Dear Friends and Clients:
I am titling this “What The?” with his being the most often question received over the last three months. As we are all painfully aware the major indexes dropped around 15% from the peaks earlier in the year. Some sectors were down over 20% which is considered a bear market. The real question being asked is why?
Although there isn’t one reason much of my research has indicated a return to normal valuations. According to Tealwood Asset Management, roughly 25 stocks (mostly technology related) of the 500 stocks in the S&P 500 index were responsible for the new highs being attained in 2018. The combined PE ratio of these stocks was 98 which is extremely expensive, (PE ratio is the price paid for $1 dollar of earnings). The example I have been using is; this is like paying $30/gallon for gas! In fact, according to SEI 15 stocks of the 500 was responsible for 67.6% of the S&P 500 total return through August 2018. We all know these names; Apple, Microsoft, GOOGLE, Amazon, Netflix and Cisco to name a few. This high of a PE ration is not likely to continue and guess what it hasn’t. These same high flying stocks are mostly responsible for the painful last three months. According to Yahoo Finance, Apple is down -35% since August 27th and Facebook is down -34.3% since July 6th.
In my opinion, below is the positive fundamental factors that eventually will be recognized:
- Unemployment is at historical lows
- Wages are up; average hourly earnings rose .4% in December and are up 3.2% from a year ago (Source; First Trust Portfolios)
- Christmas sales were very good. According to CNBC sales are forecasted to exceed $1 Trillion the strongest growth since 2011.
- Gas prices are low (fill up we all have been here before)
- Interest rates are still historically low even with the rate hikes by the Federal Reserve
- Inflation as measured by the CPI is historically low
- Corporate Profits are healthy
- The pullback has brought valuations down
- US GDP growth should end 2018 over 3.2% according to FT Portfolios.
- New trade agreements have been reached with Canada and Mexico (although not ratified by Congress)
Bottom Line according to FT Portfolios: “At some point the US will have a recession. But none of the data we’re looking at suggest a recession will start anytime in the near future. In turn, we think profits will continue to grow and that even at the current level of profits, US equities remain cheap.”
I lean to the above bottom line but also am aware of some of the negative possibilities:
- Global Slowing; According to CNBC December 18th posting market indexes in China, South Korea, Turkey, Italy Germany and Mexico have dropped into bear market territory.
- The tariff issue with China is still not settled and could get worse in 2019. This may cause emerging markets and developed Europe to continue to slow.
- The Federal Reserve is most likely going to continue to raise rates in 2019 although recent speculation is they may hold off in the first quarter.
- As interest rates rise the impact will be felt on loans many of us use including new home purchases, refinancing, car loans, student loans, home line of credits, and credit cards. The same is true for business with increased costs for credit. Eventually this will impact growth and profitability.
- The cost of servicing our national debt will also be higher with increasing rates
- The Federal Reserve is reducing their balance sheet by $50 Billion per month. This is not a small sum and may affect businesses ability to get adequate financing.
- The labor market is tight with continual reports of a lack of qualified workers. Labor rates will rise which may become an inflationary indicator.
- Lastly, the 50 day moving average pierced the 200 day moving average on the S&P 500 in December. This in my opinion is a yellow flag warning.
- Brexit still not settled.
- Might be hearing about Italy and Greece again in the news.
With all the above it is my belief that the US economy is currently the strongest in the world. As you most likely have heard this recovery since 2009 is one of the longest in history. However, as I have mentioned in the past it is also one of the slowest recoveries. It is my belief that 2019 will be volatile but in the end will provide a decent return. According to SEI’s conference I attended last November, they don’t foresee and imminent recession. They also believe that emerging markets at some point will have a significant rebound but can’t precisely predict the timing.
As always we continue to read, research and monitor the indicators that we believe are important to protect and grow investment assets. Thanks for reading and please don’t hesitate to call with any questions or concerns. We look forward to seeing you all in 2019 and wish everyone all the best for the new year.
G. Pete Fields, CLU, ChFC
Chartered Financial Consultant
The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee any future results.