After a relatively placid second and third quarter one in which the S& P 500 returned 2.93% and 7.20%, res pec t i vely, volatility has moved back to the front burner. The rise in interest rates over the past couple of weeks, pushed along by hawkish comments from new Fed Chair Jerome Powell appears to be the culprit. During a recent interview on PBS Powell noted that “the really extremely accommodative low interest rate that we needed when the economy was quite weak, we don’t need those anymore. They’re not appropriate anymore. Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point, probably.”
Despite these statements by Powell, we believe the Fed will err on the side of caution. The United States economy is still in the process of trying to gain escape velocity from the credit induced Great Recession of 2008- 09, one in which no matter how low interest rates were driven and no matter how much money was pumped into the economy, only time and the repairing of consumer and corporate balance sheets will prove to be the ultimate remedy.
We believe Chair Powell realizes this. We also believes that he realizes that despite the relatively strong consumer sentiment data, investors are still fighting the ghosts of 2008- 09, a year during which the S&P 500 tumbled more than 38%, ultimately dropping more than 50% through early March, 2009.
Despite the above as well as the unsettling political environment leading up to the mid-term elections, we believe that the financial markets, led by strong corporate earnings, an ultimately dovish Fed and relatively low interest rates, will push its way higher through the balance of 2018.
Now that we have built the proverbial Wall of Worry, one that Wall Street has climbed consistently over the past decade, let us remind those less sanguine readers of the positive tailwinds to the financial markets.
Absolute Interest rates remain low. Despite the rapid move higher, interest rates on the ten-year U. S. Treasury are only around 3.25%. Once investors accustom themselves to this higher rate, they will realize that it will not be enough to justify a shift in their asset allocation model to more fixed income. In addition, we believe that at least temporarily the bulk of this move in interest rates is behind us.
The benefits of the recent enacted tax legislation have yet to filter through to individuals and corporations in its entirety. We have witnessed glimpses of this in the form of strong consumer sentiment, spending along with 20%+ corporate earnings growth, share buybacks and wage hikes. This tailwind should last well into 2019.
Inf lation, led by the global def lationary force which is Amazon, should remain at bay. Without inflation, interest rates can only move so high before the Fed will have to pause.
As we enter this period of normalization in regard to interest rates it is historically customary for volatility to pick up. Expect more of this. However, we do not believe this secular bull has completed its run as skepticism remains high. Bull markets tend to end during periods of euphoria.
Finally, think longer term. Invest for a complete economic cycle which is historically five to ten years and allocate assets accordingly. The financial plan that you hopefully have established with your advisor should take you through times like this. That’s what it is for. That said, if you’re feeling skittish give us a call. We’d love the opportunity to get together.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call 518-2791044.
Chris + Dennis Fagan