1st Quarter 2018 Review
April 16, 2018
The first quarter of 2018 is now in the history books. What will be remembered? What can we learn from this quarter? And what may lay ahead for the markets through the rest of this year?
After posting the best January in 21 years, the S&P 500 gave back all of its gains to finish the quarter down 1.22% (see price chart below). This is the first negative quarter since Q3 2015. The first quarter of 2018 also saw the S&P 500 end of the longest streak without a 3% correction and the second longest streak without a 5% correction.
Why Did The Markets Drop?
The recent drops in the stock market have been entirely sentiment driven. According to Ned Davis Research, bullish sentiment readings reached a multi-decade high in January (lower box of the graph below). January’s sell-off was blamed for a higher than expected wage increase (I’ll explain later why this is good, not bad), which then caused people to worry about inflation, and additional fed action.
The S&P 500 found its low on February 9th and spent the next few weeks fighting its way back to within a few percentage points of January’s previous highs. Then all the talk of trade wars sent the market back down in a tailspin, as the U.S. and China both threatened to escalate tariffs on each other.
PGFG Is Still Bullish About The Stock Market
It is very understandable that the average investor’s confidence was rattled over the past few months. The markets have pulled back off of their highs, volatility has increased, and the media has stirred the emotions of investors by sensationalizing the news at hand. All of these things have given the most seasoned investor reason to pause.
Let me paint a slightly different picture for you. Let me bullet point why we remain very optimistic about what we see in this current market and afterward ask yourself if you weren’t listening to the media, “would you be an investor in the stock market?
Based on these bullet points, why would you be afraid to invest in the stock market? Does this feel slightly different than what you hear on the news? Let me follow up with a few graphs and charts that you might find interesting.
Secular Bull Market
We are in the beginning phase of a secular bull market. The graph below shows the market movement in price during prior secular bull and bear markets.
According to the Chicago Fed National Activity Index, our economy is growing above average but not so much as to be considered inflationary. As you can see from the chart below (lower box – red line), a zero reading means average growth. Anything between the two dashed green lines means moderate growth. A reading below the lower green line indicates recessionary levels. A reading above the top green line suggests inflation. We are in “Goldie Locks” territory. Not too hot (inflation), not too cold (recession), but in above average territory (exactly where we want to be).
The civilian unemployment rate continues to drop and is sitting near record lows at 4.1%. As a result of low unemployment, we are beginning to see wages increase, as companies are forced to “pay up” for talented employees. A moderate increase in wages is very good for the economy because personal consumption drives 70% of our GDP. If the average worker is making more money, they will spend more money, thus growing the economy. Economists worry that too much wage increase will cause inflation, which will make the Federal Reserve more aggressive in their increasing of Fed Fund rates.
The S&P 500 is appropriately valued based upon many 25-year historical averages.
The S&P 500 experienced record earnings in Q4 2017. The expectations for the next four quarters are even stronger (estimated quarterly earnings are in green). Earnings growth at these levels would drive the stock market up significantly if met.
Record Corporate Profit Margins
As you can see from the chart below, companies in the S&P 500 are experiencing record profit margins.
Flush with Corporate Cash
High corporate profit margins have many companies in the S&P 500 sitting with record amounts of cash on hand. The percentage of cash as a percentage of current assets is very close to record highs.
Dividends and Share Buybacks
As a result of such a high percentage of cash on hand, companies are using this cash to buy back their stock and reward their investors with more dividends.
There are so many good things going on in the U.S. economy that it’s a shame that the media is overshadowing it with fearmongering. The media has blown out of proportion the impact that the Federal Reserve might have by raising rates. The Federal Reserve has never been so transparent with their intention. They’ve told us what they plan to do, what economic indicators will influence their decision to raise rates, and how much they foresee raising rates this year and over the next few years. The media has also stirred the pot regarding trade wars. Since the financial crisis, the largest 60 economies have imposed 7,000 new protectionist measures, including the United States which enacted over 1,000 of them. That wasn’t a typographical error… Yes, 1,000 protectionist measures to protect American interest in trade since 2009. Where was the media coverage then? We are not going to have a full-fledged trade war with China or the EU. We do, on the other hand, have to talk tough to get them to renegotiate the terms of trade deals that are clearly not to our advantage. That is all that is happening. The media, on the other hand, stoked the fire so that investors would fear a real trade war.
I have been very consistent in my messaging that the media is not your friend when it comes to investing. Much of the fear that the average investor is experiencing is due to reading financial publications or watch financial TV programs. While it may seem hypocritical for me to say that since I am often on CNBC and quoted in the Wall Street Journal, I have good reason to say it. Each time that I’m on TV or asked to help a reporter out with a news story it is always about whatever “hot” topic is in the news that moment. I have never been asked a follow up question by a CNBC reporter about what we discussed in my prior interview. For example, the first time I went on CNBC World I was asked about the Chinese marketplace. The Chinese market was red hot at the beginning of 2015. When I went on in mid-May, the Chinese market had pulled back a little bit but was still near its highs. I was asked if I would be a buyer of Chinese stocks, to which I replied “no.” I told the reporters interviewing me that the Chinese market was overvalued and that the Chinese economy was slowing. This combination was not what I was looking for out of a good investment. After I gave my sage advice, the Chinese markets fell. I went back on CNBC World four more times that year (June 15th, August 26th, October 27th, and November 30th). Do you think the reporter at CNBC once complimented me for making the right call or asked any follow up questions? Of course not!!! They moved on to the next “hot” topic in the news.
To give this better reference, below you will find a chart of FXI, a Chinese Large Cap ETF. I have marked my original interview with a red arrow, and blue for the subsequent four interviews that I was on in 2015. Now you understand part of the reason why I’m jaded about the media.
Am I saying there is no value in watching CNBC? No, I’m not saying that there is no value. What I am saying is that most media, especially regarding the stock market, present news stories where they prey on two emotions, fear or greed. They will tell you about five stocks that should be in your portfolio which are set to go up in value (greed), or that the markets are going to fall apart due to a trade war and that you should sell your entire portfolio (fear). There are absolutely no consequences about their advice and zero follow up to their predictions.
At Polaris Greystone, we hold ourselves accountable for all advice we give our clients. We are continually reevaluating our client’s circumstances to understand if they are on track to meet their financial goals. Our tactical investment strategies are designed to protect our clients against the full downside of market pullbacks while participating in the majority of the upside when the markets move higher. We manage money in this manner because we know that market risk changes, therefore so should your allocation. We are confident that we will successfully navigate these choppy waters for you and help you accomplish your long-term financial goals.
As always, I welcome your questions and comments, and I encourage you to meet with your Polaris Greystone wealth advisor to keep up to date with our service offering.
Jeffrey J. Powell
Managing Partner, Chief Investment Officer
Polaris Greystone Financial Group, LLC is a federally registered investment adviser. The information, statements and opinions expressed in this material are provided for general information only, are based on data we believe to be accurate at the time of writing, and are subject to change without notice. This material does not take into account your particular investment objectives, financial situation or needs, is not intended as a recommendation to purchase or sell any security, and is not intended as individual or specific advice. Investing involves risk and possible loss of principal capital. Diversification does not ensure a profit or protect against a loss. Advisory services are only offered to clients or prospective clients where Polaris Greystone Financial Group, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Polaris Greystone Financial Group, LLC unless a client service agreement is in place.
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