Welcome to the Monthly Economic Update, it’s January 4, 2019 as of writing this article and what an absolute wild ride it’s been over the last quarter. In the last Monthly Economic Update in early December we were hoping for some sort of a Santa Claus rally and, of course, everything fell apart.
The Worst December Since the 1930s
It was the worst December since the 1930s and it’s the worst quarter that I’ve seen since the 4th quarter of 2007. We all know what followed the 4th quarter of 2007, the Great Recession. In fact, most of the pain in the markets during the Great Recession came in the final quarter of 2008 and the 1st quarter of 2009.
If you have been paying attention to the stock markets, you have seen some amazing up days such as January 4, 2019, which was up over 3% on major indices. However, January 3, 2019 was a down day, down over 3% on major indices. December 24, 2018 was the worst pre-Christmas day in history and the day after Christmas was the largest single percentage point gain in a day.
I bring all of that up because I want to make something very clear. Over 90% of the best single-day movement in the stock market, from a percentage standpoint, have occurred in the midst of bear markets. We’ve had two of those in the last two weeks. Does that infer that we are in the midst of the next bear market? Only time will tell.
I can tell you this, our quarterly indicator, which indicates the overall direction of the markets for the 1st quarter of 2019, is negative. Our long-term indicator has been falling over several weeks. As of January 3, 2019, it has dipped into “bear territory” or the possibility of bear. Keep in mind that just because these indicators say bear market, it doesn’t mean it’s 100%.
These indicators are designed to give us, as your financial advisors, the ability to look forward at what the longer-term outlook looks like in the markets today and make adjustments to portfolios accordingly.
What’s Causing All of This?
Let me start by laying a very simple foundation. The stock market is driven not just by the economy, but by corporate profit growth. We believe corporate profit growth peaked in the 3rd quarter of 2018, with the 4th quarter coming in slightly lower than the 3rd. Overall, we saw corporate profit growth of about 20% through 2018. Corporate profit growth is projected, for 2019, at only 8%. That’s over a 50% decline in the rate of growth. That doesn’t mean that corporate profits are going negative, it just means that the rate of growth is slowing substantially.
That makes sense for a slowdown in the market, but that doesn’t make sense for a bear market. If you think of that as the landscape, what’s happening on top of that is the trade negotiations going on with China. Corporations that are trying to project their profits for the coming year have no clue how tariffs are going to impact those corporate profits. They also have no clue how those tariffs may impact our GDP here in the United States. Why don’t we have a clue? Because we don’t know what the rules are going to be yet. That’s causing a lot of uncertainty in the markets.
Add to that, Fed Chairman Jerome Powell raising interest rates in December 2018 and giving a signal that the Fed plans to raise rates at least two more times in 2019. That sent the markets into a tailspin as we ended December. On January 4, 2019, Powell said the Fed is going to be patient, but we don’t know what the Fed is going to do. What we do know is the uncertainty over the trade negotiations with China and the uncertainty of the Fed coupled with the slowing of corporate profit growth sets up the perfect storm for the possibility of a recession in the next 12-18 months. Is that going to happen? I don’t know.
Treasury Yield Curve
Figure 1 – GuruFocus – https://www.gurufocus.com/yield_curve.php
In Figure 1, we’re looking at the spread between the 10 Year and the 1 Year Treasury. In the past, every time the 1 Year Treasury has yielded higher than the 10 Year Treasury it has led to a recession with the next few months. Today, we’re at 0.06% difference between the two. At one point on January 3, 2019, we saw the 1 Month Treasury yielding higher than the 3 Month, 1 Year, 2 Year, and the 5 Year Treasuries and the 10 Year was just barely higher than the 1 Year.
What this tells us is that the flattening of the yield curve, in some cases, is inverted. If in fact we get to where we’re seeing that short-term treasury, the 2 Year Treasury, yielding higher than the 10 Year Treasury that will tell us the likelihood of a recession has increased to 80-90%. That doesn’t mean it’s the end of the world. We have market cycles, contractions and expansions and we’ve been in a long expansion.
“Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble.” – Warren Buffett
Staying in Control
One of my favorite quotes from Warren Buffett is, “Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble.” What the means is, don’t panic, but that doesn’t mean sit around, wait, and do nothing and that’s not what our philosophy at Barber Financial Group is either. What it means is that we have to allow the models to do the work their designed to do. Their designed to work through good and through bad. There will always be pockets of pain, but long-term is where we have to keep our focus.
Market Indices Performance for 4th Quarter 2018
Figure 2 – Chaikin Analytics – https://www.chaikinanalytics.com/
I just want to take a quick look at the markets in the 4th quarter of 2018. As you can see in Figure 2, it’s the last 3 months plus the first few days of January 2019. Not looking at any specific index but look at the pain. Off over 20% on the quarter in some of the major indices. All of them finishing in negative territory. So, we finished with the worst calendar year since 2008. This is really the first time we’ve seen a quarter finish so poorly with the exception of the 4th quarter of 2007 and 2008.
We are extremely cautious at this point in time. We are looking at things on a daily basis. We’re here to talk with you and help you understand what the models are doing they’re doing what they’re doing, why they’re doing it, and what it looks like in the event that we do go into a recession or a real bear market.
We are here to help you understand what is going on. This is going to be my fourth bear market that I’ve lived through and helped people survive through. We want to hear from you if you have questions. Please don’t hesitate to shoot your advisor an email or give us a call. If you’re not a client of Barber Financial Group, but are looking for guidance or just some answers to your pressing questions, please give us a call at 913-393-1000 or fill out the form below and we’ll give you a call.
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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.