Seaborn Hall, 11/21/18, updated 11/23/18, updated 12/08/18
In order of importance the top five reasons for the current market correction – the major indexes are down 2-5% since the Mid-Term elections – are:
- Trade fears due to the United State’s adversarial position towards China. Tariffs are a tax on business and the current tariffs act as a drag on revenues of the big businesses of the Dow and S&P 500, causing investors to fear that future earnings will be adversely affected. Still, the current tariffs are a mere shadow of the negative effect of Smoot-Hawley in the early 1930’s. The positive side: Smoot Hawley covered almost all imports (over 20,000 items) into the United States, some thousands of products. The current tariffs affect only hundreds of products, primarily from China. Investors should bear this in mind, in addition to the fact that any breakthrough in negotiations with China will likely cause a huge boost to stock markets, as was the case, albeit briefly, this past Monday. At present it appears there may be continued uncertainty until the 90 day negotiation period with China ends, around March 2, 2019.
- The U.S. Federal Reserve Bank’s penchant for continued rises in the federal funds rate. With another rate hike expected at the end of December this year and three more rate hikes expected in 2019, investors are concerned about continued exits from equities into bonds as 2019 plays out. The positive side: The Fed can always reverse course if it sees the economy slowing, and this may currently be about to happen, especially with continued stock market volatility. Plus, according to JP Morgan, as long as the 10 year Treasury yield stays under 5%, the stock market rises about 90% of the time. The 10 year recently dipped below 3% again recently.
- Fear of increased government regulations on the big tech companies like Apple, Facebook, and Amazon. This is a big part of the reason that the technology sector has experienced major pullbacks and a large part of what has caused the overall market pullback. The positive side: According to some experts, regulations should have little long term effect on advertising revenue bottom line for companies like Facebook, Apple, and Google. With virtually no viable competitors currently, expect the Tech firms to lead again once the market rebounds.
- The results of the mid-term elections. This means it is very unlikely that we will see further tax breaks, lessened regulations, or a political environment that is conducive to long term stability and market optimism. The Democrats may also still be intent on impeaching Trump – not likely to happen, but action that could cause political instability and rock the markets. The positive side: The markets were anticipating a Democratic victory in the House of Representatives so this point may be a minor one in its current overall effect on the markets. Political gridlock may not be a negative thing for stock markets. In addition to a possible breakthrough in China trade, there may be compromises that will pass an infrastructure spending bill and a tax reform for the middle class, both of which could boost stock markets.
- Overall concerns that the market is overvalued. This includes fears that tax reform and increased earnings are already ‘baked in’ to previous stock levels and that equity markets have nowhere to go but down. This includes fear of an impending recession. The positive side: In the past, for example in the late 1990’s, markets continued to rise long after they were considered overvalued. In addition to this, most forecasters do not predict a recession until late 2019 or sometime during 2020, at the earliest. The yield curve is flattening, part of the reason for this week’s correction, but even if the yield curve inverts (a sign of impending recession) it is generally 18 months to 2 years before a recession actually occurs.
All things considered, for long term investors, CS recommends cost-averaging into the markets anywhere close to Dow 24,000, maintaining global diversification, and adding to allocations of corrected tech stocks like Facebook, Amazon, Apple, and Nvidia.
We also advocate rebalancing towards international over U.S., value over growth, and large cap over small cap. Cost averaging into long term bonds and out of some equities is a good strategy as we move through 2019. Medium sized, higher quality gold mining stocks may be a contrarian play, but primarily in the later part of 2019 or later once gold has moved down below $1200/ounce. Also take a look at mid-stream MLP’s.