What Do Investors See?
As we round third base and head for home in 2018, the current market climate reminds me of those Magic Eye books that featured page after page of autostereograms. Autostereograms are 2D patterns that, if you look at them in the right way and for long enough, allow you to see a 3D image.
But not everyone can see the hidden image in autostereograms. I’m one of those people. All I ever see is all the random colors repeated across the pattern, which distract me from seeing the real image.
Investors seem to be faced with the same problem of late when it comes to the market. Various surrounding images capture investors’ attention and distract them from what’s truly important. These distractions prevent investors from focusing on the important market fundamentals.
Let’s take a look at some of these pictures that could tempt you from your strategic investment course if you’re not careful.
The Political Merry-Go-Round
The nomination and recent confirmation of Brett Kavanaugh as a Supreme Court justice has been a persistent headline recently. While the nomination has been a polarizing one, the outcome and effect of this decision should be felt much more politically than economically in the U.S.
Investors are also beginning to turn their attention to mid-term elections in early November. Democrats could take back either the House or the Senate, and have an outside chance of winning both sides of Congress. We certainly expect to see heightened market volatility leading up to the election given the uncertainty of the outcome, similar to what occurred two years ago leading up to the presidential election.
But we caution investors against making any knee-jerk reactions with their portfolio leading up to midterms. Since 1950, the S&P 500 index has averaged a return of more than 13% in the 12 months that followed midterm elections. Furthermore, the S&P 500 index has never had a negative return in the year that followed midterm elections since 1950.1
Why have markets performed so well following midterm elections? History suggests that the certainty created by the outcome of elections, since we’ll know who will be in office, combined with a potentially more productive Congress could be reasons for market optimism . Still, we caution investors against making any speculative investment decisions, whether they be driven by optimism or pessimism.
Rising Interest Rates
Another current distraction for some investors is the fact that the Federal Reserve raised its key interest rate to 2.25% in September. This is its highest level since 2008 and the third such rate hike in 2018.
The rise in interest rates caused some consternation among some investors who fear that higher inflation and interest rates will soon cutoff the economic growth engine in the U.S. and kill the bull market in stocks.
It’s important to view these rate increases within context. The Fed has been raising rates because low unemployment rates and consumers with more money in their pockets have produced an accelerating economy that continues to gain momentum. It’s the Fed’s job to make sure the economy doesn’t overheat due to runaway inflation.
The rate increases by the Fed are being driven by a strong economy (a good thing!) with the hopes of prolonging this economic expansion for as long as possible. While we expect interest rates to eventually reach a level that negatively impacts economic growth at some point in the future, we’re not near those interest rate levels if past market cycles are any indication.
Tariffs & Trade Agreements
Finally, we’ve seen the U.S.’s trade relationships garner a lot of attention as investors keep a close eye on our trading partnerships. Some investors feel concerned that tariffs could slow both domestic and global growth. The recent trade agreement between Canada, Mexico, and the U.S. should ease the anxiety of those investors concerned about the effects of tariffs for several reasons:
First, the U.S.’s total trade with Canada and Mexico is nearly double that of China year-to-date through July.2 Second, the agreement may also serve an additional benefit of putting pressure on China to return to the negotiating table following an agreement that should unify North America.
Ultimately, trade with China represents a very small fraction of U.S. GDP. Given that roughly 70% of the U.S. economy is driven by consumer spending, we suggest focusing more attention on the health of the consumer than the current trade dispute with China.
What’s the Image in the Background?
With all of these distractions in the foreground view of investors, it’s no surprise that it can be difficult to see the market’s “3D image” in the background.
What lurks behind the market distractions is a powerful image of an economy that experienced GDP growth above 4% in the second quarter for the first time since 2014. This economic strength is bolstered by an unemployment rate below 4%, wage growth at its highest level since 2009, and a relatively low interest rate environment.
Seeing the 3D Image
The foreground headline images of Supreme Court nominations, midterm elections, interest rates, and tariffs can be blinding even to a disciplined investor. While we expect these distractions to provide some ongoing volatility to the market, we urge investors to look a little closer instead of feeling tempted to make speculative moves.
If you can disregard what are likely little more than market distractions, you should like what you see. When you consider the solid fundamentals of economic and earnings growth underpinning this bull market combined with interest rates that remain low from a historical perspective, it’s a recipe that should bode well for this economic expansion to continue.
Sources: 1 Morningstar, 2 https://www.census.gov/foreign-trade/statistics/highlights/toppartners.html