Talk is Cheap . . . or is it?

Tuesday, August 6, 2019

By: Christopher Cline

So much for the biggest stock market gains in the first half of a year since 1997.  That was the news in early July, but the last four days have taken a lot of the wind out of the market’s sails. 

The pronounced market drops began on Wednesday July 31st. Despite the fact that the Fed lowered its short-term benchmark rate by .25%, Fed Chairman Jerome Powell spooked many investors by referring to it as a technical “mid-cycle adjustment.” This caused them to wonder if there would be further reductions in the year. Powell later stated that, even though Fed officials didn’t foresee a series of cuts, this didn’t mean the Fed would stop after just one. So even though investors got the rate cut they wanted, Powell’s vague statements about further cuts were enough to cause stock prices to drop significantly on Thursday.

The decline continued on Friday, as President Trump tweeted that the U.S. would impose further 10% tariffs on $300 billion of Chinese goods as talks between the two countries stalled. These tariffs would not be imposed until September 1, amounting at this point to a mere threat (and one that apparently many of the President’s advisors disagreed with).

Monday saw the worst market decline in four days of straight declines, with the Dow and the S&P 500 down by around 3%. The fall in stock prices resulted from a deepening of threats and accusations that began on Friday. The Chinese government, which tightly controls its currency and which historically has propped up that currency to keep it trading below 7 yuan to the U.S. dollar, allowed the yuan to rise above that level. As the value of the yuan drops, Chinese goods become cheaper on the world market, while U.S. goods become more expensive. So it would appear that the Chinese took the President at his word on the threat of tariffs and beat him to the punch. The President responded with accusations of currency manipulation.

In short, the cumulative drop in the markets was due mainly to talk. Not sobering economic news or world political upheaval, just talk.

This fact is all the more frustrating because, while the economy isn’t flag-wavingly strong, it isn’t weak yet, either. July employment data showed an increase of 164,000 non-farm payroll jobs, in line with most economists’ expectations. Additionally:

  • Year-over-year wage growth rose by 3.2%;
  • The participation rate rose to 63.0%;
  • The underemployment rate fell to 7% (a 19-year low):
  • Manufacturing payrolls posted their largest gain in six months

All was not completely rosy; the May and June employment figures were reduced by a combined 41,000 jobs. All in all, though, it was a fairly strong performance, and certainly not a sign of immediate looming economic disaster.

How can such insubstantial words like Chairman Powell’s statements or the President’s tweets override fairly solid substantive data like the jobs report? As economic expansions and market growth get longer (and the current ones are of historical length), the markets become more volatile from fear, both “fear of missing out” and fear of staying in too long and being kept holding the bag. This means that any bit of news (even words that have not been translated to action) has the potential to cause outsized price swings, both positive and negative.

How do you defend against such volatility? “Common sense” says get out of the markets now, and then get back in after they’ve “corrected” in price. Sounds good, but as we’ve pointed out (seemingly ad nauseum), no one has ever demonstrated an effective ability to correctly time the markets on a consistent basis. This is due mainly to the fact that, to do so, you have to be right twice: at the time you sell (when the market is at its highest point) AND at the time you buy back in (when the market is at its lowest), or vice versa. Getting just one right, while hard enough, doesn’t get the job done. And getting both wrong can be disastrous.

And who’s to say whether we even are at a late stage? This historically long growth cycle has been fairly anemic: wages and inflation have grown very slowly, with the latter not even hitting 2%. Given our continually low interest rate environment, we wouldn’t bet against this growth trend continuing for another 4 -5 years. Nor would we bet FOR it, as the trade wars could cause economic chaos in the next year or two.

Meanwhile, remember that, despite the 5.6% drop in the S&P 500 over the last four days, that index is still up for the year, on a total return basis, by over 18%. It’s important to keep turbulence in perspective.

So our advice at this (potentially) late stage in the cycle is simple, and the same as it’s always been:

  • Don’t look at your balances;
  • Make sure you have six months of living expenses in cash (at least) to weather a prolonged downturn if you’re living off your portfolio; and
  • Call us if you’re feeling shaky or financially insecure.

Hard though it is to take sometimes, the market is simply doing what it’s supposed to do.  The best way for you to respond is to do the same.


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