There are several issues that in combination could have triggered the several days of large stock market drawdowns. In the Big Picture arena, I think we have to look at the Fed ’s current activity, which seems to be working at cross-purposes. The fairly well telescoped ending of quantitative easing matched to a fairly visible scheduled of rate rises through most of 2019 are causing concerns to both companies and investors alike. Surprising to many interest rate watchers is the fact that the 10-year bond yield has reached a seven-year high of 3.23%, while the bond yield hit a 4 year high of 3.4%. Apparently, the apprehension to rising rates is not the rate itself but the speed at which the rates appear to be accelerating. There has been a slowdown in both auto sales and new home construction recorded in the last several months that will likely increase with the advent of higher borrowing costs. In addition, there is also a growing realization that huge benefits from the President’s Tax Package, that has raised earnings per share growth in some segments to 50%, will start fading as we approach 2019.
The strengthening dollar will hurt will some of our largest companies that enjoy a large export base as our goods will become more expensive. Looking at the market itself, the surge in company stock prices, especially in technology suggests a mentality has taken hold that pushes company shares beyond sustainable prices. When I met earlier this week with a star young associate of a company that provides marketing services for Resolute, he quizzed me on the value of stocks today. In response, I asked him what his favorite new automobile was. He picked a mid-level model in the Infiniti line- up that retails in the $40,000 range. He thought that sounded fair. I asked him if he would pay $ 80,000 for that car. No, he asserted, it was way too much. He then asked me about the value of some of his favorite Tech stocks and products. No, I asserted, that’s way too much for a cell phone!
While we were fixated with the price of cars and phones, Europe’s economy has been on a downward trajectory from 2% to 1%. On the bright side of things, China, in response to a 6.7% growth rate in the second quarter (their slowest pace since 2016) has announced a fresh batch of stimulus measures.
There is some room in this report for U.S. optimism, however, as the official earnings season started just last Wednesday. Over the next 3 months, we expect earnings reports from 3600+ companies. They have been operating in a low-interest rate environment, with a rollback in costly regulation and full employment. These conditions should support a strong earnings season.
Finally, market corrections are part of investing. They will never, in my opinion, be pleasant. The best defense in my career has always been a broad diversification among industries, companies, and regions and an ownership mix of stocks for growth and bonds for stability. I believe the U.S. will continue to be favored among global investors because of its stable economy, commerce-friendly attitude, a permanent interest in promoting trade relationships and a Democratic system to manage change.