I wanted to reach out to address the recent stock market volatility. For the past few months, it seems as if every news headline has been negative and while there are certainly causes for concern, there are some reasons for optimism. Before touching on this, I wanted to reiterate some of my comments from our last letter and discuss our approach to portfolio construction.
It’s important to keep in mind that the market averages a 10% correction once per year and a 20% correction once every three and a half years. Larger corrections are infrequent, but certainly do happen as in the case of 2007 – 2008. While we won’t usually know in advance what the causes of these corrections will be, we know that they will happen. Additionally, they happen with little warning. Knowing this, we construct portfolios to weather these market environments. We do this through two primary mechanisms. One is controlling a portfolio’s risk level via asset allocation (stock vs. bond mix) and the other is diversification. Almost all our clients’ portfolios are not 100% exposed to the stock market. This is important because bonds play a crucial role in insulating our client portfolios from the stock market’s volatility. While this balanced positioning limits a portfolio’s upside when the market is moving higher, it also limits a portfolio’s downside and shortens the length of time needed to recover any losses.
Additionally, our clients’ portfolios are diversified within both the stock and bond portions. The stock portion maintains defensive exposure to utilities and consumer staples stocks, as well as some exposure to more growth-oriented areas of the market, such as technology, to provide for capital appreciation. On the bond side, our client portfolios have exposure to Treasury Bills and Bonds, mortgage-backed securities, corporate bonds, and other areas of the fixed income universe. All together, these investments allow for a mixture of portfolio growth and downside protection. It is very important to have these portfolio attributes in place before any market volatility occurs. Making moves to get more conservative or diversify after a market correction happens is a sure way to lock in losses and is one of the biggest mistakes investors make.
Currently, the market is concerned about several issues, the most important of which changes day to day. Trade negotiations with China have been an ongoing issue, though talks between China and the U.S. continue and more formal discussions are planned for January. Concerns over the Federal Reserve’s interest rate rises have also impacted the stock market. At the Federal Reserve’s last meeting they moved forward with a widely expected 0.25% increase in rates and announced a lower amount of expected rate increases for next year. While markets welcome lower rate increases, there is still a concern that any further rate increases are unnecessary, as this could slow growth more than expected and potentially invert the yield curve. The Fed did acknowledge that recent risks to the economic outlook and the changing landscape will certainly factor into their actions going forward. Talk of a government shutdown has also weighed on markets recently, but we did experience this a few years ago so there is less uncertainty surrounding a shutdown’s impact than in prior years.
It’s important to keep in mind that the Fed has been raising rates because the economic data has been relatively strong. Economic growth has been solid for two straight quarters and economists are predicting growth of 2.3% next year and 1.8% in 2020. The jobs figures have been strong, unemployment remains low, and wages are growing. Importantly, earnings are expected to increase by about 8% next year and this has been an important driver for the equity market. This backdrop provides some reasons for optimism amid news headlines that are difficult to predict, such as the China trade negotiations or what the Fed’s next move will be.
The recent market volatility serves as a reminder of the importance of diversification. The best course of action is to maintain a proper asset allocation to weather the inevitable market corrections and subsequent rebounds. We have worked together to produce a long-term strategy for your portfolio, designed with a level of risk in-line with your goals and objectives.
On behalf of everyone at Condor Capital, I want to wish everyone and their families a Happy and Healthy New Year.