Tailwinds, Headwinds, Crosswinds and How to Keep Calm and Carry On

Many investors have been shaken by this year’s volatility, especially after the long calm period with positive returns experienced prior to 2018.

March 2019 will make the 10 year anniversary of the low point in the stock market after the Great Recession. Starting from that low point, was a tremendous tailwind that worked in our favor over the last 10 years and caused the US stock market as measured by the Standard and Poor’s 500 (S&P 500 Index) to rise almost 400%. Stocks are clearly not as cheap now suggesting their returns will be more modest over the next five years.

The following is a list of other tailwinds that help market performance and enhance economic growth and headwinds that hurt market performance and slow economic growth.

Tailwinds

 

Headwinds

Economic growth - US economic growth was at an annualized 3.5% in the 3rd quarter which is significantly higher than the approximately 2% average growth rate during the recovery since the Great Recession.

 

Economic growth - Most economists expect growth to slow to 2% in the US in 2019. Please note this is still a positive 2%. It may feel like a recession when we slow from a 3.5% to 2% but it’s still growth.

 

 

 

Personal income tax cuts and low unemployment - Both have led to higher consumer confidence and consumer spending. Holiday sales and spending have increased over last year including a 19% increase in online sales.

 

Personal income tax cuts and low unemployment - Tax cuts provided short term benefits which will diminish through 2019. We will deal with deficits caused by the tax cuts for a much longer time. Low unemployment could lead to inflationary pressures.

 

 

 

Corporate tax cuts – These brought US corporate tax rates from the highest in the developed world to an average of the developed world. They effectively stopped the incentive of US companies to move operations offshore. It boosted corporate earnings which drove up stock prices.

 

Corporate tax cuts - Many companies use the increased earnings to buy back their shares which can increase stock prices in the short-term but doesn’t promote long-term growth as well as using the earnings for research and development.

 

 

 

Interest rates – Rates dropped significantly during the Great Recession and remained artificially low throughout the recovery. This helped consumers and corporations by allowing them to borrow and refinance which in turn lowered monthly payments on such things such as cars, homes and buildings.

 

Interest rates – The Federal Reserve raised rates four times in 2018. Fed Chairman Powell predicts at least two more rate hikes in 2019. Rate hikes will cause the economy to slow.

 

The severity of the next recession, and when it will occur will depend upon the crosswinds. I categorized the crosswinds from US and geopolitical risks. In the US, I see a greater dysfunction in Washington. I know you’re asking, “Can this even be possible?” Yes, this is possible, as the Republicans control the White House and Senate, but lost control of the House of Representatives in the mid-term elections. I see more political posturing and less of the country’s business getting done.This is by no means a complete list of tailwinds and headwinds. That being said, I do think we are late in the economic cycle, which normally means a slowing economy. There’s always a risk of recession in a normal business cycle. If there is a recession in the next two years, I don’t think it will be as severe as the Great Recession that typically occurs every 50-70 years.

Another crosswind is the current trade war with China, which is already figured in the lower 2% economic growth estimates predicted by most economists. The current tariffs place a 10% tax on about 200 billion dollars of imports. If this escalates to a 25% tax on all Chinese imports (about 450 billion dollars) that could be a game changer and a catalyst for a recession.

Another political crosswind which could blow positive or negative include Brexit and Mideast stability. The United Kingdom could have a hard time if no deal is reached with the European Union; an easier time if a deal can be negotiated or neutral if the March 29, 2019 deadline is extended. As far as the Mideast, the US troop pull out from Syria is bound to cause a vacuum of instability. Future peace in the region relies on how and who fills that vacuum.

My basic takeaways from all the winds described above are:

So what action should you as an investor, and New England Capital as your advisor be taking now? Our first step is to make sure your asset allocation matches your time horizon, risk tolerance and return goals. While your asset allocation can and should change over time, it should remain consistent enough to accomplish your specific financial and life goals. It shouldn’t be changed due to short-term market volatility.

The bigger risk than another Great Recession is what financial experts call “policy abandonment.” Policy abandonment is basically when investors fail to stay with their financial plan generally at the wrong time. The Great Recession caused a significant decline which was painful and temporary. Those who abandoned their portfolio allocation and retreated to cash, at or near the bottom, permanently locked in those losses. Figure A shows long-term stock investors made money even though each of the last 20 years had intra-year declines. The past 20 years includes the two worst bear markets in my 36-year career. I believe it is too difficult to successfully time the market.

Figure A  

Figure B, another longer-term view shows that long-term gains beat short-term pains. Positive “bull” markets gain more and last longer than negative “bear” markets.

Figure B

If you’re still having difficulty in the volatility you’re seeing in your portfolio, let me offer one more solution.  Look at your portfolio less often. Before you dismiss this idea, understand that volatility is a time-based concept. Your portfolio value literally goes up or down several times each second during every day. Of course, you don’t look at it second by second. So maybe just check it daily? Still too much? Check monthly or just quarterly. And if you only check the value every 10 years, you’ll probably find that you’re almost always up. In fact, diversified portfolios that are rebalanced annually have had only positive 10-year returns dating back to January 1926.

The key is that if we have the right investments and the right mix of investments, based on the goals you want to accomplish, according to your desired timeframe and risk tolerance, there’s really no point in checking short-term performance. Besides, isn’t that reason you hired us?! Please know that we typically don’t act on short-term 24/7 media information either. We know that’s detrimental to your wealth.

May you have a happy and healthy 2019!