Tuesday, December 18, 2018

I am tired of all the negative news, let's report the positive. Happy Holidays to one and all!

It is somewhat ironic to me that we are in the “joyous” holiday season, yet the airwaves are flooded with negative comments. Many of these comments relate to geopolitical events that have absolutely nothing to do with the economy. Such negative sentiment always runs the risk of becoming a self-fulfilling prophecy. There is much more positive news, which you may not be reading, that overwhelms the negative forecasts so I thought I would devote this blog to pointing those out to you.

There is no question that this has been a disappointing year from a financial standpoint, but it certainly has not been disappointing from an economic perspective. While the stock market has bounced around in all types of starts and stops, the economy has been outstanding. With the economy growing 2.9% in 2018 and unempolyment being reported at the lowest level in the history of employment in the United States, it is hard to fathom that the stock market could underperform. It looks like the traders and speculators on Wall Street are trying to talk you into believing the negative headlines.

Josh & Ava 

Josh, Joe, Ava, Dakota & Carter with Santa

Ava in her Christmas dress!

I will report on all of this very interesting information, but first I must report the activity and performance for the month of November. After an almost devastating selloff in October, the markets rebounded somewhat in November before the volatility struck again the first of December. For the month of November, the Standard & Poor’s Index of 500 stocks was up 2%, up 5.1% for the year-to-date, and for the one-year period ended November 30, 2018 was up 6.3%. The NASDAQ Composite squeaked out a small gain of 0.5% for the month of November, is up 7.2% for 2018 and is up 7.7% for the year then ended. The Dow Jones Industrial Average was up 2.1% during November, up 5.6% for the year-to-date and up 7.6% for the one-year period then ended. Just for comparison, the Barclay’s Aggregate Bond Index was up 0.6% for November, but is down 1.9% for 2018 and down for the one-year period ended November 30, 2018 at -1.4%.

During the month of November, the market vacillated back and forth on 3 basic points. First, there is the ever present concern about the Federal Reserve increasing interest rates to the point of forcing the country into a recession. The second of these was the trade conversation between the entire world and the United States, as promoted by President Trump. The third, which seems to be on everyone’s mind, is whether earnings are rising or falling in the future if the economy sinks into a recession sooner than anticipated. Of course, there are always the extraordinary headlines regarding geopolitical events that really have nothing to do with anything other than polluting the airwaves with needless information. All of these items have affected the market and I want to address them in this posting.

It seems the markets have worked themselves into an absolute frenzy over what is really going on with the economy. Every day, I read extensive articles by so-called “experts” on just how poorly the economy is performing and how they believe 2019 and 2020 will play out. While it is always interesting to hear commentators express their views on what is taking place, what I find much more important is what the experts are actually forecasting. Is it really possible that the economy that is growing at such a pace in the United States could turn on a dime to recession and reflect a negative performance in 2019? In a word, so as not to waste space, NO.

Of course, with the hustle and bustle of the holiday season, you probably haven’t kept up with the reporting of the Atlanta Federal Reserve and its anticipation of gross domestic product going forward. You may recall that the last 2 quarterly GDPs have been excellent and certainly the economy continues to be expanding as we enter into the holiday season. Retail sales are growing nicely, and as I sit here on Sunday morning at 11:30 watching traffic line up to go to Lenox Mall, there is certainly no concern for consumer spending during the holiday season.

On December 7th, the Federal Reserve of Atlanta projected that the GDP would grow in the fourth quarter at a 2.4% pace. While certainly not extraordinary, quite a desirable growth of 2.4% would be a good quarter. However, on December 14, 2018, the Atlanta Federal Reserve increased its anticipated growth rate to 3%. Isn’t it interesting that over that one-week period, the Federal Reserve would increase the projected growth rate while the market makers on Wall Street forced stocks down by billions of dollars? As I have been pointing out in these posts, there is a complete disconnect on Wall Street regarding the reality of the underlying economy, which in reality is excellent.

So, we can all concede that the economy in 2018 has been nothing short of spectacular. The economy has continued to grow throughout the year, employment remains strong, and even hourly earnings are starting to grow. That is the perfect recipe for a strong economy, but what about 2019?

In order to try to determine what exactly we should suspect in 2019, I reviewed all of my available resources to see what the experts have proposed. At the low end, some see a growth next year of roughly 2.3%, while the more optimistic have projected a 3% growth in 2019. The actual growth reported by the Federal Reserve in its most recent update projects the economy at 2.5% in 2019, a slight decline from the previous projection. In any case, even if you take the low growth rate, it would still be quite excellent and certainly above average growth rate for the last several decades. So how on earth could the so-called “learned person” of Wall Street project a recession in 2019 when all of the economists project otherwise? Also, just what economic event would turn around the strongest employment ever in the history of America in 2019 to create an economy where unemployment was rising rather than falling, like it is today? Just about no one can project any kind of negative economic event that would turn the strong battleship of financial performance around in such short time.

So, if the economy is not going to reverse in 2019, there must be something else that is leading to the extraordinary volatility that we are seeing on Wall Street. Maybe the underlying fear is that tariffs will actually convert the economy from growing nicely, to negative. Maybe those projections are not based on current reality. If you have been watching closely, you will note that a trade deal has now been entered into and signed with Mexico, Canada and South Korea. In each of those cases, although not a great deal was changed to any of the existing agreements, the changes that were made were favorable to the United States economy.

So, basically what fear lies in the new tariff war is with China. Is it possible that any deal with China, or failing to make an arrangement with China, could bring down this U.S. economy? As I have pointed out so often in these pages, the U.S. buys roughly $650 billion worth of goods from China, but only sells less than $200 billion worth of goods to China. If it came to a showdown of no trading between the countries, clearly China would be the loser. It has already been well documented that the Chinese economy is slowing, which is only self-evident when you consider their major trading partner is the U.S. Maybe you did not realize, or see the reporting, that China is now back buying agricultural products in the way of soybeans from the United States.

One of the major risks to the Chinese economy due to their inability to make a deal with the United States, is that many of the supply lines will be disrupted and moved from China to other countries. Currently, Vietnam, Indonesia, Malaysia, and India have become major players in supply line suppliers to the U.S. manufacturing. If the Chinese wait too long to make a deal, the supply lines may be too far along to move back to China once resolved.

I have great respect for our President for fighting this war. It is a war that needed to be fought 25 years ago but no other president has been willing to stand up to international pressures to try and level the playing fields. My prediction is that there will be a deal with China during 2019. At the end of the day, it will not change much, but it will at least benefit the United States and create a more level playing field. In the meantime, all of this volatile trading on Wall Street related to a potential deal with China is just a smoke screen to shake your confidence in the actual strength of the U.S. economy. The reason the Chinese will agree to a deal and the reason that President Trump will accept it is quite clear: the Chinese recognize that their economy cannot continue to grow without sales to the United States. They will make a deal not because they want to but because they have to. At the end of the day, they will not risk the effect on their economy just to play hard ball with the current U.S. president.

Of the major concerns that affect the market place and the stock market, the first two are the potential for inflation and the risk of tariffs. As explained in the paragraphs above, I find both of those fears to be misplaced and only a short-term concern. Why would any long-term investor trade around these risks knowing that each or both could be resolved within the next couple of weeks? The one major concern that maybe has some economic effect would be the risk that the Federal Reserve could actually move beyond neutral with interest rates, and therefore put the country into a recession sooner rather than later.

The Rollins family, ready for the holiday season!

The actual selloff of the markets began in October when the newly appointed Chairman of the Federal Reserve expressed with some sort of authority that their intention would be to increase interest rates to a point of being neutral and we were a “long way” from being neutral. At that point, the jittery stock market determined that maybe this newly appointed Federal Reserve was much more hawkish than the previous Federal Reserves, and therefore would increase interest rates to the point that the economy would reverse quickly and would return to a recession sooner rather than later.

Even though the Federal Reserve’s Chairman later corrected that statement when he exclaimed that “interest rates were currently near neutral,” the markets refused to accept his explanation. I think even now the Chairman of the Federal Reserve would agree that the statement on October 1st was truly a rookie mistake. While he certainly wanted to express an opinion that he would be a supporter of the economy, he quickly realized that his exclamation of exactly what their intentions were going to be was misinterpreted by the investing public.

Just to be absolutely clear, no Chairman of the Federal Reserve has any desire to throw the U.S. economy into recession. Anyone who actually believes that really does not understand political appointees. The other thing that was baffling is that no Chairman of the Federal Reserve really wants the stock market to implode. There is very much a “wealth effect” in this country. The “wealth effect” is when the market is high, investors will sell their investments and use those proceeds to buy consumer goods. They buy a new house, a new car, a new toy or go on vacation. When the market sells off, investors are not likely to spend money and are not likely to use that money to prop up the economy.

For that very reason, no Chairman of the Federal Reserve wants to see a major market selloff. Their preference would be for the markets to be stable and not to bounce around wildly based upon comments by politicians. It is clear that this Chairman of the Federal Reserve had neither a desire to create recession, nor a desire to deflate the markets. Given that he had only been in office a couple of months, you have to rack these comments up as a simple mistake.

But the more important consideration is exactly what has taken place since his original October comments. At that time, it was perceived by the markets that there would be an increase in interest rates in December and three or four rate increases in 2019. Given the flat yield curve that we see today, if that forecast had come true, there would have been absolutely zero question that the short term rates at the end of 2019 would have exceeded the long-term rates. As often is the case when exaggeration leads to forecasting, no reasonable economist could have projected that the inverted bond yield scenario as proposed by investors was realistic.

What we now see is that quite almost assuredly there will be a rate increase in December. There is a high likelihood that in 2019 only one or maybe two rate hikes will be in store. If that projection holds true to form, there is absolutely no chance that the increase in the interest rates by the Federal Reserve in 2019 will force the economy into a recession. One more actual fear defeated by the truth.

During the month of November, it was projected that the entire world was falling into recession or clearly a slowdown. The catalyst for this opinion is that during the quarter, Germany and Japan both suffered declines in GDP. Even though there were solid reasons for the negativity in these countries, investors sold before they thought. In Germany their largest industrial production, by far, is automobiles. During the third quarter, there was a severe drop in automobile production in Germany due to the model changes over the years and the adjustment to the new admission standards. As has long been the case for the entire month of August, usually Europeans vacation rather than work. While clearly a decline in GDP for the quarter, it was one that was easily explainable and not likely to occur.

Likewise, in Japan, they had severe weather and earthquakes, which slowed their economic growth. However, this week they are proclaiming that Japan’s 10 year growth cycle has one of the strongest in their financial history. And certainly inflation, while it can always be a factor in future economic growth, the fact that energy has fallen nearly 30% over the last 90 days should dispel any type of fear of future inflation.

Isn’t it interesting that when President Trump pushed the Saudis to produce more oil in order to reduce higher energy costs, the price of crude oil fell over 30% in 90 days? Maybe that tells you something about how highly inflated energy prices are today. It probably has gone without notice, but the U.S. is now the largest oil producing country in the world. The United States produces almost enough oil to be totally self-sufficient in that category. The revolutionary concept of shipping liquified natural gas is just now starting and the U.S. will be the largest ever exporter of it within the next few years. For those that do not believe in the ingenuity of U.S. engineers, just contemplate the ability to take a clear gas and convert it into a liquid that can be shipped around the world and then turned back to a gas in order to heat homes, etc. – it is conceptually mindboggling.

Everywhere I look I see only good news, except when I watch national broadcasts. I guess it is baffling to not only me, but to my readers as to why Congress refuses to do anything proactive. If it is the goal of the minority in Congress and clearly the goal of every news cycle and news channel we see to have the President removed, why is it that they do not focus on not having him at the polls in 2020 rather than trying to attempt to remove him before then? There is no conceptual way that a President can be removed against his will prior to the elections in 2020, and therefore why even try. It would seem to me that if Congress had any inclination or desire to actually help the U.S., they would focus on that rather than these incredible time-wasting and expensive investigations, conversations, and allegations. But then again, the nightly news would have nothing to report on, so…

For those of you who have not been a long time reader of my financial reports, you probably did not realize that I was a firm and longtime critic of former Federal Reserve Chairman, Alan Greenspan. While so many people were praising his genius, I was criticizing his faults. I thought he was so wrong during the 90s in virtually all of his actions and most of his speeches. I thought he made a tragic mistake when he was chairman in 1987 with the big market correction that year and I thought he handled the economy in the 90s and early turn of the decade poorly, as well.

So, I could not have been happier to see him give one of his famous quotes recently. Former Federal Reserve Chairman, Alan Greenspan, explained, “ We are moving into a state of stagflation we haven’t seen in this country in quite a while. It’s slow. It’s progressive.” It really cheered my heart to see him once again express a negative thought about the U.S. economy. There really could not be a stronger contrarian call of the markets than having Alan Greenspan himself express the negativity. He had been so wrong so many times in my economic past that it cheered me to hear his voice once again, and to know how likely it is that he would be wrong again.

In this holiday season, I hope you spend more time with your family, enjoy the season, and worry less of the fears on Wall Street and have conviction in the reality that the economy is great, interest rates are low and earnings are increasing. All three of these will lead to higher markets, and I am not sure whether that is today, tomorrow, this week or next, but I do know with absolute assurance that the markets will be higher years from now than they are today.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins