As we ushered in what appears to be an overall steamy July weather-wise, money-focused media outlets prognosticated what markets, interest rates, inflation, etc., may do in the six month sprint to 2019. Before we get too enamored with any forecast, a look in the rearview mirror is useful.
Remember October 2016, just before the presidential election? On Oct. 22, 2016 CNBC declared, “If Trump is elected president, it would be exceedingly harmful to markets.”
An Oct. 24, 2016 CNN Money Report warned, “If Donald Trump wins the election, U.S. stocks (and likely many other markets overseas) will almost certainly tank. ... Almost everyone on Wall Street currently predicts Hillary Clinton will win the White House. A Trump triumph would likely cause investors to flee stocks to the safety of gold and bonds.”
The New York Times, Oct.31, 2016 quoted the eminent MIT economist Simon Johnson, who posited that Mr. Trump’s presidency would ‘likely cause the stock market to crash and plunge the world into recession.’”
The Chicken Little’s of Wall Street and academia called it wrong. The sky did not fall and U.S. market averages rose to unprecedented heights. Both the Dow Jones Industrial Average (“Dow”) and the S&P 500 Index notched all-time highs on Jan. 26, 2018. Both indexes closed below their record highs at second quarter’s end. Propelled by “big tech,” the Nasdaq Composite Index hit an all-time high on June 20, closing down from that record at quarter’s end.
Having observed the folly of past prognostications, we will refrain from pythonic musings. But there are cross trends that can weigh on markets. First, the Big Five tech giants have been leading the parade—Alphabet, Amazon, Apple, Facebook, and Netflix. These five stocks are distorting the S&P 500 Index as passive investing followers pour in money, ignoring soaring valuations. The very large capitalization companies in the tech sector have an outsized influence on the index. While the index contains 500 stocks, based on capitalization weightings, a small handful of soaring growth stocks at the top are eroding concepts of diversification.
Throughout the recovery from the 2007-2008 market thumping, inflation has been running below the 2 percent annual target set by the Federal Reserve Bank. With our economy expanding, core inflation, excluding food and energy, is now up 2.2 percent as of May 2018 year-over-year. All items inflation, including food and energy, necessities that impact your buying power, clocked in at 2.8 percent for the same time frame. (The Wall Street Journal, 6/30/18)
When you combine inflation numbers with the low rate of unemployment, Mr. Market worries that the Federal Reserve may be more aggressive in raising interest rates to restrain inflation, biting the “hot stock market” President Mr. Trump has been touting in defense of his tax-cut and deregulation efforts. Those initiatives certainly improved the bottom line of all manner of businesses, helping to fuel the stock market run. Tax cuts put more money in the pockets of consumers, bolstering consumer spending and confidence.
As to potential warning signs, emerging market stocks and currencies are being crushed by rising crude oil prices and a stronger U.S. dollar. Chinese stocks ended the first half of 2018 as the worst performer among the world’s major markets, slipping into bear market territory. Trade tensions are worrying traders globally and are likely to restrain American market progress until some measure of calming resolution.
Historically low interest rates prompted borrowers to leverage up in droves. Rising interest rates will constrain new borrowing and cause stress for debtors unprepared for higher rates.
Investors with ample and secure paychecks are likely to ride out any potential recessionary downturn. Diversification strategies should include U.S. mid-cap and small-cap firms which in general are less sensitive to a rising dollar and trade tensions, especially firms focused largely on the domestic market.
Retirees dependent on a “paycheck” or “playcheck” from their portfolio should have a sufficient low risk to “no risk” reserves so as to ride out any downturn in equities. We do expect market volatility to continue, potentially accelerating on declining trading volume as traders head for the Hamptons or some other venue to beat the heat.
The economy is doing just fine, but on Wall Street “good news” often translates into “bad news” as the tea leaves get cloudy.
Enjoy your summer!
Lewis Walker, CFP®, is a financial life planning strategist at Capital Insight Group; 770-441-2603. Securities and advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative and investment adviser representative of SFA which is otherwise unaffiliated with Capital Insight Group. He is a Gallup Certified Strengths Coach and a Certified Exit Planning Advisor (CEPA®).