For the four months ending April 30th, the S&P 500 ended with a small decline of -.96%. Coming off of a 20% return in 2018, if one were just now checking the headlines it may all make sense.  However, for those of us who observe the markets more frequently, we know the ride has been nothing short of mundane.

 

We entered the year with a jubilant, yet unsustainable, start. There isn’t a person among us who didn’t -for a second -think the day was coming when 12 consecutive months of higher stock prices and double digit returns would end. Now that it is upon us, I think it’s critical that we understand exactly what’s happening and approach the markets with a rational and steady hand.

 

First off, I believe it’s important to understand that the anomaly isn’t the current state of affairs, but rather, it was the 12 months leading up to this. Volatility and swings in the stock market are commonplace; and, unfortunately, investors have grown accustomed to slow and steady returns day in and day out. Sadly, there is no such thing and, more often than not, the stock market will take 3 steps forward and 2 steps back leading to volatility much like we’re seeing today.

 

The cause of these steps will always vary with the season. Today, for instance, the volatility in the markets is being caused by the financial war in which we find ourselves with China. I stress the term ‘financial’ since it emcompasses all that I believe to be happening on both sides. While the U.S. is busy imposing tariffs on our largest import partner, China is busy selling U.S. Treasury bonds and buying U.S. dollars. This is precisely why the 10-year treasury has increased to 3% from 2.4% to start the year, and the Dollar spot index has risen from under $90 to over $92.45


Why does the stock market care about this, you ask? Well, it’s really quite simple. As our interest rates go up borrowing costs increase which impact the expenses for corporations who hold debt. As expenses rise, profitability decreases and hinders growth and stock valuations. Like gas prices, steady rises over time are easier to handle and plan for, but sharp moves such as the one we’ve seen recently spark shock waves that make investors very nervous. In addition to this being a headwind for corporate finance, it has also translated to a bond route which has seen prices erode at a steady pace. This is why it is so critical that your bond positions have maturity dates while the volatility in the bond market has been wild.  Knowing when your fixed income actually matures is essential.

 

On the currency front, the sharp rise in the dollar also impacts corporate profits, and this is another head wind for stocks. Because most of our domestic companies sell abroad, it is a matter of currency risk when they bring this money back. Take Europe for instance.  Let’s say that a U.S. company makes a widget and sells this in France. At the time of the sale, the exchange rate is $1 for .95 Euro. The widget sells in Paris for 10 Euro and when the money is sent back to the U.S. it is converted in to $9.50 U.S. dollars. Now, let’s say that a few weeks go by and the dollar has STRENGTHENED against the Euro. The exchange rate is now $1 for .85 Euro. The same widget is for sale in Europe for 10 Euro; however, when it is converted back to U.S. dollars it is worth only $8.50. While nothing has changed with regards to the input costs, the sale’s price or even the price tag in Euros, due to the fluctuation in base currency,  the U.S. company has made less money.

 

Now that we understand the headwinds, the big question is, what happens next? Is this the start of the next big bear market or just a pullback that will, in hindsight, be viewed as yet another great buying opportunity? My experience and gut says the later; however, I’ve learned through 20 years of experience that empirical evidence is needed before any thesis can be tested.

At this point in time, our portfolios remain well positioned. A typical 70/30 moderately aggressive portfolio has nearly 20% in cash and short term treasuries. This is in addition to the approximate 22% invested in fixed income. Approximately 50% is invested in equities while just under 10% is held in our alternative asset class, Gold. Each equity position held is still above respective stop levels, and every single position, thus far, has reported excellent quarterly earnings and their businesses remain very healthy despite the tricky business environment.

 

While I can pontificate about what I believe will happen, I take comfort in the fact that we’re approaching this tape with three key disciplines:

 

1.) We’re already conservatively allocated, being less exposed to stocks than our targeted allocation suggests. This cash can be used for buying securities as they go on sale.

 

2.) We hold Gold as part of our equity allocation as a hedge against inflation and other potential unforeseen market / currency concerns.

 

3.) Each equity position we hold has a level by which we would exit and move on. So far, none of our current positions are close to being stopped out. We hold great companies run by excellent managers. They are compounding their book value; and, regardless of where the market may price them in the short term, these are businesses I hope to own for a very, very long time.

 

If you find yourself overly concerned about this market, despite the steps we’re taking, maybe we need to sit down and revisit your exposure or allocation levels. It is of critical importance that you are able to stomach the normal ups and downs of the market in order to capture the upside when the clouds clear.

 

As a side note, while I’m not sure how long my popularity will last, the media has been particularly interested in my thoughts of late. Last week I had the opportunity again to sit with the fine folks from Bloomberg to give what ended up being a very lengthy and meaty interview. I encourage you to watch that clip below. As always, we appreciate your faith and trust in us and we look forward to continuing to serve you.

Until next time

~ Quint

 

Joule Financial, Tatro Capital is a fee-only fiduciary adviser helping individuals, families and businesses set and attain financial goals.