Kevin: Greetings. August 7th, 2019 market update. A little bit of a fun in the last week John?
John: Volatility is back. We saw it in May, we’re seeing it again now in reaction to the latest news from tariffs and our trade relationship with China.
Kevin: So the market’s down about 6% from the peaks over the last week. We had a similar kind of a decline in May, correct?
Kevin: Mostly related to tariffs in the China dispute. You know, just to put things in context , I mean the market being down 19% fourth quarter of 2018, we had a nice run up and through July of 20% or so. Volatility is back. Volatility normally comes from uncertainty. Correct?
John: Right, right. And there is always going to be uncertainty, but markets tend to overreact. But it seems like the backdrop now is a little bit more, I would say cautious, look what the Fed did cutting interest rates and that was an “insurance measure” on their part to help sustain the expansion in the U.S.
Kevin: So the bond market, if we turn to that for a second, you have another decline in the 10 year treasury. You have short-term rates in some circumstances being below the longer term rates. Oftentimes they say that’s a predictor of recession, but a lot of that might have to do with currency flows, and negative interest rates in Europe, and money trying to find a place where it’s getting a positive yield.
John: Well, I also think it’s a “fear trade” as well. I mean there’s a flight to quality that drives bond prices up and yields down, so we’re definitely seeing that now too.
Kevin: Well you put that all together and you say, where are we at in terms of the economy in terms of earnings?
John: Well, we’re looking for a 2% of real growth in the U.S., which is subpar, but earnings were great last year related to the tax cuts. So now we’re seeing year over year quarterly earnings on the S&P 500 maybe down 1%.
Kevin: The market seems to be digesting that reasonably well in terms of understanding that comparison.
Kevin: So we’re still really in the range of long-term PE ratios if you feel that the earnings are sustainable. Just putting it all together is there is a heightened risk, there is uncertainty. You’ve got things like Brexit. You have the economy having a prolonged expansion here, which people keep thinking it’s going to end ultimately. But there doesn’t seem to be any egregious signs of excess, but there’s areas of concern or uncertainty which cause more volatility. And like we said before, in line with your overall objectives, it’s a reasonable time to be reducing risk if you feel appropriate according to your needs.
John: Well, there’s also the backdrop of a slowdown in global growth, China in particular, so markets are watching that situation very closely. But I think businesses, business sentiment is also waiting to see how this is all going to play out before they make additional investments.
Kevin: Right. So it’s like cautious and patient kind of a sentiment, really.
John: Yeah. Well, there are good things happening. Of course unemployment is very low. We have more people participating in the job market in the U.S. That’s a backward looking indicator, but still pretty healthy. So we’ve got some good signs still out there that may be supportive of the market going forward, but certainly these clouds are beginning to develop.
Kevin: Well then you got to go back. So the market will decline at some point in time for some reason, you know? The last one we had was over a 50% decline in 2007. It took five years and change for it to get back to its peak. Hopefully we’re not looking at something like that. I don’t think the comparisons really ring true in terms of the amount of leverage and debt in the system. But, as long-term investors, going back to our earlier point, is to be aligned with what you need to do. Have the appropriate risk on the table, any appropriate risk off. This kind of thing is going to be a discussion we’re going to have on an ongoing basis for the rest of our careers, anyway. Until next time, enjoy.