As your trusted financial advisors, we want to take this opportunity to reach out regarding the market declines and increased volatility that we have experienced in recent weeks. We would like to provide some insight and perspective, as it relates to the prevailing macroeconomic backdrop and the resulting shift in market conditions. More importantly, we’d like to touch upon how all of this affects your personal investments and long-term financial goals.
Experiencing market declines and increased volatility can be disconcerting for any investor. However, it is important to keep things in perspective, especially given where we are in the current market cycle. The present bull market is approaching its 10th year, the second longest recorded since 1926. The overall strength of this equity bull market, in conjunction with the historically low volatility levels experienced leading up to 2018, has occasioned complacency among many market participants. In fact, 2017 was the only year on record where no “down” months were recorded for the S&P 500 index. This is a sharp contrast to the amplified volatility and market corrections we’ve experienced in February and then again in October of this year.
Although the current drawdowns seem excessive when compared to the past few “up” years, they are actually in-line with historical market behavior. While equities have averaged an annualized return of 7%, there are an average of three pullbacks and at least one correction of 10% or more each year (based on data back to 1950). Our investment committee expects the resurgence of market volatility in the near term. Furthermore, being in the latter stages of the business cycle can mean there will be even greater short-term sensitivity from the markets. We view the increased volatility and market pullbacks as a sign that we are potentially returning to more “normal” market behavior, and not necessarily as an ominous signal that the next bear market is around the corner.
During both up and down markets, our message remains consistent: focused use of both fundamental and technical analysis is the cornerstone of a sound investment strategy. At this point, we still view the overall fundamentals as being strong, albeit weakening marginally. The US economy is in excellent shape, with unemployment near all-time lows and gradual but consistent GDP growth to the tune of nearly 3% year-over-year growth for 2018, significantly higher than 2.2% for the previous five-year average. Consumer spending is growing steadily, consumer and business confidence is high, and manufacturing surveys are near record levels (by historical standards). We continue to see strong corporate profits, with consensus estimates calling for a third consecutive quarter of 20%-plus growth in earnings for S&P 500 companies, thanks to strong economic growth, tax cuts, and what has thus far been a largely muted impact from trade tariffs. Lastly, inflation has been hovering around the Fed’s long-term target of 2%.
U.S. equity valuations seem unlikely to rise much more in the face of monetary-policy tightening. However, the recent correction has brought equity prices back to historically reasonable levels that may reignite interest. A harsh October has left the S&P 500 forward price-to-earnings (P/E) multiple below its five-year average for the first time since 2012. Moreover, based on recent price action, P/E multiples have reached levels last recorded at the tail end of the 2015-16 correction in stocks.
From a technical perspective, the S&P 500 remains in a long-term uptrend, and while the market has violated some short-term support levels, the longer-term indicators are still flashing green, including the lack of a 200 day/50 day moving average crossover. At Tompkins Financial Advisors, our investment committee vigilantly monitors both fundamental and technical indicators in an effort to optimize our portfolios and introduce the right protections.
Even though we are cautiously optimistic about the markets in the near term, we do feel there are some important risks that need to be considered. Interest rates are dominating the headlines and acting as the catalyst in the current bout of market volatility. However, it is imperative to note that the Fed is raising interest rates because it is confident in the underlying strength of the US economy. Thus far, Fed Chairman Jerome Powell has continued to propagate a gradual approach to raising interest rates. The inherent risk is that an overly hawkish Fed could raise rates too quickly, causing the yield curve to invert, sending the US economy into another recession. The spread between the 2YR and 10YR treasuries has tightened in recent months, but the curve has yet to invert. Although we expect the Fed to continue its gradual approach, we will continue to monitor Fed action and any deviation from their telegraphed slow, measured approach. Trade tensions offer another potential risk capturing our attention.
We are keeping a watchful eye over several key risks that could spill over and threaten the continuation of the business cycle through 2019 and 2020. Those aforementioned risks include: the political turmoil in Brazil and Italy, US mid-term elections, Brexit, a trade war, rising US inflation, failure on China’s part to stimulate economic growth, and lastly, the inability of Europe and Japan to reignite their growth impetus. That reads like a long list of risks, but many are interconnected and we regard all of them as containable in the near term.
Our tried and true, prudent approach to managing investment portfolios is relevant now more than ever. As a firm, we believe in constructing risk-managed, globally diversified investment strategies. Our goal is to deliver consistent, risk-adjusted returns in any and all prevailing market conditions. We strongly encourage you to stay vigilant but to avoid making any impulsive moves during this latest round of volatility. At moments such as this, it is vital to remain adherent to your long-term financial plan. As always, please contact your financial advisor and portfolio manager with any questions or concerns.
Tompkins Financial Advisors
Chris Kim, Chief Investment Officer
Brian Howard, President
Tompkins Financial Advisors Investment Committee
Chris Kim, CFA®, CFP®, CMT®, Chief Investment Officer
Matthew Kelley, MBA, CFA®, Portfolio Manager
Tamer Elshourbagy, Portfolio Manager
Victor Hugo Marin, Investment Analyst & Trader
Matthew Fox, MBA, CMT®, Trader, Analyst
Allen Margolius, Portfolio Manager