The New Year greets us with the sobering reality that the financial markets have declined around the world. The Federal Reserve has reduced monetary reserves over the past eighteen months leading to a less accommodative money supply growth. The animal spirits of extraordinary high money supply growth from 2009 through 2016 have disappeared.
All market indices dropped +10% for the month of December, 2018. Short-term interest rates have been raised 7 times since 2016. Fed policy indicates it intends to raise rates twice in 2019, but will base that on economic data. We believe that the Fed has already gone too far and should rest from further tightening.
In 1929, the Fed Chairman Roy A. Young decided to raise rates and drop money supply over 30% in three years as a response to the Great Crash of 1929. With very little experience, the Fed made an error in its policy leading to the Great Depression. Hopefully, Chairman Jerome Powell will reverse course and not raise rates further.
Current U.S. Treasury Bond Yields:
1 Year 2.61%
3 Year 2.50%
5 Year 2.55%
10 Year 2.72%
30 Year 3.03%
In response to the U.S. stock market decline, the silver lining for the financial markets is that yields on bonds have actually dropped in the past six weeks. Longer maturity bonds have declined significantly as the 10 year yield dropped below 3% having traded above 3 percent during the first half of 2018. The short end of the curve is inverted which suggests a minor recession is around the corner.
In 1987, the financial markets were tested yet the banks were able to negotiate the market collapse. We did have several investment banks that eventually went out of business including Drexel Burnham, Kidder Peabody and Prudential Bache. In 2008/2009, the fully deregulated banks were all in trouble. Essentially, the financial markets screeched to a halt as banks were caught with no capital. At present, we do not believe that any banks are in trouble. Should the financial markets drop further it will present a clear and present danger to the nine banks that are too big to fail.
All industries in the S&P 500 dropped in December. Previous market declines in 1987 and 2009 were quick and furious. This more recent decline was a steady daily drop essentially that began after Labor Day, 2018. The high-frequency trading platforms employed by private equity firms and hedge funds exacerbated daily volatility in stock prices. The powerful drop in the market suggests that either an economic slow-down or recession will occur in 2019. Great debate is occurring by leading market strategists arguing both sides of the fence. Recessions are defined as two successive GDP growth either being flat or declining. The latest quarterly GDP growth was up 2.7%.
According to the Wall Street Journal, net inflows for U.S. mutual and exchange-traded funds in the first 11 months of the year fell to $237 billion, according to new estimates compiled by research firm Morningstar. That was down 62% from the year-ago period, the steepest decline since 2008. Asset managers attracted a record $629.5 billion in net flows during the same period in 2017, a boom year for the industry. The five largest growth stocks which include Apple Computer, Amazon, Google, Facebook and Microsoft all declined since Labor Day.
Today we believe the decline is a welcomed entry point to buy good companies at a reasonable valuation. Investment positions held on a long term basis remain with good capital gains. More recently the dividend paying stocks have fared better than non-dividend stocks. Reflecting back on the severe market declines in the past, time has rewarded those who remained invested.
We look forward to the New Year. We believe the markets will recover as corporate earnings continue to be reasonably good. We will focus on companies that continue their corporate stock repurchase programs, insider buying, and competitive advantages in the market place.
We welcome the opportunity to meet with you in the coming months and consider it an honor to manage your assets.
Russell L. Robinson
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027