According to NASA, at some point in 2018 the Voyager 2 satellite launched way back in 1977 officially left our solar system and crossed into interstellar space. Scientists estimate that the twin Voyager space craft could continue sending back data for another 10 years before they run out of fuel.
In 2019, the United States economy may reach a milestone of its own: the longest economic expansion without a recession.
Perhaps we can keep this party going. Yet, just like the Voyager space craft, eventually we will just run out of gas.
From our perspective, we are starting to see evidence for an economic deceleration already. Despite what the short-termists and scaremongers would say, we view this as probably a healthy thing. The cycle of government deficit spending in support of the economy needs to stop. However, with the removal of this accommodation, we need to be prepared for more turbulence. The way we do that is by staying true to our purpose and recognizing that cycles are normal. If we can be mindful of these rhythms, we can turn them to our advantage or at
least avoid dangerous mistakes.
2018 In Review
Looking back at last year, what started out with the sunniest of outlooks gradually got more complicated as the year wore on.
At the outset of 2018, economies the world over were achieving new highs. This was no accident as the US, China, Europe and Japan all did their part with unprecedented levels of stimulus. Low interest rates, tax cuts and debt-fueled spending were all used to spike the punch bowl.
Simply put, when you drop cash from a helicopter, investors will use that money to buy assets. In 2018, that cash spigot started to dry up. The Federal Reserve Bank began to slowly apply the brakes by raising interest rates. Savers and investors were happy to see their cash and CD yields rise to 2.5%. However, if you were a home buyer, you were surprised to see mortgage rates climb towards 5%. If you were a business owner, your cost of borrowing increased.
US markets were still flying high early in the year when cracks began to form overseas. Persistent weakness in Europe and Japan dragged down investors’ sentiment. A strong dollar and White House rhetoric hurt trade. China, the largest economy in the world, saw growth decelerate.
By Q4, US economic indicators that previously were green began turning yellow. Stock market indexes turned red. As the ball dropped on Times Square, 90% of global asset classes showed negative returns for the year (see chart). According to fund manager Jeffrey Gundlach, that would be the largest such percentage since 1901.
A Look at What’s Ahead
We envision 2019 as a prize fight with two powerful boxers battling it out, creating fireworks as they go.
In one corner is the risk of recession. In the other corner, continued expansion.
Our expectation and that of most economists is that we will avoid a recession for another year because the US remains fundamentally resilient. Confidence and spending remain strong. Businesses continue to hire and invest.
Yet, the push and pull of good news and bad news will keep investors on edge. This will create a volatile environment where we might see a 5% stock market drop one month followed by a 5% jump the next. So what do we do next? Do we remain spectators or do we jump into the ring where the action is?
Should We Take Any Action?
The last time I flew cross country, we hit some rough turbulence somewhere over the Midwest. “Don’t just sit there, do something!” I shouted in the direction of the cockpit… on the inside.
On the outside, my demeanor was calm while I focused on trying to avoid spilling tomato juice on myself. After a few minutes, the pilot got on the intercom and calmly advised that the rough air will continue for a while longer and we should stay in our seats.
Like with flying, turbulence is part of the investing experience. There are bouts of discomfort that can only be avoided by not getting on the plane in the firstplace, and there’s no fun in that.
It is human nature to want to take action when we feel threatened. Yet, when it comes to being a long-term investor, reacting may be the worst thing to do.
On December 24th, one of the least traded days of the year, the Dow Jones Average dropped by 800 points. On December 26th, a few stock brokers got back to work. That day, the Dow index rebounded 1,000 points – a 6% gain. With humans mostly absent from Wall Street, clearly the computers were in control. However, an investor that reacted to the first drop would have missed out on one of the largest rallies in stock market history.
The volatility we have seen in the past few months is not unusual. We have seen this before in 2011, 2015, 2016, and in February of 2018. In all those cases, solid economic fundamentals here in the U.S. helped markets rebound.
| Asset Class – Index | 2018 |
|---|---|
| Large Cap Stocks – S&P 500 Index | -4.4% |
| Small Cap Stocks – Russell 2000 Index | -11% |
| International Developed Stocks – MSCI EAFE Index | -13.4% |
| Emerging Market Stocks – MSCI Emerging Markets Index | -14.3% |
| REITs – FTSE NAREIT All Equity Index | -4.0% |
| High Grade Bonds – Barclay’s U.S. Aggregate Bond Index | 0.0% |
| Cash – 3 Month Treasury Bill Rate | 2.0% |
Could It Get Worse?
It’s possible. Bear markets — defined as a 20 percent fall in stocks — average a 30.4% drawdown. Obviously we’re nowhere close to that right now. As we mentioned at the outset, we have not seen a recession in 10 years. In a sense, we are overdue.
The real fear is that the next recession will be worse than an average bear market; perhaps another 2008 calamity. This is where the economic fundamentals are especially important. We simply do not have the risks in place now that we did then. The U.S. banking system is much better capitalized; household debt is lower and energy is cheaper. We can certainly expect more challenges, but a 2008-style crisis is unlikely.
If the Market Goes Down, Do I Have Time to Recover?
When recessions happen they don’t tend to last as long as people think. Since 1945 the average recession lasted 13 months, with the longest lasting 18 months. This is also where diversification comes in handy. Not only can diversification protect your portfolio from one poorly performing investment, it can also help keep you on track during a recession.
If you are close to or in retirement, it’s likely you have around 40% of your portfolio in Cash and Bonds, which are considered ‘safe’ asset classes. In a recession, you can draw from this side of your portfolio while waiting for stocks to recover.
After 2008, it took stocks around 4 years to return to their pre-recession highs and that is without including dividends. Investors that stuck around were well rewarded for their patience.
The real fear is that the next recession will be worse than an average bear market; perhaps another 2008 calamity. This is where the economic fundamentals are especially important. We simply do not have the risks in place now that we did then. The U.S. banking system is much better capitalized; household debt is lower and energy is cheaper. We can certainly expect more challenges, but a 2008-style crisis is unlikely.
S&P 500 Values
| Date | Price |
|---|---|
| Jan 15, 2019 | 2,609.37 |
| Mar 1, 2013 | 1,550.83 |
| Mar 1, 2009 | 757.13 |
| Oct 1, 2007 | 1,539.66 |
The Power of Planning
When NASA scientists launch something into space, they have a plan. They know to a high degree of confidence based on meticulous calculations that a certain tin can will arrive at a certain rock at a certain hour.
Financial planning has the power to do this for you by putting stock market volatility into perspective and in the context of your personal situation. A financial plan will ‘road test’ your portfolio under various historical stock market conditions. Simply put, it will show you how a decline in the market will impact your ability to maintain your lifestyle in retirement.
If you are still nervous, we have the solution for you to regain your confidence. At Longwave, springtime is financial planning season. When you engage with us in financial planning, we revisit and update your plan. Unlike the average investor, you are not adrift in space. The financial plan we put together is your mission control – it provides not only a destination but also GPS for your journey.
