It’s Time to Respect Risk Again
Since we left off last month, the market is still going through a “tantrum” as it adjusts to higher interest rates. During this time, investors have been harshly reminded that stocks do have risk involved after years of running higher with little resistance.
Over the past few years we have watched growth significantly outperform value. With every slight correction, investors have rushed back to the same “hot” high growth stocks. But like a child and a hot stove, eventually they will learn their lesson.
People had completely disregarded value stocks with steady cash flows as they chased big returns which seemed to be “easy money.” These companies had gone basically sideways for most of the year while the sexy growth names (i.e. Facebook, Amazon, Netflix) shot up. All this happened while fixed income rates, like bonds and CDs, remain at laughably low levels. But as we sit here at a crossroads in the market which has been a wild roller coaster, these boring lower returns don’t look so bad anymore.
his rotation from growth to value tells me there is some sanity in this market (reference newsletter) but there a few things that have me worried this time.
- There are fears that we could be toward the end of the economic cycle. We are in one of the longest expansions in US history and it can’t last forever. And the fact corporate America is likely overleveraged with the Debt to Earnings ratio at the highest level in 15 years is not helping matters.
- There is a chance we could have seen peak earnings. The argument is that US economic growth may have already peaked while higher interest rates could translate to lower stock valuations. “Markets trade on expectations and often peak well ahead of economic activity.”
- We have signs of a possible global economic slowdown. Germany and Japan’s economies shrunk in Q3 and it appears that China is starting to feel the effects of the trade war. Along with that emerging markets are also starting to feel some pain from higher US interest rates.
- There are also worries about 2019. The thought is that we have pulled ahead most of the good news from 2019 already with a stimulus that was temporary and a Fed that is raising interest rates.
Even with all this, I still don’t think we should fall off a cliff just yet. And that’s why these pullbacks can be healthy. The higher you run without a correction the harder the fall. Hence the term “soft landing”, which is what the Fed is trying to do. If you run too hot (leave rates low), inflation creeps in and the fed will be behind the eight ball then. If they tighten too much (raise rates) and they could stall the economy. That’s the tightrope they are walking. Then throw in the fact that we are at artificially low rates then that really shows the pickle the fed is in.
I still see a lot to be positive about here. The Fed may be changing their tune. They have recently made statements in which they are looking into the data and may be showing signs of slowing the pace of rate hikes. We should also be looking at one of the best Christmas shopping seasons in a while on the backs of tax stimulus and historically low unemployment. But the real catalyst could come when Trump meets with President Xi later this month at the G-20 meeting and I am very optimistic that these two could make a deal.
In addition, the recent selloff has knocked most of the tech darlings back down to reasonable levels as they have sold off over 20%. (link on tech correction). So if you missed out on them before, now you have the opportunity to pick them up for a very nice discount to where they were trading just a short time ago.
In conclusion, I’m still cautious right here as the market continues looking for a bottom. I want to see investors start to nibble at some of the names that have been really beaten up. This would signal that investors see value and could set up the beginning of a consolidation process. I’d also love to see us kick off Black Friday with a bang and see signs of strong consumer and underlying economy. Finally, if Powell has “blinked” and slows the pace of rates, the market could see that as a positive giving us another potential bullish catalyst. However one can’t help but feel that this correction feels different.
Stay tuned to see if a Santa Claus rally is in the cards or if investors will get a lump of coal in their stocking.
Have a Happy Thanksgiving!
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Clint Kirby – Chief Financial Strategist
DreamWork Financial Group
Clint Kirby, DreamWork Financial Group, is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.