May You Live in Interesting Times
The third quarter of 2019 was a wild ride. In the month of August alone, the S&P 500 moved more than 1% in half of the month’s trading sessions. We also saw the worst trading day of the year on August 5th. There were two other trading days where the market declined over 2.5%. Unfortunately for investors, there doesn’t seem to be little hope for a pause in these dramatic market swings.
September is typically the worst month for stock performance, yet this year, we saw the S&P 500 gain 2.45% this year. For the year, that index has returned 18.59% as of the end of Q3. While those returns seem impressive at first glance, there is more to the story. When we look at the market returns over the last year (September 30th, 2018 through September 30th, 2019), the stock market only returned 1.78%.
This volatility is something that I have expected over the last few years. Indeed, most of my quarterly reports have urged investors to remain cautious while holding a steady course. Looking forward, you should expect more of the same. October is historically the most volatile month according to the CBOE Volatility Index (VIX).
There doesn’t seem to be a consistent reason behind October’s volatility. Despite the turbulence we may see this month, it rarely translates to negative returns for the last quarter of the year. Over the last decade, the S&P 500 index has averaged a 4% return during Q4. That didn’t happen last year though. The S&P 500 declined 14.28% in the fourth quarter of 2018.
Are we about to take yet another slide down this year or will the markets prove more resilient? It’s hard to tell, but many of the same factors are in place that pushed the market down at the end of last year. The primary cause of market volatility over the last few years hasn’t changed. Investors remain concerned about the trade war’s impact on the economy as well as the Impeachment of the President.
The loudest noise in the room happens to be the latter at this point. In previous articles, I had discussed how the impeachment process has historically impacted market performance. Earlier this year, I had come to the conclusion that impeachment was likely, though I did not believe that the President would be removed from office. It seems that removal from office is a more likely scenario than at any point prior.
The two charts below show the market movements during the two most recent impeachment proceedings. They tell two very different stories. During Nixon’s Impeachment, the market fell. In contrast, during the Clinton Impeachment, the stock market rose. The lesson to take away from this is that impeachment itself, while it makes for volatile trading sessions, does not appear to drive the markets.
The takeaway here is that the current political climate will have little lasting impact on the market overall. In fact, it may have little impact on the performance of the market even while we’re in the midst of the process. Investors have had three years to become accustomed to the swings in policies. Volatility appears to have become priced into the market.
The stock market appears to have shrugged off concerns for now. While there have been stumbles, 2019 has been a good year to remain invested in the markets. Ironically, the President has helped that growth despite the uncertainty his policies generate. The markets have adapted to this President’s style… JPMorgan even went as far to create a ‘Volfefe Index’ to help track how his tweets have impacted stocks.
Opinions about the market have been nearly equally divided between the bears and the bulls over the last few years. In the last few months, however, I’ve noticed an increase in bearish sentiment. Indeed, we are seeing more and more reports that point towards a downturn. We’ve touched on the inverted bond yield in the past. Now we’re seeing a slew of other indicators arise.
The trade war has taken its toll. The ISM Manufacturing Index has fallen to a 10-year low. The ISM Service Index fell to a 3-year low as well. CEO confidence is at a 10-year low while CFO confidence is at a 3-year low. Jobless claims have increased slightly while consumer consumption and sentiment has declined.
The bulls will be quick to point out that there is positive news to counter that data. While the global economy is slowing, several analysts predict that U.S. GDP will remain positive in 2020. The unemployment rate is also at the lowest point seen in many years. Stocks continue to remain attractive as bond yields are offering diminished returns. These factors are why we’ve seen the market continue to rise.
Perspective has a lot to do with how an investor views the markets. For example, in 2017 the markets made large gains based on the promise of tax reform. The promise of deregulation also spurred growth. In reality, there wasn’t much difference between the economy in 2016 and 2017. What had changed was our perspective. The chart below does a good job illustrating that change.
Perception can rapidly change. To show how easily this can be done, scroll back to the unemployment chart just above the Annual Economic Confidence Index. I originally used it to illustrate the fact that we’re currently at record low unemployment. What I didn’t tell you is that each of the previous lows in employment are followed by spikes in unemployment. Those spikes are followed by grayed out areas on the chart. Those are all recessions. Low unemployment doesn’t look as good once you know that fact.
A deeper look at our current unemployment numbers shows yet another disturbing trend. While the unemployment rate is declining, the amount of people leaving the workforce has been steadily increasing. We can blame that on an aging population, but we also have to understand that many people have simply given up on finding work.
This is perhaps the greatest danger for the economy at this point. A change in perception could create a dramatic swing in how the market performs. Making matters worse is the fact that over 80% of stocks are held by just 10% of the population. A change in how the wealthiest Americans view the market will have a far greater impact on the stock market than any other factor.
The majority of wealthy investors now believe a recession is likely in 2020. Many have decided to move to cash instead of risking their money on investments. If the ultra-wealthy decide there is too much risk in the markets, they could dump stocks. That will lead to a huge decline in valuations.
The ultra-wealthy have different needs than most investors. They also have the luxury of sitting on the sidelines for whatever comes next. For the rest of us, we need to continue to grow our investments for the future.
What this means to you is that, despite the headwinds, it’s best to keep a steady hand on the wheel. Your goals haven’t changed. Your comfort with investment risk hasn’t either. An attempt to time the market when it’s this volatile would most likely hinder growth instead of helping.
That doesn’t mean we should ignore the warning signs. While there are unknowns, we can still draw many lessons from the past. For instance, if a worst-case scenario arises, there are asset classes that will outperform the overall markets. Investors made record inflows into precious metals last month. Value investing has seen a boost as many seek safety in defensive stocks.
Wall Street has been rushing towards safety lately. Many of the market positions now being favored are moves that I had made months prior. That should help boost performance for client accounts, yet there is the reality that we could be wrong. The trade wars could come to an end. The President could start tweeting like a normal person. There are a multitude of reasons why the bull run could continue. And that’s why we need to stay the course.
Who knows where the future will lead. We are indeed living in interesting times.