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November 2018 NewsletterSubmitted by McCay Wealth Advisory on November 2nd, 2018
“The brave man is not he who does not feel afraid, but he who conquers that fear” -Nelson Mandela
For investors, 2018 has been a volatile year marked by several significant geopolitical events and some significant economic policy changes that have led to increased investment volatility. As of Friday, October 28th, 2018, 80% of investment asset classes were negative for 2018 which has led many people to question the benefits of diversification for 2018. Although the S&P500 around a month ago experienced frequent highs; the global economic backdrop has not been as kind in 2018. The Federal Reserve’s aggressive interest rate strategy combined with several geopolitical events have masked the incredible strength of the S&P500 earnings and US economic growth.
From the onset of the 2008 Financial Crisis the Federal Reserve has supported economic growth through aggressive use of monetary stimulus and low interest rates. With US economic growth averaging 3.4% to 4.4% in 2018 upon initial readings, unemployment falling to 3.7%2, and inflation hitting 2.33% the Federal Reserve seems set on “normalizing” their policies to pre-2008 to 2018 philosophies. In short, this means raising interest rates and selling bonds they have purchased to reduce interest rates. Investments are valued based on the opportunity in the beholder and when interest rates rise some investors will see a greater opportunity in these investments. From a valuation perspective though the S&P500 trades at 15.5x4 Forward earnings (6.45% return), currently has a 1.94% dividend, and some estimate share buy backs this year to exceed 4% of the S&P500 value. So, for comparison sake the 10-year treasury is paying 3.108%5 and the S&P500 Total return should be around 12.39% for 2018. Clearly, interest rate increases offer future opportunity; however, valuations are not that close currently.
“In politics stupidity is not a handicap”- Napoleon Bonaparte. No matter who the President or which party is represented; it is very unlikely that they will ever mow your grass for you or drive you to work. It is the everyday worker that gets the job done and not the greatest orator. The year 2018 has been marked by economic tariffs and the rewriting of significant trade deals as well as an Italian Government that does not like budgets, the rise of Populist Governments Globally, and the typical unnecessary wars that are so common in human history. On the plus side, the NAFTA trade agreement has been renamed but is largely intact. South Korea and the United States have a new trade agreement; however, the USA, Europe, Japan, and China are not done yet. As with the two previous agreements the worst fears were never realized and at the end of the day the interconnectedness of the global economy lead to a compromise to avoid the failure of all. It is likely that eventually these other countries will come to the same conclusion that Mexico, Canada, and South Korea came to. Populist governments continue to win national elections and these candidates often want to make radical changes, but “he who holds the gold makes the rules” and rarely are significant changes being actually implemented.
The geopolitical nature of 2018 seems to resemble 2011 in my opinion, and eventually investors started ignoring the noise and started focusing on economic opportunity as we saw in 2012 and 2013. Interestingly, much of the profit growth realized in these years was actually earned in 2011; therefore, it definitely paid to be patient then.
“Be strong in body, clean in mind, lofty in ideals” -James Naismith. With Economic growth ranging between 3% and 4%, unemployment at 3.7%2, and inflation at around 2.33% it is hard to argue that current economic conditions do not show incredible strength. The question as always is how long will this continue or is there a shadow out there somewhere? With 48%4 of companies reporting earnings as of Friday October 26th 77%4 of companies have had positive earnings surprises and the blended earnings growth rate shows a 22.5%4 profit growth from last year. The future or forward expected Price of Stocks divided by earnings per share is 15.5 or 6% below the 5 year average for stocks. So what gives? If US companies are performing so strongly then why are equity markets in the US basically flat for the year? Quite simply, it is a result of a fear of what the future could hold, and in my opinion, a lot of people think the 2008 economic drop was so bad that we all are just obsessed on when it will happen again. Long Term investors and retirees should focus on the fundamentals and their financial plan since fundamentally the economic picture is strong. Consider the long term as the economic picture for the world continues to grow. Billions of people enter a capitalist economy where they can have things like electricity, cars, and the ability to travel! From Vietnam to Poland this is happening in a way few people thought possible in 1980.
“What we learn from history is that people don’t learn from history” – Warren Buffett. Investing is not an easy task, but it can be a very rewarding one. Sticking with a Long-Term diversified plan is a proven strategy to recognize significant returns with reduced volatility; it is not perfect, but we feel like it is the best option for long term investors. As always if you have any concerns or questions please do not hesitate to contact me at 931.728.2130, 931.474.2130, or at Brent@mccaywealth.com. Thank you for the opportunity to work with your Family.
Brent Alan McCay
Chief Executive Officer & Managing Principal
1. )Bloomberg.com update on market values on 10/26/2018 at around 1pm.
3.) CPI Home: U.S. Bureau of Labor Statistics.
4.) S&P500 Fact Set from 10/26/2018 page 1.
5.) CNBC Market Data from 10/29/19 at 9:13am.