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The Good, The Bad and The Money

September 12, 2018

Fun Fact Number One: On December 29, 1967 the epic film “The Good, The Bad, and The Ugly” was released. Although the film received some negative pushback upon release, it is still considered to be one of the best films of its time. The film grossed over $25 million at the box office. In today’s dollars that would be a whopping $189,805,031.45. So why is this important? August 22nd marked a historic day in the history of the stock market. The current bull-run has now surpassed 3,453 days while generating over 400% total return to investors. This is essential as trade wars with China increase and the ability to obtain capital is shrinking.

 

So where do we go from here? Is there time to still capitalize on this bull market or has it run its course? The real answer is no one really knows. Investor sentiments towards a rewarding market can change at the drop of a dime. It is essential to understand the great impact of an impending market correction that most investors fear is near. The S&P up over 8 percent YTD and the Russell up over 13% YTD shows that there is still strength in the markets especially in small cap growth companies.

Let’s take a different look at this. As we can see the stock market has been on an incredible uptick and frankly hasn’t looked back since the earlier part of 2009. So let’s discuss The Good, The Bad and The Money.

 

The Good

 

Since March of 2009 the market has been increasingly gaining growth and really hasn’t looked back since then. According to the Conference Board’s index, consumer confidence rose to hit 133.4 in August marking an all-time high since 2000. This number is important as many economists look to this number to gauge consumer confidence in the market. Furthermore, the survey measures American sentiment on current economic conditions and prospects for the next six months, including business and labor market conditions. Since consumer spending accounts for about 70 percent of U.S. economic activity, economists pay close attention to the number.

 

"Expectations, which had declined in June and July, bounced back in August and continue to suggest solid economic growth for the remainder of 2018," Lynn Franco, director of Economic Indicators at The Conference Board, said in a statement.

 

If you are an investor who invested in the market at the start of 2009 you are probably enjoying a nice 400 plus percentage of growth in your portfolio. Since the early 1930’s we have experienced 4 bull markets that lasted over 10 years with an average total return of about 853 percent and an average annualized return of 18 percent. As stated above we have already surpassed this data and are trending to be in the 500 plus percent range spanning over more than 3,400 days.

 

What could this mean for the average investor? If the average investor holds a portion of their portfolio in the market, their portfolio could grow significantly over time. This of course, requires patience, time and tolerance. The rule of thumb in the market place has long been 7 to 10. Essentially this means that your portfolio can grow on average 7% for 7 years out of 10, with 3 years of potentially negative growth in the market (also known as a bear market). Now keep in mind that over the past century, the chance of the market going up or down on any given day has been equivalent to the flip of a coin. With that said, over the long run, investors are much more likely to experience a positive return, with rolling 10- and 15-year returns positive 84% and 88% of the time, respectively. More impressively, this sample includes 18 recessions and the pre-WWII era, when it took the market 25 years to reach its 1929 peak (as stated by JP Morgan Asset Management).

 

With this in mind, how should one move their investible assets? I tend to think that most investors are moderate investors at heart. This lends to the idea that a moderate investor should have his assets mixed between stocks and bonds. If an investor invested $10,000 in the equity portion of his portfolio back in January of 2008 and left those funds in the account it would be worth $17,400 today. That’s a compound annual rate of return of 5.7% and a total return of 74%. Nice right? That’s what is good about the market today. One could have substantial growth in their portfolio if they steady the course and follow their plan.

 

The Bad

 

For investors who are risk adverse, they are missing out on such an opportunity to grow their assets. Many risk adverse investors are still emotionally hurt (and in some cases financially hurt) from the 2008 market crash and great recession. They fear that the market could crash yet again, and they could lose a significant portion of their portfolio in a short period of time. While past performance is no guarantee of future results, an investor must be aware of the potential drawbacks of not investing in the market.

 

Think of it this way. The risk adverse investor seeks investment choices that either guarantee a specific return or their money is held in cash, cash equivalents and bank CDs. In July of 1984 your local bank CDs paid an interest rate of about 11.27%/12.06% for a 1 year and 5 year CD respectively. While those rates were phenomenal, one must understand that during the same time period, mortgage rates were at an all-time high of over 18%. Additionally, the rate of inflation (a general increase in prices and fall in the purchasing value of money) was at about 5.5% for the decade of the 80s. So the growth from your CD was effectively going towards the payment of your high mortgage rate and the increased cost of goods. As we evaluate this more closely we see that the interest rates on mortgages today have gradually increased from record lows of around 2.75%, just a few years ago to 4.25% currently. This lends to the idea that if mortgage rates are low and S&P is up over 8% Year over Year, then the opportunity to jump in is at hand. But is it really?

 

According to a Forbes article written in the earlier part of the second quarter; many individual investors are anticipating continued volatility and/or think that the current political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment, but not all. We’ll discuss trade policy in the next section. For now let’s focus our attention to interest rates and its importance.

 

While many individual investors either approve of the recent interest rate hike or don’t expect it to affect the stock market, some are concerned about the impact that rising rates will have. When the FOMC raise interest rates they are essentially trying to slow the market down. This works in two ways: One way is the interest rates that are typically charged for loans and other lending products increase, thus making it more expensive to obtain traditional financing. The other major way an increase in taxes works is that it reduces the amount of money consumers spend as products are more expensive.

 

As mentioned before, the great recession of 2008 can be a great example of how this concept works. If you recall, the FOMC reduced the interest rates back in 2008 down to zero. Doing this essentially, made it less expensive for consumers to make purchases because it was not so expensive. In fact, them keeping the interest rate at zero started a chain of events that allowed for the American people to somewhat get back on their feet. Now that we are in a booming market we can see the FOMC making adjustments to the interest rates to slow down the spending of the consumer. With that said investors should take advantage of the rates that being made available today as the Fed has already committed to raising the rates a few more times this year.

 

Fun Fact Number Two: You may or may not know this, but banks don’t just lend to consumers and commercial companies. They also lend money to one another. To accomplish this banks charge each other a special rate to borrow money from each other. At the end of each day banks has to hold a certain amount of capital on hand in reserves. These reserves amounts fluctuate all throughout the day because of the spending habits of consumers and businesses. Now because the balances fluctuate, banks may need to borrow overnight to meet the minimum capital requirement. The rate they charge each other is called “The Federal Funds Rate”. This rate is essentially the rate the FOMC are trying to influence when rates are either raised or reduced.

 

So what about the current economy? With interest rates rising and the uncertainty of the future, if an investor stays risk adverse and keeps their money in cash, CDs etc. they could potentially find themselves in a situation where the rate of inflation is outpacing their investment growth. The current estimated rate of inflation in the United States is 1.9 percent. With that being said, a conservative investor would have to earn at least 2 percent or better on their cash holdings. As I stated before, investors should analyze all investment options before jumping out of the market. The market provides for growth in your portfolio and CDs and bonds are more for stability. However, in this current environment time will tell the direction the markets will go.

 

The Money

 

So we can see that investor sentiment in the coming quarters many prove to be disparaging. Trade wars with China are increasingly becoming a major concern of United States businesses. This trade war, which is arguably the biggest trade war in modern economic history, may change the way countries enter into agreements where trade is concerned. Automakers and manufacturers stand to be among the most affected by these tariffs. There are great concerns for trade wars and tariffs being assessed to our foreign allies. We have seen this before. During the time of the great depression several tariff conversations erupted and two major Acts passed both the Senate and the House. Those two Acts were the Smoot-Hawley Tariff Act passed in 1930 and the Fordney-McCumber Act which was passed in 1929. The Smoot-Hawley Tariff Act which was preceded by the Fordney-McCumber Act, passed in 1922, was a bill perceived as both punitive and protectionist, raising the average import tax to 40%.

 

It’s worth noting quickly the ideology of protectionism. Protectionism is the economic policy of restricting imports from other countries through methods such as tariffs on imported goods, import quotas, and a variety of other government regulations. There seems to be a consensus among economists that protectionism has a negative effect on economic growth and economic welfare, while free trade, deregulation, and the reduction of trade barriers has a positive effect on economic growth. But I digress…

 

The Fordney-McCumber Act incited retaliation from European governments, but that did little to hinder American success. The Smoot-Hawley Act was essentially created to provide revenue, to regulate commerce with foreign countries, to encourage the industries of the United States, to protect American labor, and for other purposes. Both Representative Hawley and Senator Smoot argued that the drastic increase of tariffs on foreign imports would subsequently increase the sales of American products. They felt that this would be true as the cost of goods would go down. As the Act went through the process of being approved, many additional tariffs were added, most notably, to certain imports. Consequently, this act did not accomplish many of the goals it set out to achieve. In fact, the act raised tariffs on over 20,000 imported goods. This act did not protect nor did it help the American people or economy. Other countries began to assess and increase tariffs on United States goods, which caused the prices of certain goods to increase. In fact, after Smoot-Hawley’s passage, specific countries like Canada and Italy retaliated in kind with their very own punitive tariffs on American goods.

 

This set off a domino effect of trade wars across the globe that resulted in a 66 percent decline in total world trade from 1929 to 1934. The Act took nearly 60 years to dismantle, correct update and change. So why is it important to understand this act and its historical relevance? Well if one would take a look at this economy and the current conditions of this administration, we are potentially headed in the same direction. The proposed and now enacted tariffs imposed on China are gearing up to be one of the largest and most controversial tariffs in our history. In early August, the United States started to collect an additional 25 percent duties on 279 Chinese import products. China subsequently imposed their own Tariffs on soy beans which resulted in fresh tariffs on $16 billion worth of additional imports from the U.S. including fuel, steel products, autos and medical equipment. The levies took effect at the same time that the United States tariffs were imposed. Actions like these will only result in feud, frustration, misunderstanding and a loss of money.

 

You may ask why I spent time writing about the tariff situation affecting the United States, China and other nations abroad. Well hopefully this answer suffices: When there are increases in tariffs, companies have to change their way of operation. There’s typically an increase on the cost on certain items and goods, which in turn affects the consumers. American families are just starting to rebound and see sustainable growth. The trade war could end up costing the United States many of the things we have worked hard to secure. Overall, time will tell how these new tariffs will affect the United States.
 

Conclusion

 

The ugly truth is that this could all blow up. I mean tomorrow isn’t promised, nor is the stock market promised to continue to break earnings records. So if you are a person who likes to do research and obtain probabilities, here’s one for you: Over the past 100 years the US economy has only seen 2-3 major market corrections; the Great Depression and most recently, the Great Recession. This tells me that there is less than a 3-4% chance of a huge market correction taking place in the near future. Now, we might see dips in the market, like October 2016, but nothing more than that.

 

Whether the bull market ends tomorrow or continues on for the next three years remains to be seen, but investors can take solace in the fact that a long-term investment approach has historically worked in their favor. As long as you steady the course and do not deviate from your goals, I think you will be just fine.

 

Written By: Terrell Wilson, Financial Contributor

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