I hope this letter finds you healthy and enjoying the holiday season. Please allow me 10 minutes of your time to share some thoughts. If you are irritated, frustrated or in any way agitated by the current markets, hopefully this will provide some calming perspective
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Predicting the future?
Throughout the past 27 years in this industry, financial markets have gone up and down hundreds of times. Consider there are approximately 250 trading days per year. That is more than 6,750 days of markets opening, increasing and decreasing, and closing. Over the past three decades there have been thousands of predictions – almost all of which have been repeated many times over – to tell us what will happen in the future. When markets seem to be especially volatile – like the past few months – many predictions will start with something that sounds like this: “This time it is different…It has never been this bad before…These 10 things need to happen or the market will never go up.” The more market volatility, the more absolute these predictions become. It feels like whatever happened most recently will continue to happen.
Very few predictions are accurate. Most often reality is far different.
Several years ago, when asked by a client to predict what the market would do the following year, I realized something in a moment of clarity: I can’t predict what will happen with markets. I don’t know what tomorrow’s market will bring, much less next week, next month, next quarter or next year. If we are honest with ourselves, every one of us would agree there is no one who can correctly and consistently predict the market. Yet there is no shortage of people who roll in front of a camera or jump onto social media every day to assure us they have it all figured out. I’m here to assure you – they don’t.
Every one of us – from expert to novice – has access to the same basic economic, financial and investment information. You should expect me – your advisor – to digest this information, and I do. I read, study, analyze and contemplate data…the same data the experts on TV and social media have access to. In the spirit of objectivity, I take in varying points of view, even if I might not agree with the point of view (or the person delivering it). All the while, I’m consciously filtering the data into fact and opinion – I want the facts, but I want to form my own opinion. In my mind, I’m assigning probability to various outcomes that I think could occur. Finally, I translate my thoughts into something that I intend to be relatable to you and offers you the best opportunity not only for today, but also for the future. What I intend to deliver is advice that is based on information, knowledge, experience and wisdom. Advice that I construct based on what I believe is a reasonable probability and not a guaranteed prediction. You should expect and even demand that I am objective and reasonable. If you want absolute guaranteed polarization, that is one remote click or internet search away.
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Try this exercise the next time you watch the news: Listen critically, evaluate the tone of voice and body language of the presenter, and above all else differentiate between fact and opinion. Most often, news is disseminated starting with some factual information and then a dose of opinion. Here is an example:
“The Dow decreased today as investors are increasingly worried about the global economy…and with holiday shopping in full swing, some of those shopping will certainly have this weakening economy on their mind.”
This is almost verbatim from a morning news show from a week ago, delivered in a 30-second segment. Visibly present were the grim faces and nodding from the other reporters who were looking stoically into the camera, all wrapped up at the end with filler comments thrown in to agree with – and confirm – this grim assessment.
I’ll rewrite the sentence, underlining the original and inserting my critique in parentheses:
“The Dow decreased today (fact)
as investors are increasingly worried about the global economy (opinion….maybe some investors ARE worried about the global economy…maybe some investors sold to get money to go holiday shopping…maybe some sold simply because the market went down, even though they have no idea why the market went down, and even though they have given no thought to what would have to happen to cause them to buy back in, they sold anyway….and how can we know investors are “increasingly” worried – much less worried at all – about the global economy?)
and with holiday shopping in full swing, some of those shopping will certainly have this weakening economy on their mind.” (two opinions popped up here…it is possible, and even likely, that some shoppers would have a weakening economy on their mind, but not absolutely certain. And it is opinion that the economy is weakening. Just because the first part of the statement suggests that investors might be worried about the global economy doesn’t necessarily mean the economy is actually weakening!)
If you evaluate the information critically, do you reach a different conclusion than simply reacting to impulse?
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State of affairs
Market volatility picked up almost three months ago in late September. Ask yourself: “What changed so significantly in the world to cause the volatility?” Challenge yourself to make a list of the events, issues, headlines or data that are possible causes of volatility. Assign a key word to each item on your list. I’ll share part of my list with you. To save time, I’ll condense my key word list to 5 items. In no particular order of priority, they are:
It is improbable that you haven’t heard anything about the Federal Reserve (Fed) in the past few months – the Fed and all things related to the Fed have been all over the news. The Fed controls money supply. The most transparent tool available to the Fed is a lever to control the federal funds rate. The Fed will increase the rate to decrease the amount of money circulating in the economy, and decrease the rate to increase the amount of money circulating in the economy. The Fed raised the fed funds rate by .25% yesterday, December 19, 2018. For months, it was anticipated by the majority of analysts that the Fed would increase this rate by .25% at their December meeting. For the past several weeks, it wasn’t hard to find one or several media reports to support the prediction that, if the Fed increased rates in December it will have a negative effect on the economy, and markets – meaning investors. Yesterday was the 9th increase by the Fed since December 2015. All nine increases were by .25%. This means the Fed has increased the federal funds rate by 2.25% points in 36 months. Ask yourself: Is it probable that the 9th interest rate increase will sink the economy? I believe not. And, to those who are thinking “but the Fed is going to increase again in 2019 – maybe more than once!” I say this: Be patient and give the Fed an opportunity to conduct their meetings next year. They didn’t make a binding decision yesterday for all of 2019. Recall the horrible start to the stock market in the first 3 months of 2016, in large part attributed to this: at their December 2015 meeting when the Fed increased rates by .25% (for the first of what is now 9 increases), the Fed suggested they might increase four more times in 2016. The market panicked at the beginning of 2016. By the end of 2016, how many times had the Fed increased rates? 1 time. Once. Not four. Be patient, and put things in perspective. If the Fed had increased rates yesterday by 225 basis points (by 2.25%) the result would likely have been horrific. They didn’t…they increased rates by 25 basis points, a .25% increase. I expect as time goes by, yesterday’s 25 basis point increase will probably be as memorable to you as the first 8 increases – which is to say, not at all.
Let’s continue with a recap of early 2016, but with the focus on what was happening with oil. Throughout 2015 the price of oil had been trending down, and the price continued declining into 2016. The low point for oil was in 2016 at a price of around $27 per barrel. We were told nearly every day that the decrease in the price of oil was a precursor to – guess what? – slowing global demand (sound familiar? It isn’t hard to find recent headlines that say this very thing). To believe this was to believe that the global consumption of oil would decrease. What did history prove? The world didn’t sink into a recession, oil prices came back up and by the end of 2016 the S&P 500 had gained 12% – pretty good for a stock market that from January 1st through February 11th 2016 had lost 10.2%. And what came of the prediction that global oil consumption would decrease? The pace of worldwide oil consumption has increased every year since the end of the 2008-2009 financial crisis. Who distinctly remembers the headlines – or the market – of 2016? It was only three years ago, but many of us might not remember how edgy and unnerving things felt at the time. I recall the feeling – very distinctly. And I can assure you the same feelings many investors have today were nearly identical 3 years ago. The conclusion I’m drawing from 2016 oil prices is this: don’t buy into the hype that the decrease in oil prices “is different this time” or that “this is really bad for consumers.”
This is a legitimate topic to give some cause for concern, for this reason: it is confusing. Confusion equals uncertainty, and investors hate uncertainty. Uncertainty is different than jumping to the conclusions that the trade issues will never be fixed, or that trade will evaporate, or that prices for everything we consume will jump exponentially. Here is a way to envision if trade is causing uncertainty (and thus causing some of the market volatility). Pretend there is a company that makes a consumer product. The company purchases some raw materials from a supplier in another country, and sells the consumer product to various buyers both domestically and internationally. Now assume there is the threat of tariffs. Would the consumer product company potentially be impacted by tariffs? Yes. Will the cost of buying raw materials stay the same or increase? Should the company stock up on buying raw material today? Will any transport lines (truck, train, ship and/or plane routes) have to be renegotiated? What will happen with the price of currency – will it cost more to buy raw material because of tariffs and maybe because of an increase in currency exchange rates? And who will buy the consumer product if the company has to increase prices to make a profit? These are legitimate questions. However, my process of thinking in probabilities instead of predicting absolutes leads me to this conclusion: I believe it is reasonable to expect trade tensions to dissipate, for this reason: money. There is far too much money to be made – by the U.S. and other countries – by selling products and services for the managers (government) to want to keep their team (workers and consumers) on the sideline. There is tension today, and no assurance that a resolution will occur. But the probability is that the desire to continue to want to make a profit will create enough pressure to produce a resolution. In reality, resolutions (plural).
What has been so different in the past three months that, suddenly, has caused some to think we have a bad economy? There are dozens of methods for measuring the health of the economy, just as there are numerous ways to measure our own health. You can’t define the totality of your health by simply taking your pulse and temperature. Likewise, saying that we have low unemployment and low jobless claims does not offer a thorough assessment of the broad economy. Our economy has improved ever so slowly over the years since the Great Recession caused by the 2008 financial crisis, and my argument is that the economy is still growing, but the pace of growth is likely slowing down. This is altogether different than saying the economy is contracting (i.e. regressing). Imagine you are walking on a slope. There is a significant difference between climbing a hill where the upward slope is starting to level out but is still going up versus walking on a slope that is going down. The impact on your body of walking uphill and walking downhill are totally different. Same concept for the economy. My conclusion from the collective economic data I evaluate is that we haven’t crested the hill.
This one is tricky. It wouldn’t be hard to convince most investors – whether you actually feel this way – that there is negative sentiment hanging over the market. There is nothing scientific about this as it is a subjective assessment of the emotional state of affairs. I’ve used many ways to explain sentiment during client meetings; here is one explanation: Imagine you are one of many people in a movie theater. Your only source of information is what you can see and hear from the movie that is playing. There are no windows, naturally. You are literally in the dark and have no information about the outside world. And then someone opens the theater door and yells “Fire!” You don’t know who yelled, or even if they have credible information. But you are very likely to take either one or both of the following actions: (1) pause to consider if there really is a fire, and if you think the risk is legitimate you (2) get out of the theater. Substitute a few words in this story, and we have a simple explanation of how markets will sometimes trade on sentiment. When markets “pause to consider information” it doesn’t happen in one day. The pause is usually days, or weeks, and means investors stop buying, and maybe start selling. After all, no one runs into a theater that might be on fire. The current pause in the market has been exactly three months long. Selling causes prices to decrease, which causes more selling, which causes more declines, and so on. This is almost always the time when the rhetoric and doomsday theories pop up – and they can seem very convincing, especially when we have real-life market declines to prove the theories. It becomes much easier to associate cause and effect when there is bad news at the same time that markets are bad.
This is the time when many of us – me included – question whether or not “we should do something.” Even if we are evaluating data, thinking critically and rationally without emotion and determining the best long-term course of action is to remain diversified, it is hard to not react emotionally when market volatility is causing investments to fluctuate.
I am irritated and frustrated with investment markets – but I am not alarmed. I am not alarmed, because I believe there are investment opportunities that have been created by the negative sentiment. The negative sentiment is not going to last forever, and I want to be in the market when it shifts. I don’t believe the decrease in oil prices or yesterday’s quarter of a point interest rate increase from the Federal Reserve are issues that will strangle financial markets. I believe the trade tensions will fade in the coming weeks and months. Most importantly, I believe that the economy – which is the collective production and consumption of goods and services by millions of people – is a lot more resilient than what we are supposed to believe from most of today’s headline news.
Please contact me if you have questions.
Thank you for your continued patience, confidence and trust.
Timothy A. Weller, CFP®