Dear Valued Clients and Friends,
Welcome to 2019, and Happy New Year! I am sure for many investors, getting out of 2018 is fine by them …
What 2019 will hold is sure to be the subject of a lot of punditry analysis and forecast in the weeks ahead (including our own, as our annual Market Epicurean white paper recapping the year behind and analyzing the year ahead will come out next week). We have a few other nuggets to cover in this week’s Dividend Café, so the lack of comprehensive 2018 recap analysis is mostly due to the fact that (a) It takes more than 48 hours to do all I plan to do, and (b) Next week is a better week for it. With that said, much of this week’s Dividend Café is sure to fire you up for 2019, and certainly give you a feel for where we stand in the economy and global investment markets … So welcome to 2019, and let’s pick it back up, in the Dividend Café!
Dividend Café Video
Dividend Café Podcast
The market brings in the new year
The Dow went up ~265 points on Monday as the calendar completed its last day of trading for 2018 (volume was extremely low, I assure you). The market was closed Tuesday for New Year’s Day. The Dow was down 400 points on Wednesday but then rallied all the way back to positive territory. As I type Thursday morning preparing to go to press the market is down over 400 points, so so far a net even on the week of about 300. Next week represents a more normalized week in terms of traders being at their desks and capital markets being 100% open for business. None of the major questions surrounding markets have been answered (the Fed, China, oil), and earnings season will not launch (with 4th quarter results) for a couple more weeks, so we have no reason to expect markets to provide clarity or calmness any time soon.
A little cheating
Okay, NEXT week really is the week my 2018 recap will be coming, but with that said, feel free to make a mental note that in 2018 the S&P 500 ended the year down 6.2% and the Dow ended the year down 5.6%. In December alone, those two major market indices were down 9%. The bond market ended the year in positive territory (by +0.1% using the Aggregate Index that blends Treasuries, Corporates, and Agency Mortgages), just barely avoiding a negative return in both major asset classes. All of the relevant details, particulars, subsets, and so forth of 2018 will be covered at greater length next week!
Some volatility comparisons
Number of days the market moved up or down > 1% in all of 2017: Eight
Number of days the market moved up or down > 1% in December 2018: Nine
Number of days the market moved up or down > 1% in all of 2018: Sixty-four (64)
8x more volatility by that measure in 2018 vs. 2017. 8x.
Fear of a Melt-Up???
Equity investors who just lived through Q4 of 2018 are probably not remotely thinking about the possibility of a violent reversal to the upside in equity markets, but rather are just hoping for some degree of stabilization and modest movement in a better direction. Certainly our base case would not be for a “melt-up” in equities any time soon. But is the possibility of such a thing ridiculous? It is not probable, but it is certainly not ridiculous.
Consider the following macro possibilities:
(1) A Fed that announces a dramatic swing towards to dovishness, primarily centered around a pause on their balance sheet reduction program;
(2) A sweeping, substantial, globally-received trade deal with China;
(3) A flood of capital spending in the business sector to drive productivity growth.
How each of these things are more likely to play out in 2019 and how we want to be positioned around potential tailwinds and headwinds are covered in next week’s sweeping white paper, but yes, a “melt-up” is certainly on the list of possible 2019 actions, with the above three catalysts the likely-needed spark.
This week’s non-recession watch
I was highly persuaded by an old white paper from the New York Fed of the 3-month vs. 10-year yield curve as the right metric for measuring problems in the economy. The present “recession risk” with the model presented is roughly 15%, though obviously subject to change. And models have a funny way of being great, until they become not great. But it does bear repeating – my firm conviction (not model-driven, but ideological) is that it is an actual inversion that indicates a pending recession, not a “close -to-inversion,” and that even an actual inversion provides no clarity around timing.
* Goldman Sachs Research, December 27, 2018, Estrella & Trubin, NY Fed, 2006
The computers did it
Because I am not convinced that algorithmic or high frequency trading is really at the heart of much of what has happened in capital markets the last few months, I do not intend to give the subject a lot of attention in my annual white paper coming out next week. Do I believe that on those days of accelerated selling (or buying) where markets seem to lose connection to the real world, computer trading exacerbates what is already a highly volatile environment? Of course. And do I believe that the heavy volume of ETF ownership (exchange traded funds) makes for self-fulfilling prophecies within markets at certain times? Absolutely. But do I think that in a more sustained way the computers are distorting values and actual prices for long-term investors? No, I do not – not until provided far better proof than what has been offered thus far (which is long on rhetoric, and very short on evidence).
But this much should be said – whatever inefficiencies or potential problems may be exacerbated by algorithmic trading, etc. are not likely to be understood or foreseen by regulators. Whether it be for a sustained period of time, or for a day, or even for just minutes, any disruption to capital markets is a disruption to capitalism, and should be addressed. Disciplined investors are removed from the risks of computer-driven dislocations by nature of their timeline and process, but that certainly does not mean any systemic risks building up in our technological evolutions should not be addressed.
If you ever needed a reminder that …
… markets exist to provide the deepest embarrassment to the greatest number of people possible, consider the following. Treasuries are flooding the markets right now (23% of all fixed income debt outstanding), as larger U.S. deficits need to be covered with even greater Treasury supply. And at the same time, the three largest holders of U.S. Treasuries (the Federal Reserve, China, and Japan) are either shrinking their holdings (the Fed), or not buying a greater amount (China and Japan). And what has been the response to this seemingly concerning development??? Rates have collapsed, and Treasury prices have rallied.
Go figure.
But the fact of the matter is, supply/demand imbalances are but one factor in Treasury bond pricing (or any other capital asset). Growth and inflation expectations also matter, a lot. Now, this is not to say that we forecast rates to stay this low all through 2019 (we do not), but it is a reinforcement that capital markets are complicated, possess third and fourth order effects hard to forecast, and are never to be taken at face value.
Politics & Money: Beltway Bulls and Bears
- No deal seems imminent in the partial government shutdown, and the market doesn’t seem to care. The new Democrat majority House has been installed, and we shall see what lies ahead.
- If anyone doesn’t believe the trade war is negatively impacting the U.S. economy, read the quarterly guidance report from Apple’s Tim Cook that came out this week.
Chart of the Week
As stated, next week will be the more comprehensive year in review. But in the meantime, take a look at the full year chart of the S&P 500 just to set the table for the week that was in equity markets.
* Strategas Research, Quarterly Review in Charts, p. 4, Jan. 2, 2019
Quote of the Week
“Be at war with your vices, at peace with your neighbors, and let every new year find you a better man.”
~Benjamin Franklin
* * *
I do wish you and yours a very Happy New Year, and hope that your entire holiday season was refreshing, joyful, and memory-filled. I am completely and totally amped up for 2019, whatever it may bring, and thankful for the holiday season I did get with my family. It was a wild December, no doubt, and 2018 was a pretty crazy year in a lot of ways. I love the whole idea of new year’s resolutions, and I assure you that I (and the Bahnsen Group organization) have many of them! So with that said, enjoy your weekends, and we look forward to a more formal launch to 2019 next week. Happy New Year!
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
www.thebahnsengroup.com
