Market Update: Complacency is not a Strategy – Part II

I think I spoke too soon – or did I? Ten days ago, in my last message to clients, I wrote about complacency and how sitting on your hands during times of little or no volatility can be risky.  I cautioned investors who might be stuck in their comfort zone to be mindful of increasing probabilities that a correction in the market was possibly overdue.  I also mentioned that at Capstone, we had made adjustments in client portfolios as the possibility (as I put it) that a “pause in the rally, or even a medium-sized pull-back from current levels” was more likely than not. 

Since that May 3^rd post, the S&P 500 is down almost 5% and volatility has made its way back onto the scene.  Last week, the Trump administration raised the rate of tariffs on $200 billion worth of Chinese imports from 10% to 25%, and is also targeting a second round of potential tariffs on another $325 billion as the President repeatedly Tweets that “China broke the deal”.   This morning, Beijing struck back announcing its own plans to apply tariffs on $60 billion worth of U.S.-based goods beginning on June 1^st  and now the teleprompters and machine traders are revving their engines. 

In my message, I urged all investors to remember the extreme volatility we experienced late last year as the markets reacted to the exact same types of headlines we’re hearing all over again right now.  Going into the end of last year, the S&P 500 entered bear market territory despite a positive economic backdrop.  So, are we in the same boat all over again? 

Well, first I want to be clear on something…I am NOT suggesting that I predicted the future and was forecasting the current sell-off in stocks because nobody can do that!  The message that I was sending was – don’t be complacent.  And now, notwithstanding the fluky timing of my message (full disclosure:  Capstone was rebalancing client portfolios in weeks prior), the market in real time is verifying that complacency is, indeed, not a strategy but that being disciplined is. 

Ok, let’s take a look at where we are now.  In my opinion, I still feel that the US economy is in great shape, inflation has been tame, job numbers are strong, and the Federal Reserve is remarkably friendly versus being so hawkish earlier this year.  From a macroeconomic standpoint, we’re in good times. 

Let’s look at some data:

1. US labor force growing at .5% per year (Source:  Bureau of Labor Statistics)
2. Productivity of that labor force is growing about 1.5% per year (Source:  Bureau of Labor Statistics)
3. With 2% inflation we land at 4% nominal economic growth (Source:  Bureau of Labor Statistics – CPI Home)
4. Stocks, according to many analysts are fairly valued but not overvalued (Source:  Kiplinger.com)
5. Gross Domestic Product or “GDP”, despite some recent slowing, looks relatively healthy going out to the year 2020 (Source:  Kiplinger.com Economic Forecasts)

When considering these types of conditions, investors should take note of the following:

1. Generally, bull market cycles don’t end with a market at fair valuation – markets have traditionally topped out at overvaluation.
2. Based on current valuations, if we believe in the historical patterns of price-to-earnings multiples, the market, longer term, can continue to run after cooler heads prevail and a deal with China is reached.
3. The qualitative factors that exist at market tops simply aren’t present today (yet).  That is, the market might top out when it senses a looming recession – which doesn’t seem likely at this point based on GDP numbers and projections.
4. With the US Federal Reserve as friendly as ever, the interest rate picture looks neutral – which many market participants view as a positive for equities.
5. Even after today’s rout, the S&P 500 is still up over 13% for the year.

So, is this the same boat?  Well, it kind of feels like it and it’s conceivable that the tariff fights with China, though resolvable, can continue and I think it’s reasonable to believe that the volatility will persist for a while.  Meanwhile, as stocks will surely zig-zag through the noise and change direction as the wind blows, it’s important, as always, to focus on being cautious and responsible when investing (not complacent) and stay on a long-term road  using strategy and discipline as the key drivers of investment success.

Please don’t hesitate to contact us with any questions about your investment portfolio or financial plan.  Capstone advisors can be reached at (570) 587-7800 (Direct) or 888-587-7526 (Toll Free).