A week that started optimistically for the equity markets turned downright ugly on Tuesday as the major indexes dropped -3% or more. Thursday appeared to offer a reprieve after a powerful late-day rebound, but the declines hit again on Friday. Currently, investors are being buffeted by news that appears to shift by the hour, and fear of what might come next seems to be behind this week’s wild swings in stock (and bond) prices.
The bottom-line worry is that economic growth appears to be slowing and along with it, corporate profits. At this point, there are only whispers of the “R” word, and virtually all economists and most investors—including ourselves—do not see a recession on the near-term horizon. What we do see are three primary concerns that are weighing on the markets. We don’t believe that these three issues, either individually or collectively, will weigh heavily enough to crush the bull market that began 9 years ago. Rather, we think the decline that started in October is a textbook correction that will give way to new highs in the indexes next year. In addition, we think the correction is just about over and a sustainable rebound is nigh.
Let’s briefly review the three big worries:
1. Inverted yield curve: You may have been hearing that a portion of the yield curve—that is, the line tracing the level of interest rates from short- to long-term—“inverted” earlier this week. And that inverted yield curves are a harbinger of recession. This is highly technical, so we won’t bore you with the geeky details. Instead, we’ll just mention three facts: 1) the inversion is minuscule and affects only a tiny portion of the curve; 2) inverted yield curves aren’t always followed by recessions; and 3) when recessions do follow, the lag is typically 12 to 24 months. So even if this indicator were correct today (and we think it’s not), it’s still way too soon for the stock market to be reacting to a recession that might not occur for 2 years.
2. Brexit: Prime Minister Theresa May is having a bad year. After 18 difficult months, she succeeded in negotiating a deal for the UK to leave the EU in an orderly fashion. Despite its many flaws, it is just about the best that could be hoped for. Yet no one, including most members of Parliament, seems to like it. But neither has anyone presented anything better. It now seems likely that this deal will be voted down by Parliament. This could result in the worst-case scenario of a “hard” Brexit, in which there is no deal with the EU over tariffs or immigration. But as of this week, a more likely possibility is that Brexit doesn’t happen at all. The European Court of Justice (ECJ) is scheduled to release their opinion on Dec. 10 as to whether the UK can unilaterally rescind its decision to leave the EU. A legal opinion earlier this week from the ECJ Advocate General said that they can. If the full court agrees, the UK could simply say, “Sorry, just kidding, we don’t really want to leave after all.” Whether Parliament decides this on its own, or the UK takes it to a vote, remains an open question, but the odds of “No Brexit” just went up significantly.
3. Tariffs: This is the only issue that really bothers us. The problem isn’t so much that there are currently tariffs on Chinese imports to the US (and US exports to China) and that there may be more and higher tariffs in the future. The problem is the extreme uncertainty in knowing if, and when, these tariffs may be applied and at what rate. The Trump administration is certainly not helping clarify this, as their messaging seems to change daily. In the long run, if tariffs are applied and remain for some time, businesses and the economy will adjust. But in the short term, the lack of clarity around tariffs means that businesses and consumers have no idea how much many items will cost and thus may delay purchasing and investment decisions. The result could be a slowdown in economic growth as business owners and others await more clarity.
In sum, there really are only a small number of issues weighing on the markets and only one—tariffs—that may be with us for several more months. But what is important to keep in mind is that they are all temporary, unlikely to lead to a recession anytime in the next year or two, and to a large extent, already reflected in equity prices. And on top of this, the US Federal Reserve has recently become noticeably more dovish, suggesting that interest rates won’t increase as quickly next year as previously thought. All this suggests that current market malaise should be short lived and soon give way to healthier returns.
Dr. Ken Waltzer, MD, MPH, AIF®, CFA, CFP®
Managing Director, KCS Wealth Advisory
Laura Gilman, CFP®, PFP, MBA
Managing Director, KCS Wealth Advisory
Nick Nejad, CFA
Director of Investment Research, KCS Wealth Advisory
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