Fourth Quarter 2018
The October Effect
Historically, October is the most volatile month of the year. One reason is investors recall historical market crashes, like the Panic of 1907; Black Tuesday, Black Thursday and Black Monday 1929; and Black Monday 1987. Yet, despite these ominous events, the reality is October has marked the end of more bear markets than their start.
Although the summer months were reasonably calm, October was the most volatile October we have had in 10 years with a total of eight days closing up or down by 1% or more. Although the market has 50 days closing up or down by 1% or more. As October draws to a close, we stand at 44 with two months to go.this is certainly disconcerting for many investors, it is important to note that the volatility we have experienced this year has been more normal than not. For example, in an average year,
Pullbacks and corrections (a pullback of at least 10% but not more than 20%) are normal and healthy market phenomenon. Regardless of their trigger, they cause investors to re-think their behaviors and expectations and get them into line with reality. For example, in our Third Quarter 2018 comments, we talked about how recent stock market performance had been largely driven by a handful of technology stocks, dubbed FANG by market aficionados. In October, these stocks were among the hardest hit with Facebook ↓7.7%, Amazon ↓20.2%, Netflix↓ 19.3% and Alphabet (Google)↓ 9.7%. By comparison, the S&P 500 Index was down only 6.9%.
Experienced investors know that pullbacks and corrections spell opportunity not doom. Along those lines, it should be noted that stock market valuations are more favorable now than they were at year-end 2017. For now, we remain optimistic that the bull market remains intact.
77% of the recent earnings reports for Standard & Poor’s 500 companies have beaten expectations.
Economic growth remains solid
For full year 2018, the Congressional Budget Office (CBO) projects that real or inflation-adjusted gross domestic product (GDP) will grow by 3.1% for the first time since the 2008 financial crisis. In 2019, it projects GDP growth to slow somewhat to 2.4% as the Fed continues normalizing interest rates.
Unemployment remains low
In October, unemployment held steady at 3.7%. That said; the CBO projects that it will continue falling through 2019. This is good news for workers for several reasons. One, everyone who wants a job can find one. Very simply, there are more jobs being created than workers available to fill them. Two, while the economy has been creating jobs for a while, it is now creating jobs in high-paying industries, like health care, manufacturing and construction. In other words, there are now more good jobs. Three, employers are being forced to boost their wage and benefit packages to recruit and retain their employees. Real wage and benefit growth is finally emerging.
Tax cuts are working
Ninety percent of all individual taxpayers have more income in their pockets based on the Tax Cuts and Jobs Act (TCJA). But, they are receiving other benefits, too. Here are examples of how corporate tax savings are working in our community.
- Avista is passing its tax savings along to its customers in Washington, Idaho and Oregon. Specifically, customers will save about $50-60 million on their utility bills because, as of January 1, 2018, Avista's income tax rate dropped from 35% to 21%. Also, about $442 million will be returned to customers over the next 35 years because of changes to depreciation expense.
On an important note, these savings will be passed along to all customers but they will be most meaningful for low and middle income customers for whom utilities represent a large share of their spending. Customers in other states will receive similar savings from their local utility companies, too.
- Dry Fly Distillery, popular maker of craft distilled beverages, is investing 100% of its tax savings. Specifically, it is embarking on an aggressive plan to build new facilities and expand production, and hiring new employees.
- Inland Northwest Bank employees (excluding senior management) received 2017 year-end bonuses of $500. Also, it raised its in-house minimum wage to $15 an hour and increased wages for employees making more than $15 an hour, which impacted more than one-third of its 200 employees.
Coupled with a thriving economy and low unemployment, the tax cuts are putting more money in people's pockets. In turn, this helps to sustain economic growth as about 70% of the domestic economy is consumer-driven.
All eyes remain on the Fed
The Fed remains committed to raising rates at a gradual rate into 2019 and early 2020. Its primary goal being controlling excessive demand and inflationary pressures by normalizing rates. Already, higher mortgage rates are moderating the housing market, which had become increasingly speculative in a number of markets.
How high and how fast to raise rates is largely a judgment call. Too much or too fast and the economy sputters, then dies. Too little or too slow and inflation runs away. For this reason, the Fed bears watching. But, investors should understand that, ultimately, higher rates will impact all asset values.
When all is said and done, it is important to recognize that there are some things you can control as an investor and some things you cannot. For example, you cannot control the economy or tax legislation, and you cannot control the political climate. But, you can control the diversification of your portfolio across and within asset classes. And, you can control the quality of your holdings. As always, we recommend maintaining a well-diversified portfolio of high quality holdings.