Apparently Santa came early this year! Or at least that’s what we’re telling ourselves given that top of our Christmas list every year is “less government”. So we’re going to choose to look at this Christmas, with about ¼ of the government shut down, as a happy little present and just ostrich out all the nonsense about why we’re actually in a partial government shutdown and how much of 2019-2020 will also be spent in a partial shutdown…
For the equity markets, however, it has been an absolute bear of a holiday season. Quite literally:
Quiz: What’s the best performing asset class this year? Cash. Literally nothing has had a positive return except for cash money. And if that’s in a bank, chances are it’s not even keeping up with inflation.
Fun fact! US stocks and bonds have posted negative returns in the same calendar year three previous times: 1931, 1941, and 1969. Something like this hasn’t happened in 50 years!
US markets had their worst week in a decade last week, losing 7% in a 5-day span (update: 9.5% in a 6-day span counting Christmas Eve Day - the worst Christmas Eve Day ever!) in what is largely being blamed on the Fed’s rate hike and continued balance sheet contraction. Which is nonsense, but is easier than trying to explain a mass psychological shift from “3+% economic growth” to “end of cycle”.
If you’re trying to figure out when this sea of red parts and we cross over to the other side...good luck with that. It probably ends with the Fed easing again, but that’s likely a year or so away. Unless Trump fires Powell and makes the Fed an executive branch puppet and then all bets are off.
Valuations and future return prospects look a lot better now than they did in September, so don’t be afraid to put long-term money in the market. In the shorter term, however, it seems like investors are needing to pay more attention to fundamentals now that the Fed has stepped back, and fundamentals would suggest another 25% drop to fair value, probably more like 40% since such drastic drops tend to overshoot fair value. (For a refresher of how we figure “fair value”, refer to The Price is Right, Part 2).
That’s not to say the market is going to drop 25-40% from here. There are several periods during bear markets when stocks advance. The question is whether those gains are durable, or whether they will be erased by a further leg down in the future. Our preference at the moment is to get out of the way and just watch. We started 2018 with 94% stock exposure. By June we were 74% stocks. October saw us reduce that down to 45%. And now as the year draws to a close we are looking at only 24% stock exposure headed into 2019. There will likely be a time in the next month or two where we’ll be willing to step in and try to catch the falling knife, but that time is not now.
No, now is the time to enjoy the holidays with friends and family. We’ve been watching this bear market develop and are positioned accordingly. So let us fret over bears that don’t hibernate during the winter, and you spend your time singing carols, watching old movies, and having an extra cup of cheer. We’ll see you in the New Year.
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