It’s been quite some time since we have experienced a bear market. In fact, heading into the fourth quarter of 2018, we were in the midst of the longest bull market in the HISTORY of our country. So, it came as a bit of a surprise to most, that we experienced a compact, yet ferocious, bear market.
There are several headlines/themes we are closely following as we move forward:
1. Global Growth Concerns—This was the main driver behind the December portion of our correction. Europe is currently facing the shadow of Brexit and Italy is now officially in a recession. Couple that with the slowest growth in China in over nine years, and you have a recipe for concern. Our belief is that the US economy is strong enough to stand on its own. But, it certainly would not hurt if the rest of the world began to turn the corner toward renewed growth.
2. The FED and Interest Rates—President Trump has been critical of the FED, as rising rates could damage economic growth. But, FED chairman Powell recently stressed the importance of managing policy according to their mandates of maximum employment and price stability. This tells us the FED is going to be less aggressive in raising rates, which is a real positive.
3. Internals and Leadership—It’s always important to pay attention to subtle shifts in the market leadership. To this point, technology and consumer discretionary stocks have led us higher. It will be very telling if these cyclical groups continue to lead and could very well signal that we will hit new highs at some point this year. If leadership turns to more defensive industries, it may be a signal that we have more volatility ahead.
In the end, there were a lot of circumstances that led to our 4th quarter bear market. Make no mistake, it was a bear market. That said, we believe the strength of the US economy will ultimately drive strong corporate earnings, which will push equities higher. The question we must ask ourselves is whether this January rally is a bear market rally, or a new bull run. For now, we are in the bull camp and very encouraged by the market behavior over the last five weeks. But, we have a raised eyebrow for indications that may tell us we need to get more defensive.
The market got hit hard in the fourth quarter, which was a bit unexpected considering how strong our US economy is right now. Many of the US equity markets experienced a bear market in the short three-month time frame. That is very unusual behavior. That said, the markets started rising after Christmas and look like we may be setting up for an extended run higher. There are several factors that caused the quick downdraft:
1. Investor Sentiment – In August and September I remember seeing, in just about every major news source, that we were in the longest bull market in the history of our country. I cannot refute what they were saying. But, the topic itself spooked investors and moved them into a “shoot first” mentality.
2. Interest Rates – At the first of October, the yield curve (2 year and 5 year) inverted. I won’t bore you with the economics class. But, when the yield curve inverts, it can signal a recession is coming. In this case, the yield curve went back to normal, so it was a false alarm.
3. Miscellaneous – This will probably sound a bit arbitrary, but the last 10-15 years has seen a huge ramp-up in electronic program trading. This is important because as the markets hit certain levels, the program trading kicks in. When trading kicks in, it can create “air pockets” in the markets that cause more drastic sell offs. The only good news is that it also works in reverse.
From a big-picture perspective, we feel very good about where the markets are, and we believe 2019 will be a good year for the economy and the markets. We went through a “shock” in the 4th quarter, but buyers are now coming back in. If the US economy remains strong, we feel the markets will follow suit.