Global Stock Markets Face Fork in the Road: Is the Worst Over?

 In Quarterly Update, Strategy Updates

2018 can best be described by Charles Dickens who wrote, “It was the best of times, it was the worst of times. Within the backdrop of strong economic data and corporate profitability, global equity markets advanced well into September, only to give back all of the gain – and then some – ending the year with all major indexes in the red. The media quantifies a bear market as a decline of 20% or more, and most major indexes have either surpassed that threshold or are within striking distance.  For all intents and purposes, we would classify this as a bear market. The question investors should be most concerned with is: is it a gentle bear market or a more aggressive grizzly? Let’s take a look at some data points.

As we mentioned in our last Strategy Update, the market is approaching a fork in the road and the direction it takes will be dependent on economic data. The road to the left (gentle bear) goes in a direction where we find that most of the decline in stock prices is behind us. This road will be full of signposts that argue the global economy will continue to grow, albeit rather slowly, and avoid a recession. These economic data points released in the coming weeks will allow us to get some verification. One of the mile markers will be stronger than expected earnings. Earnings season starts this week, so we will be paying close attention to these reports. Finally, a more constructive stock market environment requires significant policy expertise. This relates to a more accommodative Federal Reserve, progress in tariff negotiations and lastly, but not least important, getting our government turned back “on.” From our perspective the data points on earnings and the economy are easy to judge. However, we think the market’s biggest problem is the unknown of potential policy missteps. We are hopeful economic and earnings data are supportive and that policy makers can successfully navigate these issues. If some or none of these data points yield positive results, we are more than likely going to be traveling down the other, much less forgiving, fork in the road (grizzly bear).

In the absence of supportive economic data and/or policy success, we believe that global stocks could easily decline further. If one considers that the average bear market decline is approximately 38%, it is easy to see how much worse this could get for investors. Down this road are signposts that earnings are worse than expected and the economy is teetering on recession. That alone could be enough to send stocks down another leg, but combined with a policy error could really solidify the grizzly bear case. Though bear markets can be difficult, keep in mind that they are not long affairs – usually just 6-9 months – which means we may be a good way through this one. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so – and given our strategy we will be well positioned.

 As you well know, we have taken a very defensive posture with your portfolio to ward off the chances of a more significant decline. This has helped your portfolio weather some of the recent bad days and weeks. It will also significantly protect you should the grizzly bear scenario unfold in the next few weeks and months.

It is impossible to know which fork in the road the market will take. Anyone who says they know for sure would be mistaken. To quote Jack Bogle, the veteran Vanguard CEO, this week in Barron’s magazine, “This is no time to take significant risk and if anything investors should reduce risk at these levels. We strongly agree with Mr. Bogle. Though recent declines in your portfolio are easily recoverable, a more significant decline would be a challenge and not one we would want you to face.  When we consider the importance of the assets we manage for you, we feel that taking the tact of “safer than sorry” is the right call. Of course the risk of our defensive position is that the market takes the more constructive fork in the road and we underperform for a short period (as we will need to reinvest your funds). We think, and hope you agree, that it is a risk worth taking.

At the present time the bulk of your assets are in fixed income, generating better than money market return. We do not see this as a long term investment strategy, but a very good safe harbor until we get better clarity on the issues ahead of us.

In your taxable account, we may have taken some significant capital gains from selling some of your big stock winners in recent years. These sales on balance were timely as many stocks are much lower today and now your portfolio is more defensive. However, with the gains come capital gains taxes. Keep in mind our thoughts that it is better to pay thousands in taxes, than to lose millions in market value. Your tax liability will be about one-third of the total realized capital gains, which for most clients amounts to about 2-3% of their total portfolio value – a small price to pay for portfolio protection.

We hope you find this update helpful. If you have experienced any changes in your financial circumstances or would like to review your portfolio please let us know.

All of us on the team wish you and your families a very Happy New Year!

If you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.