Anyone else getting a bit seasick watching the market making these huge swings over the last month? In reality, we have not experienced a “normal” correction in over two years, so this correction was not unexpected. The bigger problem is that extended periods of time with low-to-no volatility in the markets tend to reverse to much higher volatility and that’s what we are experiencing today. The ironic part of this drawdown is that it’s being driven by a global economy that is much stronger than most expected.
Along these lines, there are a couple of themes we think bear watching as we move forward in 2018:
How quickly does inflation return? – The US economy was one of the few global economies that grew consistently from 2010 to 2016. When there’s low global demand for goods and services because of a stagnant economy, inflation remains low. Couple the slow growth with the money the FED pumped into the banks, and inflation was kept artificially low for an extended period of time. However, last year marked a significant turn. The global economies have now lifted, in unison, and that has created a very real threat of renewed inflation.
Will the rates continue to rise? – The answer is “yes”. As inflation picks up, the FED could have to raise rates faster than they would like and that’s what has the equity markets spooked. The FED would ideally like to raise rates slowly. But, if inflation accelerates, they will have to be much more aggressive, hence the knee-jerk in the market.
It’s a real “good news/bad news” scenario right now. If the economy grows strongly, rates will go up. Eventually, this could hurt global growth. For now, we believe this corrective phase will eventually give way to higher prices later in the year. But, we also expect the markets to be more volatile than they have been over the last couple of years.
As mentioned in previous communication, we have generally raised our cash positions. We are monitoring potential trending opportunity to reinvest those monies.
The markets are starting 2018 with the same momentum from last year. Investors have embraced the global economic reemergence and the stock market lift. There are several factors that are pushing this rally, which bare monitoring:
How will the Trump tax cuts be used by Corporate America? – The tax cut bill was probably the worst kept secret on the planet. Everyone knew it was coming, but one thing we did not know was the final form. The next question is, “will the bill stimulate growth in our economy”? The early results are in and the answer is a resounding YES. Walmart recently announced they are raising their minimum wage by $2, which puts more dollars in their employee’s pockets. Apple, which has 94 percent of its total cash of $269 billion outside the United States, said it would make a one-time tax payment of $38 billion on the repatriated cash. Apple said it would put some of the money it brought back toward 20,000 new jobs, a new domestic campus and other spending.
Will Europe continue to improve? – Our recent numbers also say YES. Germany just came out with the best GDP numbers they have seen in six years. The UK, in the face of Brexit, just announced the best manufacturing numbers in over 11 years. Momentum is certainly cycling through Europe and it looks to be contagious.
Will rates stay low? – This one is a bit tougher to call. We are experiencing strong growth around the world and this growth will eventually lead to higher inflation. At some point, the FED may have to be more aggressive in raising rates. But, the longer they stay down, the better for economic growth.
This economic growth cycle has legs, but that doesn’t necessarily mean the stock market is not overvalued in the short-tem. We do not want to go into our shell too quickly. But, a normal correction in this time frame would be healthy and one we expect to get started in the next couple months.