Is it Different This Time?
In August of 2015, we published an intra quarter update to address market concerns over the swoon investors experienced that summer. No doubt, if you are reading this note, you remember the 11% drop in the US stock market in just over a week related to issues surrounding Greece, Brazil, Puerto Rico and China. Oil prices ranged from $38-$45 barrel, well below what many needed to produce profitably at the time. The 30-year mortgage rate could be locked in below 3.50%. The Fed had not even started to raise short-term rates. The broad US stock market was flat for the calendar year however rapidly declined 10% in the middle of August.
So why do we reference this period? Because what follows mirrors recent history. Over the past three and a quarter years, US equities have returned more than 50% (13.6% annualized) through November 20, 2018. It has not been a straight line, but results have benefited those who accepted market risk.
Since the end of this past September, in percentage terms, the decline has been remarkably similar. The news stories are different, but the themes are not. What has changed for the better is the overall condition of global economies. Back then, the Federal Reserve was seven years into handing out ‘free money’ (Fed Funds Rate at 0.125%) to banks; today we have a rate approaching 2.50%. Although higher, rates on consumer and commercial loans are still very reasonable and the energy market is rationally priced and balanced. These are two essential industries the economy needs to function properly.
Up until recently, markets have priced in an additional 1% increase in short-term rates over the next year. We believe that this is too much, too quickly. More time is needed and increases should occur at a more measured pace. The increase in rates, which is beneficial to savers, has the effect of slowing economic growth at the margin. It is this slowing that has recently repriced into stock prices. The two most powerful factors in today’s market are growth and momentum. Growth is highly prized and momentum has a lot of followers. The public stock markets provided price discovery and liquidity, but that liquidity is often misunderstood. For smaller investors, the ability to execute a trade does not impact the market price. However, when large pools of capital try to move quickly, the window is never big enough and prices adjust quickly without much to show for it.
As much press as the stock market receives, the bond market is much larger and has also been impacted by recent volatility. Corporate bond prices have declined more than Treasuries and due to market structure issues, will likely experience continued weakness into year-end. However, this weakness should not necessarily be interpreted as fundamentally bad news, rather something that is normal in this part of the economic cycle.
We continue to enjoy relatively cheap money and energy, two critical ingredients for continued global economic growth. We may not get the progress many expect, but global economies are moving in the right direction and this will lead to higher security prices over time. Corrections like the one we are currently experiencing are normal, difficult to predict and provide an opportunity to take advantage of mispriced investments.
As Thanksgiving approaches we want to wish you a festive holiday season and thank you for your support and confidence.
Should you have any questions, please feel free to reach out at any time. We look forward to continuing the conversation.
Daniel Aronson, CFA Bruce Langer, CFA Ben Frey, CTP