Integrity Competence Prudence
Thoughts on 2018
I hope the new year is starting out good for you and you had a good winter break holiday. I am writing to both share some data points on the financial markets from 2018 as well as some thoughts about it going forward.
As you probably have heard on the news Dow Jones index fell 5.6%. The S&P 500 was down 6.2% (with dividend it was down 4.56%) and the Nasdaq fell 4%. Aside from cash there was no where to hide. Over $7 trillion was wiped from global equity market cap from the peak in January.
The selling pressure was arguably rooted in real and valid uncertainties: trade disputes with China, Europe, Mexico and Canada, tightening financial conditions because of higher rates, and softening global growth.
On a side note the weakness wasn't just limited to the financial markets as there are also signs of slowdown in the residential real estate markets as the effects of higher mortgage rates and the larger inventory of homes and days in the market have also brought about a slow down in real estate market.
Back to the stock markets ... we did not have the usual year end rally that I had anticipated which tends to start in mid to later November and runs through the year end. One factor again was the rhetoric coming from White House which got more bellicose and created more uncertainty as we came toward the end of the year.
As I had shared with you before my biggest worry about the markets and the economy has to do with all the tangential effects of this high risk new cold war policy with China. I realize this isn't the first time U.S. or for that matter any other existing superpower has had to deal with a rising superpower. From 1950's to 1990's U.S. had a cold war with the former Soviet Union and during that time life went on, and both the economy and stock markets grew and went higher.
That said though there are some important differences. For example during the multi decade cold war with the former Soviet Union we weren't trading with them, American companies weren't relying on selling their services and products there, U.S. government didn't rely on them to finance our national debt by buying our treasuries, or provide cheap labor to American manufacturers. This is why this administration's policy toward China is such a high risk policy.
But what does this mean for your current investments and more importantly what needs to be done going forward. Investing is about evaluating and if possible calculating the range of outcomes and the odds of each outcome and then deciding to either make the investment or not. Now this whole process gets more difficult and nearly impossible as the time frame gets shorter and smaller.
The way it looks like the economy will slow down in 2019. Likelihood of a 3-4% GDP growth rate is very low, and because of the uncertainty in the economy, corporate earnings for U.S. companies will be lower and if this trade war tension doesn't subside they will be significantly lower. As a result of all this the likelihood of Federal Reserve raising short term interest rates will be very low.
If tomorrow Donald Trump decides to forego the tariff / cold war with China the equity markets will be up 5% and then 20% by year end, and if he decides to up the rhetoric and pressure, then markets can go down more than 10-15% from current levels.
Which is exactly one of the main challenges of making investment decisions in the past couple of years. So instead of trying to predict how the markets will do, or in this case what a president will do in the next 6-12 months we should keep our focus on what the outcome or at the least the general economic trends and by extension the markets will be in the next 3-5 years.
My guess is that 5 years from now the earnings for U.S. and other countries with developed markets and economies will be much higher than what they will be in 2019. Unless of course we have one of those extreme unlikely events which also has a high negative consequence be it another global economic meltdown or worse a world war. So does this mean that I think right now is the best time to invest any available cash? No.
I don't think right now is a good time both from the price level perspective in major indexes and from a timing perspective. And since I am not smart enough to know the exact bottom is why my plan is to invest any cash that is not needed in the next 2-3 years, in small increments throughout the year.