What the Fed

The Dow Jones Industrial Average (DJIA) posted it’s third-worst point drop in history yesterday. It fell by 1,031 points, which was a decline of -3.56%. The two previous 1,000 point plus declines were in February of 2018. The market fell by -4.6% and -4.15% at the time. 

A 1,000-point drop is a deceptively headline grabbing event. The -777.68-point decline in September of 2008 was far worse in comparison, but most will focus on the point change rather than the percent difference. Investors need to ignore day to day fluctuations while remaining focused on the long-term planning goals. That being said, we should also remain vigilant in regard to where market trends are headed. 

One trend that has solidified over the last few years is that volatility continues to remain a threat. Volatility tends to cause investors to sell near the bottom and then miss out on the subsequent rebound. While the top five Dow point drops have occurred since 2018, the market rebounded to new record highs afterward.

This volatility is taking place despite relatively positive economic news. What is behind this? Today the blame lies on Coronavirus. Last month it was impeachment. Last year it was the Mueller Report (the market declined -6% after it was released). From my perspective, none of those are the root cause. The trend that I’ve noticed lately is that investors continue to find themselves distracted by the big news stories while ignoring smaller ones. It’s almost like Groundhog Day… Investors pop their head out occasionally and decide they don’t like what they see.

Coronavirus is a good example of this. The available information on the virus shows it to be less lethal than previous pandemic scares such as SARS or MERS. It’s also less of a concern than influenza at this point. What the virus has done is given investors time to reflect on other market concerns. 

Yes, the virus will disrupt supply chains, but so did the Chinese New Year last month. The transportation index has been in decline since well before the virus appeared. It’s declined -9.4% since last year… at best, Coronavirus simply alerted many investors to this fact.

As I’ve been pointing out for some time, the constant spin and distractions seem to be successfully burying issues like this. Brexit finally took place and almost no one reported on it. The manufacturing index has been in decline. Tariffs continue to push farmers into bankruptcy while adding almost $1,000 in taxes to the average American family. Europe and Japan are trending towards recession. Oh, and the bond yield curve inverted yet again this week. 

Perhaps most worrying has been the Repo market. I touched on this in my annual newsletter and have since delved even further into the subject. I came across the chart below last Friday while researching the topic. It concerns me enough that I spent the weekend researching what it means for my clients. 

What prompted the huge increase in monetary supply was a spike in overnight lending rates. The interest rate on September 16, 2019 spiked from 2% to 10%. There doesn’t appear to be much consensus about what the root cause is, but everyone agrees that interest rates spiking five times higher would slam the brakes on the economy. 

The best explanation I’ve come across so far can be found here. The result of this interest rate spike has been the Federal Reserve flooding the markets with easy money. When the Fed has pulled back on these liquidity injections, the stock market has had noticeable declines. What I infer from information like this is that the current market highs cannot be sustained without Fed intervention.

Is this the beginning of a downward trend? It’s hard to tell. As I write this sentence, the Dow is currently down 400 points. The indice has been down seven of the last eight trading days. That doesn’t make a trend, but the news is concerning. Historically, we know that there have often been have declines like the ones we just saw. We also know that it’s impossible to know when the markets will begin to rise again.

We cannot remove investment risk, but we can prepare for it. We have done this by setting portfolio asset allocations to match both your investment time horizon and comfort with market risk. I’ve also selected investments over the recent years that help temper large swings. If the markets continue to slide, I will take appropriate measures to protect client accounts. 

That doesn’t mean I can prevent losses, but we can limit them. It’s far easier to dig oneself out of a small hole than it is to dig out of a large one. As always, please pass along any concerns you may have. 

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