By Paul Nolte.
Our long national nightmare is over.” Gerald Ford would be incredulous to witness this year’s election efforts. It is not certain that come Wednesday morning, that it will be over. While the markets have declined nine straight days (longest since Reagan!), it has done so in a rather mild fashion. Surprising that it isn’t more, given the rhetoric and vitriol from everywhere. As far as the economy is concerned, the jobs report on Friday continued to show decent jobs gains, good wage growth and cemented a Fed increase when they next meet in December.
Their meeting last week could have been skipped, as little new information was passed along. The Fed officials will be out and about the next two weeks, chatting about monetary policy, especially in light of the election results. For all that has been thrown at the US economy, it continues to bump along, growing at a modest rate that should keep inflation, wage and earnings growth relatively low. All of which argues for a Fed to hike rates in December and sit back and watch…for a long time. The less they tweak, the better things may be for investors and corporations alike.
The market’s nine straight days of declines last happened late in 1980 and was a rather regular occurrence over the prior twenty years, happening nine times between 1961 and 1980. Save for a huge surge off of the October 1974 bottom, the average decline of the remaining eight is just over 2% for the following month with just two positive. More importantly the markets are once again hitting their long-term average level. Last time below the average (Aug’15-Feb’16) we saw volatility pick up as well as selling pressures. It also marked the last 10% decline from the peak to the February lows. For much of the past four years, the markets have been in a steady uptrend, but over the past 18 months the markets have moved sideways with much more volatility. It is too early to rule out another 10% decline in stock prices, but like February, it would present a very good buying opportunity for long-term investors.
The election and results this week could keep the markets volatile over the short-term, but the economic data does not yet suggest that this is “the big one”. Growth remains intact and larger declines should be seen more as buying than selling opportunities. The Fed did little to move the needle at their meeting last week, indicating that December is the most likely time for a rate increase. Of course, they will leave themselves an out if the global economy or US markets get squirrelly after the elections. Much as the British Central Bank did following the Brexit vote, we would expect the Fed to stand at the ready to keep the economy greased. It is unfortunately what we have come to expect from the Fed, injecting monetary policy for every ill that may be suffered, even though it may not be needed.
Rates have been rising for much of the past few months, and we are seeing an increasing likelihood that rates should continue to rise at a slow, but steady rate over the coming year. Of course that bars an economic calamity sometime in 2017! The “risk off” trade over the past two weeks came at the expense of some of the better performing asset classes over the past six months. As with much of the markets, we are expecting nothing more than a correction that could reset some of these asset classes for a good run in 2017. One part of the market that continues to decline is the REITs.
We highlighted the utilities last week as an interest rate sensitive sector that has suffered as interest rates have increased. REITs also tend to move with interest rates, as they distribute much of their earnings to shareholders in the way of dividends. As a result, they tend to have dividend yields similar to utilities, but with an added bonus of having some growth to the value of the underlying properties. They have been a great part of the market to invest in since the beginning of 2014, as investors clamored for income. The run up, similar to utilities, ended in June as investors realized that interest rates were indeed going higher and could pose “competition” to the dividends earned.
Their 15% decline since the end of the second quarter is well ahead of the still painful 10% decline in utility stocks over that same period. We are expecting the end of the election cycle to be on Wednesday, but given how the campaigns have gone, that may not be a foregone conclusion. Stocks are likely to react to the election news, but we expect that in a week or two, they will settle down and once again reflect the expectations for global economic growth and corporate earnings. Interest rates are likely to continue to rise, ever so slowly in the months ahead. As a result, we are shortening our maturity schedule as bonds come due and focusing on shorter term bond mutual funds as well.
