Third Quarter 2018 Newsletter
VOLATILITY AND UNCERTAINTY
Volatility has returned to the market, highlighted by the two day 1400 point decline in early October. As a broker friend of mine used to explain “more sellers than buyers”. The psychology of the market changed on a dime as a combination of rising interest rate fears and China trade concerns stopped, at least temporarily, the market’s move to new highs. Historically October has been one of the most volatile months for stock market performance. This year the battle will be whether strong third quarter earnings can beat concerns of higher interest rates.
Martin Feldstein, economics professor at Harvard, former head of the National Bureau of Economic Research and top advisor to President Reagan, recently highlighted the potential impact of rising interest rates on the stock market. Feldstein posits that as the Fed keeps raising rates to historic levels the average price earnings ratio of the market will retreat to its historical levels, some 40% below the current ratio. This implies a market decline of 40% probably sometime in late 2019 or early 2020 unless the Fed reacts to slower economic growth or pressure from President Trump. It is generally understood that the Fed doesn’t stop its tightening until it has gone too far. Anticipating the timing lag effect of increased interest rates is not the easiest thing to do, so it is very possible that it will happen again. This has been a frequent enough occurrence in the past that it has become known as “three steps and a stumble”. This time there is more likely to be five or six steps (interest rate increases) and the stumble could more likely be a fall. The recently lowered forecast for world growth by the International Monetary Fund should also dampen the expectations for the US economy but that does not appear to be a concern for the Fed at this time. This is particularly unusual since the Fed Open Market Committee has projected declining growth ahead; 3.1% growth for 2018, 2.9% growth for 2019 and 2.0% growth for 2020. It is likely that history will repeat and the Fed will stumble us into to a market correction.
Looking at economic forecasts for the fourth quarter should create uncertainty. The Atlanta Fed is still projecting final 3rd quarter Gross Domestic Product to increase 3.9% in its GDPNOW forecast while the New York Fed’s Nowcast calls for only a 2.25% increase in the 4th quarter. It may be that this year marks the peak of US economic growth which should reduce some of the market enthusiasm created over the last year.
While we are concerned about the sustainability of the market’s strength at this point in the cycle, it is possible that a middle-class tax cut and unexpected Republican strength in the mid-term election could fuel a quick and dramatic market rally before the impact of the Fed action sinks in. We have been early in our caution warnings but, like the NE Patriots, the game isn’t over until it’s over. But we feel time is running out.
Our regulators are making a major issue about cybersecurity and with good cause. Every day we are bombarded with news of security failures by Google, Facebook and major retailers. Our goal is to protect that unique information that we have in our files for our clients. Account numbers, social security numbers and financial data should be protected. A recent study by the AICPA revealed that 61% of the respondents have never checked their credit report to be sure they haven’t been hacked. We are all allowed one free credit report check a year. The way to do this is to visit annualcreditreport.com on-line or call 1-877-322-8228. You won’t be able to get the report by checking with the individual credit companies, only through the annual credit report request service. Here’s hoping you find everything in order.
As many of you know, Needham Advisory has recently merged with Kimball Capital Management (KCM) and will continue to operate as Needham Advisory Corp. George Kimball, Principal of KCM has over 34 years of investment and wealth management experience. George graduated from Hamilton College, has an MBA from Duke University and is a Chartered Financial Analyst. George and I have been informally working together over the last year and find that our approach to serving our clients is very much the same. We recognize that with two qualified advisors there is much better protection for our clients should either of us be unable to perform our duties. Our regulators are always checking on our development of a succession plan for the protection of our clients. This step responds to this requirement as well as adding significantly more depth to the organization. George will be moving his operation from Lexington to our office in North Andover. We look forward to introducing you to George in the near future.
For the 3rd quarter the Dow Industrial returned 9.63%, The Russell 3000 7.13%, and the S&P 500 7.71%. For the year to date the Dow is up 8.83%, The Russell 3000 is up 10.57% and the S&P 500 is up 10.56%. The Bloomberg short Govt/Corp index is up 0.26% for the quarter and down 0.07% for the year to date.
Robert B. Needham, CFA October 19, 2018