We hope everyone had an enjoyable summer. This week ushered in a much needed correction in US equity markets. Through Thursday, October 11, 2018, the S&P 500 was now down over 6% for the month. The recent shift in markets was motivated by concerns over rising interest rates, trade tensions with China, and a shift out of technology stocks. Technology leadership is under pressure, as many managers lock in gains on many of their best performing stocks.
Since the beginning of October, Haven raised cash across all client portfolios to both lock in profits and minimize losses. As of Thursday’s close, we held between 20 to 30% cash, depending on client risk tolerance. Today, we redeployed some of the cash to take advantage of the market dip. Cash was invested in the large cap equity index fund, IVV. As industry leadership emerges, the index fund will be sold, and cash will be redeployed into individual stocks.
Rising Interest Rates
The Fed raised rates 25 basis points at their September meeting and is on track to raise rates another 25 basis points in December. Further, the Fed signaled plans for 3 additional hikes in 2019. Following this meeting, Fed Chairman Powell gave the market a dose of “indigestion”. He mentioned that the Federal Funds rate is not yet close to neutral, and the Central Bank may raise rates higher than the perceived neutral rate. The neutral rate is the rate at which interest rates are high enough to prevent inflation. In response to these events, the yield on the 10-year treasury rose to 7-year highs and is now hovering at 3.2%. As interest rates rise, bond prices fall. Rising interest rates have pushed the bond market into an official Bear Market. History reveals that as interest rates rise from abnormally low levels, both bonds and stocks initially fall. Stocks eventually recover, while longer term bonds remain depressed because the low yields on bonds are locked-in until maturity.
Trade tensions between the US and China are growing. Equity markets worry that today’s trade tensions may begin a global trade war that depresses trade globally, thereby reducing worldwide growth. This week the IMF (i.e. International Monetary Fund) reduced global growth forecasts for 2019 from 3.9% to 3.7%. Trade concern was reflected in this week’s market action, as companies exposed to global trade warned of margin compression, which resulted in the companies lowering earnings forecasts.
Growth vs Value
Growth’s more than two year outperformance over value is taking a pause. Equity markets witnessed a massive rotation out of technology and growth oriented stocks into sectors such as consumer staples and utilities, which are less volatile and typically produce income in the form of dividends. Year to date, technology oriented growth stocks such as Netflix, Amazon, Apple, and Microsoft led the market higher. Over the course of this week, these names as well as the Technology and Communication Services sectors pulled back sharply, leading the market lower. However, it’s important to consider a year to date perspective. Even with this week’s draw down, year to date performance for these leaders is as follows: Netflix +67%, Amazon +47%, Apple +26%, Microsoft +23%.
It’s possible this week’s action is overdone. Economic indicators suggest the US economy is strong and growing at a sustainable rate. US GDP growth came in at 4.2% in the second quarter. Consumer spending, which consists of two-thirds of US economic output, rose at a 3.8% annual rate. The US unemployment rate fell to 3.7% in October – its lowest level since 1969. And finally, the Consumer Price Index (CPI) rose less than expected, +0.1% indicating that inflationary pressures are modest.
Over the intermediate to long term Haven Wealth Group is bullish on the economy and on equity markets. We will not worry about the equity markets until we start hearing signs of the “R” word (i.e. recession). The Federal Reserve is raising interest rates because US economic growth is strong, unemployment is low, and tax cuts are stimulative. Interest rates today are still low by historical standards. A gradual return to normal interest rate levels should benefit the US economy over time.
Markets never go straight up. Periods of correction and consolidation are healthy and normal. We are watching diligently for an opportunity to fully invest cash. Please call if you have additional questions.
The Haven Wealth Group Team