ever. Amid all the daily chaos, these protectionist ideas are likely to be the greatest cause of negativity across virtually all asset classes. These global trade ideas have risen from populist demagogic slogans filled with vague promises and lacking any coherent strategy or tactics. I have heard zero support for these ideas throughout the business and investment communities and one can only imagine the pressure in DC to get past these terrible ideas.
The WSJ recently noted 12/25/2018: Just about every material you’d need to remodel a kitchen is now subject to the earlier round of tariffs. Many U.S. vendors import the majority of their materials from China. Flooring, cabinets, countertops, sinks, refrigerators and lighting fixtures are on the list of imports from China that now have a 10% tax, as are many of the materials used to make them, from plywood and quartz to stone and granite.
Companies across the construction supply chain have tried to mitigate the impact, including by looking for alternative suppliers in neighboring countries like Vietnam and Cambodia or loading up on inventory in the event that the tax jumps to 25% in January. But many say they have had to raise prices to offset the effects of tariffs. American suppliers are now raising prices as well, as tariffs on foreign products have boosted demand for theirs.
https://www.wsj.com/articles/how-tariffs-could-trickle-down-to-your-kitchen-remodel-11545742801?mod=hp_lead_pos6
Note the line: American suppliers are now raising prices as well, as tariffs on foreign products have boosted demand for theirs. The consequences of these type of trade actions are usually rising prices. The slogan should be “less for everybody” as the inflation will soak up consumer spending and will likely diminish living standards.
The presidency stands on the cusp of a new democratic congress eager to diminish what they perceive as numerous transgressions against core democratic principles. The federal government is in shutdown for the third time in last two years as GOP has held total control. The WH has a temporary AG, bizarre resignation of Secretary of Defense and a 3rd chief of staff. The Mueller investigation has been a cloud over the presidency from nearly day one. We all can agree this is not the best-case scenario that could have been imagined two years ago. The markets have moved 180 degrees from confidence to disdain in GOP leadership.
The crucial opportunities of infrastructure, health care reform (remember repeal and replace?) and fiscal reforms that could place the federal budget on firmer ground have all been forgotten. Instead we have vague notions of glory through trade threats, tariffs and shaky promises of bringing back manufacturing to the USA. Looking to the future via advanced training, innovation and embracing new technologies is what has always propelled America forward to economic achievement. It is startling to see presidential power impulsively deployed to the US economy and global supply chain. Counterfactual thinking about the post WWII era seems to be leading to delusions about recreating the past where a high school diploma and hard work could lead to a life of dignified work and economic security. Hope springs forward to a time when leadership focus can get to the things that can really help those hurt by the complexity of rapid technological advance and global trade impacts on domestic manufacturing.
During all of these challenges, the Federal Reserve has proceeded in efforts to normalize, or gradually raise interest rates to levels that meet the goal of price stability and maximum employment. Looking back to ten years ago, we were at the beginning of an era of massive support of the global monetary system via central banks worldwide.
“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” FOMC statement 12/16/2008
https://www.federalreserve.gov/newsevents/pressreleases/monetary20081216b.htm
The global markets were flooded with cash beginning in late 2008 as the Federal Reserve Bank of the United States began a multiyear process that sought to bolster the US economy.
Fast forward to 12/19/2018 and monetary posture and policy has moved from extreme accommodation to what has been referred to as “Normalization”. The process began at the end of 2015 and has been a sharp source of worry for equity markets ever since. Q4 2018 has seen of a convergence of cost of money fear with escalating policy risk. The price of money is a constant fixation of the global markets.
The President has been eager to add his voice via a barrage of agitated tweets about the Federal Reserve and what a mistake it is to continue a process that has been public knowledge for quite some time.
Fiscal policy in the US has also continued to stoke current fears. The recent unfunded tax cut that is exploding the deficit and aggregate federal debt, are revealing the terrible flaws and willful blindness of congress to the dire challenge of spiraling federal debt. One can only wonder what has happened to the conservatives that were so fixated on Federal spending and rising debt. The tax cut passed in 2017 was paired with no cuts to spending or growth in government. These actions are utterly lacking in courage and shockingly hypocritical after years of GOP complaints about spending.
Indications are strong that starting political experience and service by becoming president is a bad idea. One of the postscripts of this political era will likely be that government service prior to running for the presidency is likely to be really important. Deep knowledge of our legal system, history and working of the levers of power are not something that is learned via reality TV.
Understanding that The Federal Reserve is an apolitical institution is a glaring example of the problems that this naivete presents. The reason that the Fed stands outside of ideology and politics is that every president would seek cheap money via low interest rates and other monetary policy help to propel the economy. A politicized Fed would cause the Dollar to lose credibility. The fact that the world is based on the US Dollar provides a massive structural advantage that must be preserved. Public statements about the price of money will hopefully cease as the integrity of how our banking system works will become crystal clear to the White House.
It seems the causes of the Q4 2018 are largely self-inflicted. There is now going to be waves of hand wringing and anxiety about a crisis of American government and dark concerns about removing a president. One way or Another the next 24 months will pass. The US political system, economy and spirit of what it means to be an American will easily withstand this and emerge stronger.