Capital Market Comment
July 23, 2019
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
As the market makes new highs, burning questions remain. Can it continue to rise? Is a correction/bear market imminent? These issues are particularly troubling for investors who have been inundated with a plethora of negative forecasts for the better part of the “bull” market.
Many analysts, pundits, and media talking heads have highlighted the market risks for the past 10 years. Budget crises, trade conflicts, government shutdowns, Brexit, Iran, Turkey, interest rate hikes, global growth, and political conflicts are just some of these factors. Trying to assess the extent to which the market has discounted them makes for interesting headlines, but does little to advance investor knowledge or discipline. These “opinions” only serve to enhance “egos” while giving the impression that one can actually determine the extent to which the market has actually discounted investor concerns. They can’t!! The discounting process is dynamic and reflects the many inputs from different segments of the investment landscape. Random behavior is part of daily price moves.
It is important to recognize that the bull market has been operating in the shadow of the 2008 financial meltdown, and investor behavior appears to reflect that. For example, just in the first half of 2019, according to Axios, $140 billion was taken out of the equity market and found a home in bonds, money markets, and other cash equivalents. Many of those instruments have near record low yields. These asset classes offer little opportunity to meet investor objectives for education, retirement, and other goals. This trend has been underway for years.
Throughout this market cycle, many analysts make reference to particular segments of market history to find similarities to the current period. Inevitably, reasons emerge to short circuit the market’s prospects. Yet every time, the market defies these observations. Why does it appear to be so different this time? Or is it? This long-term “bull” market has been interrupted three times with declines: two cases can easily be defined as “bear” markets, and in the third case, a severe correction occurred. During these declines, many market sectors fell more than 20% and some greater than 30%.
The most recent decline (September 21, 2018 – December 26, 2018) meets the bear market criteria. Fortunately, it was compressed into a relatively short time frame.
One can make the case that a new “bull” market began in late December 2018 – a different perspective on the market. What is most interesting is what sets this cycle apart from other periods. Historically, we have never had an extended period of negative interest rates. It now captures $12 trillion of bonds. Given the monetary and economic dynamics in the world economy, there is little reason to think that this scenario will change soon. We have returned to a central bank centric world with the European Central Bank, the Bank of Japan, Peoples Bank of China, and other central banks around the globe becoming more and more accommodative in an effort to stimulate growth. This approach ensures continued bond buying, keeping downward pressure on interest rates, and expanding liquidity.
The Federal Reserve’s reversal in January from a rising interest rate strategy to a pause, then a patient phase, has led to a clear signal that they will be lowering rates. Chairman Powell and many members of the Federal Open Market Committee have indicated that the global risks justify such a move. More importantly, their failure to achieve the 2% inflation rate has become a basis for the change in strategy. Moreover, there is an emphasis upon the need to be symmetrical in their inflation target, allowing inflation to rise above 2% to account for the periods below 2%. Also, the inversion in the yield curve, a warning signal about economic growth prospects, provides additional evidence of the need to lower rates.
The equity market will be functioning in a world with little to no competition from fixed income and cash equivalents, as well as foreign rates which are negative (the German 10-year Bond at negative 0.35% and the Japanese 10-year Bond at negative 0.15%). At the same time, the S&P 500 has a projected earnings yield of 5.8% (the 10-year U.S. Treasury yields 2.07%.) As long as there is little risk to the economic recovery, equities offer the best option.
As we go through this earnings season, in which a fair amount of uncertainty exists due specifically to trade disruptions, volatility is likely to increase. Sell-offs can easily occur given program trading, algorithms, quant models, and hedge funds. However, with the bias upward as liquidity expands, any pull-back offers a good entry point.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or email@example.com
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.
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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.