Markets retreated in February, the worst down month in two years. A record surge in volatility caused several ETFs designed as leveraged bets on low volatility to plunge, with at least one being forced to liquidate and hand its investors a near total loss.
The Causes of February’s Market Retreat
The initial catalyst for the sell off was inflation. The January jobs report showed that wage growth rose 2.9% year over year. After years of pundits fretting over the lack of inflation, this was enough to send bond yields soaring and investors running for the exits.
Concerns were compounded by the transition from Janet Yellen to Jerome Powell as Chair of the Federal Reserve. President Trump’s call for tariffs, 10% on aluminum and 25% on steel, further spooked markets.
That the markets were trading at nearly 19 times earnings, well above average but admittedly less than prevailed in the Dot Com era of the late 1990s, did not help. Complacency and bullishness ran deep, and many investors had let their guard down.
Why We Are Longer Term Bulls
Despite the threat of higher inflation, higher interest rates and trade tantrums, we remain bullish longer term.
Corporate earnings appear strong. This year’s profits should climb 6 to 8%. Assuming price to earnings multiples stay constant, that would translate into a 6 to 8% market gain.
However, last December’s tax reform, primarily a tax cut for corporations, cut the Federal tax rate from 35% to 21%, meaning shareholders’ earnings went from 65 cents on each pretax dollar to 79 cents, a gain of just over 20%. Tax reform will provide a tailwind to earnings.
Interest rates remain low. Although rates may rise over time, this is still a good time to buy a house or invest capital in a business. Real rates of interest are historically low.
The economy is strong. Wall Street’s and Main Street’s perception that the regulatory burden will remain low under the new Administration persists. Joblessness is at a multi-decade low.
Overseas economies have benefited greatly from quantitative easing abroad. This is providing a robust lift to US multinationals; nearly 50% of the S&P’s revenues come in from overseas.
Bond Surrogates Have Declined Precipitously This Year
Despite the 10% correction following one of the best January’s in years, the S&P 500, including dividends, remains up nearly 1% for the year. However, a number of stock sectors, known for their low volatility, above average dividends, and low cyclicality, remain down for the year, in some cases by double digit percentages.
These stock sectors are often called bond surrogates. Many investors who normally bought bonds for their rich yields started purchasing stocks that had many bond characteristics – stability, big dividends, less influenced by shifts in the economy, in other words, “bond surrogates.”
This year, as interest rates moved up over inflation concerns, change in the Fed’s chair, and indications that rates would rise overseas, bond prices fell. As investors fled bonds, they also fled the bond surrogates. Because stocks do not mature like bonds, their durations were infinite. Examples of these sectors include real estate, utilities, telecom, and consumer staples.
Note: David G. Dietze, JD, CFA, CFP™ is President and Chief Investment Strategist of Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Avenue, Summit.
For 25 years, Point View Wealth Management, Inc. has been working with families in Summit and beyond, providing customized portfolio management services and comprehensive financial planning, to develop and achieve their financial goals. Click here to contact David Dietze, John Petrides, Claire Toth, Donna St.Amant, and Elaine Phipps, or call 908-598-1717 to learn more about Point View Wealth Management, Inc. and how we can help you and your family meet your financial objectives. To sign up for our complementary commentaries and newsletters, e-mail us at email@example.com.
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