Commentary
Happy New Year !!!
Hard to believe we are closing in on the end of the decade (730 days and counting), but as 2018 emerges we are approaching the 20’s at warp speed, which begs the question: Will we see a repeat of the Roaring 20’s from a century ago? If we do, life will get most interesting indeed. A quick history lesson is in order, just to freshen our memories: Things were sailing along (Just like today, I might add) when all of a sudden, October, 1929 came about and started ‘The Great Depression’. Now I am not saying we are headed down that path, but we are coming off ‘The Great Recession’ not even 10 years ago, which resulted in ultra-low interest rates/hyper-loose monetary policy, thereby driving up risk assets (read: Stocks, Real Estate, Bitcoin, etc…) to record high prices and an ever growing public sense of being bullet proof to anything that can cause the party to end or dare I say, crash.
Many people forget that economic cycles have and do occur which means that prices go up, can and do in fact, come down. A multi-decade bull market in bonds (1981-2017) has fed the stock market’s insatiable appetite, leading to new heights of prosperity for many Americans, as household wealth creation soars. However, debt on a personal and corporate has expanded exponentially as well, resulting in greater leverage than ever before. But as long as you have a chair when the music stops…
Here are some major bullet points to consider for 2018:
• Rising Interest Rates will eventually lead to competition for stocks.
• Volatility will reappear.
• Federal Reserve and the Great Unwinding (A closet interest rate increase)
• Political Uncertainty as the year unfolds: Rampant, if Democrats take control of Congress.
• Bifurcated Goals for Investors: Growth-very long term; Income-ever increasing retired public.
• Municipal Landmines: Pension & Health Care Obligations – Spur changes to equalize everyone and stop the open ended financial liability.
• International Opportunities, better than Domestic.
• Tax Reform ambiguity.
As always, there are many issues to ponder, as we start a new year and 2018 is no different. Some are tertiary in nature, which can become front burner issues, in their own right, given the right circumstances. I am speaking of the recent tax reform (especially on the State level), bifurcated goals for investors, increased volatility in the face of rising interest rates, municipal landmines and greater investment opportunity internationally, than domestically. But individually, do not hold the weight and/or command the attention that my two major flashpoint issues do.
Let’s begin with the Federal Reserve. I sincerely hope they could be a non-factor some year, but given a new Chairman, synchronized global economies on the upswing and the implementation of the Great Unwinding bears very close watching. Considering QE1, QE2, Q3, TARP, ZIRP, etc., had never been used before, we really don’t know how the draining of $ 4 trillion dollars is going to affect anything, let alone the economy. Previous history is not encouraging simply because the Fed tends to overshoot all the time, be it tightening or loosening monetary policy. Suddenly, you are asking the government to be efficient and “get it right”…?!?!?! That’s a huge ask, to say the least, however we can still dream, right? Problem is, this is not just a 2018 issue, but multi-year, so we may not know a successful outcome for quite awhile, while we will probably understand a negative result more quickly. Yes, the Federal Reserve wants to raise interest rates 2-3 times this year, but are you aware that by selling securities, the Fed is draining liquidity and is a de facto interest rate increase?!? This is classic Econ 101, which we have not had to use for a few decades (try 3 ½), so it is time to dust off this particular textbook and causal effects. Although we can “hope for the best, we really should prepare for a less than the best” outcome. I am not trying to be Debbie Downer here, but this has never been done before. We are the petri dish, real time experiment and while we have the smartest people in the room, theoretically, and corporate earnings will be better because of tax reform, last I knew, the federal debt was at $ 21 trillion and growing. Add in those rising interest rates combined with much narrower stock leadership and the risk is climbing…
The second and potentially more impactful event are the 2018 midterm elections: Should the Democrats regain control of the House and/or Senate, how will the market react? In the past, gridlock has been good. Question is, will it be so this time around? I am not convinced it will be, given the peeling back of many government regulations, the animal spirits of tax reform, at least on the corporate side and general optimism, that has been accomplished since November, 2016. Love or hate, President Trump has energized business confidence which has fed into the record stock market run and made personal balance sheets quite buoyant. Should the script flip in November, will reforms and confidence grind to a halt?!? If so, the wealth effect, currently in vogue, will recede for certain and with one too many nudges from the Federal Reserve, tipping into a slowdown is guaranteed, whereas a recession is not out of the question. Slowdowns equate to equity pullbacks, period.
Thus, where does one invest in 2018? International equity markets (ex-US) which are more favorable than domestic based on historical valuations and shorter term bonds, high-grade corporates and good, old stodgy CD’s. I know that sounds boring, is not sexy, but given the investment euphoria, since March 6, 2008 (S&P low of 666), one should be focused on capital preservation or at the very least, minimal capital depletion. Europe is still providing easy money, albeit less, and most economies are just starting to emerge from the Southern Euopean flu, which plagued everyone for most of this decade. Stocks are reasonably priced and offer global diversification, whereas bonds offer a fixed maturity date, repayment of principal and if you stay within 1-3 years, you can participate in the rising interest rate environment, through prudent laddering. Throw in select Municipal Bonds, which are in favor as a way NOT to increase your AGI, come tax time, and that is 2018 in a nutshell, or almost in a nutshell.
As I have noted in many client meetings, one thing we are not is complacent. Risks are elevated and volatility is coming back; Add political election uncertainty and 2018 will be challenging on many fronts. Gains in all types of assets have been breathtakingly easy, but if fundamentals matter (and they should), regression to the mean is a phrase you may become familiar with. Let’s see how it goes…
All The Best…
