EQM Capital LLC Q4 2018 Market Review – The “Bird Box” Market

Posted on Jan 8, 2019

I had the pleasure of watching the new Netflix movie “Bird Box” over the holidays.  In the film, Sandra Bullock, must wear a blindfold to avoid being infected by a mystery entity which causes one to harm themselves.  I think this has parallels to the current market environment.  Investors should blindfold themselves right now to avoid self-harm!

The longest bull market run in history has not yet ended, but it came dangerously close in the 4th quarter of 2018, approaching a bear market 20% decline.  The Dow finished the year with its worst December since 1931.  Despite evidence that the U.S. economy is still chugging along, such as the strongest holiday retail shopping season in 6 years, investors were still worried.

What’s worrying the market?

A mixture of domestic and global events contributed to the market sell-off during the quarter. Even more frustrating, there was really no place to hide.  Every major asset class from global stocks, to government debt, corporate bonds, and commodities posted negative returns for the year.  Only volatility and cash posted positive returns. During the financial crisis of 2008, at least government bonds and gold were up.

So what is to blame for this global confluence of negative returns?

Yield curve signaling doom – Every U.S. recession for the past 60 years has been preceded by something called an “inverted yield curve”. This occurs when the 2-year Treasury bond pays a higher rate than the 10-year Treasury. While this did not happen in December, the 3-year bond did surpass the 5-year, for the first time since 2011.

Wavering confidence in the Federal Reserve – The Fed raised interest rates again at its December meeting and its rhetoric remained somewhat hawkish. Fed policy has sparked criticism from both Wall Street and the Trump Administration. The new Federal Reserve Chair Jerome Powell has since softened his language and so has the Administration. At the end of the day, the financial markets want an independent Fed free from political pressure, but the Fed also needs to inspire confidence.

Ongoing trade war – The trade war remains a negative overhang on global markets. Here in the U.S., tariffs are already taking a toll on some industries such as automobiles, technology, and agriculture. And there is evidence that China is also feeling the economic pain as well in the form of slower GDP growth.

Government shutdown – The government is experiencing its third-longest shutdown, as the Administration and the newly divided Congress remain in a standoff over the funding of the border wall.

Signs of global economic weakness – While a strong jobs report heightened investor confidence that economic conditions in the U.S. remain generally robust, many other markets around the globe are in bear market territory as their economy’s falter.

Beyond the wall of worry, there were other technical factors in-play in December such as programmed trading and tax-loss selling.

As the market hit certain technical triggers, computer programs automatically liquidated positions, making market conditions even worse. This particularly was an issue over the holiday season, as many traders went on vacation leaving the market essentially on “auto-pilot’.

As for tax-loss selling, most investors have not had much in the way of capital losses to recognize in a while. The sell-off in the fourth quarter allowed investors to finally cash- out some of their capital gains without tax consequence.  Those funds are now sitting on the sidelines in cash or short-term treasuries.  As market negatives dissipate, we could easily end up with a “V-shaped” recovery.

 

When should I take off my blindfold?

The good news is that most of the market negatives are short-term in nature. Trade policy, the direction of interest rates, the government shutdown, are all situations that can and will be resolved.

The biggest cause for concern, an economic recession in the U.S., is unlikely to occur next year given the underlying strength in the economy unless the Fed is too aggressive in raising interest rates. As mentioned, the Fed is already softening its tone and is likely to take a “wait and see” approach going forward that is dependent on economic data. And while global growth has likely peaked, it is still growing at a positive, albeit, slower pace.

We very well may see that “V-shaped” recovery in the markets, although volatility is likely to continue until the many uncertainties worrying investors are resolved.

As usual, we advise our clients to stay focused on the long-term and not panic. So keep on your blindfold on if you have to, to avoid being possessed to harm yourself on this rollercoaster ride of a market.

Disclosure

The opinions expressed above should not be construed as investment advice. This letter is not tailored to specific investment objectives. Reliance on this information for the purpose of buying the securities to which this information relates may expose a person to significant risk. The information contained in this article is not intended to make any offer, inducement, invitation or commitment to purchase, subscribe to, provide or sell any securities, service or product or to provide any recommendations on which one should rely for financial, securities, investment or other advice or to take any decision. Readers are encouraged to seek individual advice from their personal, financial, legal and other advisers before making any investment or financial decisions or purchasing any financial, securities or investment related service or product. Information provided, whether charts or any other statements regarding market, real estate or other financial information, is obtained from sources, which we and our suppliers believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this letter should be interpreted to state or imply that past results are an indication of future performance.