Argent Quarterly Investment Commentary – October 2018
“If you know how the journey is going to end,
you can afford to be patient along the path.”
– Joseph Ellis, Historian
The question we most frequently hear is, “How much longer can this bull market for stocks last?” It is a fair one to ask. Using the S&P 500® Index as a measure, this rally matches its longest run in history, with U.S. stock prices quadrupling since their March 9, 2009, lows. That stretch continued in the third quarter – the best quarter since 2013 – with the S&P 500 Index up 7.5 percent, buoyed by strong corporate earnings.
The truth is that expansions do not die from old age. Expansions most often die from central bank tightening following credit expansion, significant inflationary pressures or unexpected geopolitical events. Our central bank, the Federal Reserve, is slowly increasing interest rates, but at a very measured pace and from record-low levels. As to inflation, there are some signs of it, but nowhere near the levels that have caused previous slowdowns. Finally, geopolitical events, such as that which occurred September 11, 2001, are almost impossible to predict.
That being said, it is interesting to review what was happening a decade ago, just prior to the start of this long expansion, as it has been almost exactly ten years since the September 15, 2008, Lehman Brothers bankruptcy. Within just a few weeks, Merrill Lynch had been sold to Bank of America, AIG had collapsed and required a government bailout, Goldman Sachs and Morgan Stanley were forced to convert to bank holding companies, Washington Mutual collapsed and was absorbed by the government, Wachovia was forced into a sale to Wells Fargo, General Motors and Chrysler filed for bankruptcy and Ford had to be saved by government loans. Meanwhile, unemployment soared and thousands lost their homes. We reflect on this because the recovery from the 2008 debacle provides a fascinating study of how adaptable businesses are to change. It also points out that government intervention in certain aspects of our legal and regulatory environment is, at times, necessary to help stabilize matters. (TARP actually worked.) Finally, it reinforces what we all intuitively know – that stock market gains are never made in a smooth and uninterrupted manner.
So, how long can this bull market last? Over the past 70 years, we have had 35 corrections of 10 percent or more, and every four or five years a correction of 20 percent or more. During every calendar year, there is also an intra-year decline averaging 14 percent. So, yes, one should expect this market to have a sharp decline at some point. However, looking at things objectively, the good news today still far outweighs the bad news. Of primary importance, corporate earnings are going to be up over 20 percent for the year (with only half of that due to the corporate tax cuts enacted last year). In addition, Gross Domestic Product (GDP) growth in the second quarter was up a resounding 4.2 percent, and we expect the third quarter will come in around 3.5 percent. Most economic analysts expect the good news to continue through 2019, perhaps pushing 3.0 percent GDP growth over the next 18 months.
Yet there are risks. The Fed just raised interest rates for the third time this year, and it seems likely there will be another rate increase this December, with perhaps two or three more in 2019. That would push the Fed Funds rate above 3.0 percent. The risk is that as interest rates increase, the yield curve will continue to flatten, possibly becoming inverted. That has historically been a warning of a slowing economy. Thus, we need for the Fed to be prudent, showing some restraint to avoid tightening too aggressively. Another risk, of course, relates to tariffs. As we have stated in the past, trade skirmishes don’t particularly worry us, but trade wars are a huge issue, with no winners. So far, we still appear to be in the skirmish stage, but time will tell.
Entering the fourth quarter, all eyes in the U.S. will be upon the mid-term elections. Candidly, we try not to get caught up with political worries, instead focusing on corporate earnings growth, interest rates and a balanced regulatory environment – these being much more critical to future stock market performance. In that regard, the stars seem aligned for reasonably good market returns, despite obvious risks. As to the risks, we frequently repeat our favorite Calvin Coolidge quote: “If you see ten troubles coming down the road, you can be sure that nine will run into the ditch before they reach you.”
(c) 2018, Argent Capital Management
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