January 2019 Newsletter

2018 will be marked by a market selloff on fears that the longest running bull has come to an end.

• Market sentiment shifted in early October 2018 as Fed Chairman Powell set a hawkish tone to monetary policy. The Fed will have to be more receptive to markets in 2019.
• President Trump may need to listen to the markets that for now have lost faith in his leadership.
• Corporate and government debt along with shadow lending are a new rising concern.
• Trade and tariff wars will be front and center in early 2019.
• A divided congress has set a confrontational tone that will likely create a lot of volatility for markets in 2019

The fourth quarter of 2018 will be marked by a wild ride that saw US stocks post their worst year in a decade as the S&P 500 fell more than 6% in 2018. While earnings have been strong the S&P 500 went negative for the year as outlook has disappointed along with signs of global growth slowing. The month of December alone was the worst month on record since 1931 shedding almost 11% in just over two weeks before bouncing up 3.4% since a December 24^th worst Christmas eve drop ever followed by the biggest single-day point gain ever on December 26, 2018 seeing the DOW move to the upside by 1,086.25 points.

We started last year with the fear that inflation would rise causing pressure on U.S. treasury yields to go up for the ride putting pressure on company earnings. We ended 2018 again with inflation remaining stubbornly low and a brief inverted yield curve.

Investors will be happy to see 2018 come to a close having suffered losses that began in early October set off when Federal Reserve chairman Jerome Powell told the markets that the fed saw rates a “long way from neutral,” only to step back the wording in late November to “just below neutral.” The hawkish fed tone statement marks the start of the sharp sell off from the S&P highs at 2940.91.

It appears the fed is listening to the markets and is stepping back to a less hawkish tone as it attempts to do the hard task of reducing and rolling off its balance sheet. I don’t envy the task of the new Fed with a 3.4 trillion dollar balance sheet on its back. The great unwind will require precision as central banks around the world un-wean us from a decade of quantitative easing measures that helped us recover from the credit crises of 2008.

The S&P 500 ended on a down note suffering its sharpest losses in the month of December, down 11% in just two weeks. Friday December 21 and Monday December 24 felt like a very panicky puke out that we hope will mark the bottom for the markets. The panic selling saw the volatility index rise sharply and conversations with fellow investors over the holiday dinner parties centered on the panic sentiment of cashing in and throwing in the towel. Investors have good reason to be spooked given that so many stocks are down 30% and more. The lack of volatility in 2017 and through the first three quarters of 2018 created complacency among investors that were caught off guard and fully invested in what became the longest bull market run just this past September.

It has been prudent to sell as we have been suggesting since the start of 2017 but the selloff in our opinion has been overdone and now presents good strategic opportunities. We expect continued volatility and the days of passive investing are behind us and will in fact be a headwind to the markets as increased volatility that we believe will be with us at elevated levels for some time will feed on itself as a generation of unseasoned investors will likely continue to hit the panic sell button in the new world of ETF derivative trading. Add on top of this the algorithmic trading models that feed on momentum either way and we can expect big snowball effects to build sending markets to big moves in both directions. The new market paradigm will require selective stock picking that will require tactical strategies over just buy and hold passive investing supported by central banks that have been floating assets for over a decade.

The fourth quarter of 2018 saw the gains of the so called Trump rally that started the night of the 2016 election almost wiped out. Before markets started to take a dive down, President Trump took great pride in touting the market performance for what he called the greatest economy that the U.S. has ever seen. Looking back on the new administration’s policies one has to wonder if perhaps they shot themselves in the foot by taking on China in a trade and tariff war that dampened the effects of the sugar rush that the markets were on after deregulation and tax reform policies were enacted.  In essence the president was playing with the house’s money until the market correction. Markets appear to have lost faith in president Trump as evidenced in how they no longer react positively to the regular tweets that once had the weight to carry markets. The president will have to take heed of the actions of the markets and become more conservative as President Trump enters his third year as president.

If President Trump likes to measure his success by how the market performs he will have to find a box tight enough to lock away  his Director of Trade, Peter Navarro. We have heard some positive tweets of late on progress being made on trade talks that will have to continue in early January to help outweigh the growing signs of a global growth slowdown. The slowing global growth sentiment will not be able to handle the weight should the talks derail and the trade war escalate.

The last four days of  market trading  in 2018 saw gains for the Nasdaq. At Cavu Investments we think that strength in big tech including the FAANG names will have to continue as they have been the leaders in the decade long raging bull run. As the tech giants go so will the markets as the overall indices have been following big techs lead.

In closing I would like to wish investors a healthy and prosperous new year and end with two important lessons I learned from the wise investor that markets have been turning to for years in turbulent times. The sage investor, Warren Buffet turns 89 this year. Mr. Buffet has said that investors should not place too much weight on the politics of which party holds office and who is elected President of America.

One of Warren Buffet’s  famous sayings is, “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” One has to wonder if this wise advice should be applied to the Presidency of the Unites States of America as the last quarter of 2018 has investor patience wearing thin over the Trump administrations chaotic leadership. Impeachment will be a huge market risk in 2019 as Robert  Mueller’s investigation continues. Markets will have to regain confidence in the Trump led Republican leadership and the New Year will require bipartisan cooperation of the divided congress. That and a Federal reserve that steps back it’s tightening monetary policy as it acknowledges deteriorating market conditions should help support markets in 2019. The market’s two biggest worries are trade wars and Fed ‘tightening’ through rate hikes as it attempt to shrink its balance sheet.

Goldman Sachs analysts say that 2019 will be all about “landing the plane.” In Goldman’s view a growth slowdown is necessary to “land the plane’ and that the two key historical risk factors-inflationary overheating and asset market bubbles-remain largely absent.”

At Cavu, we are optimistic that although it will be noisy and volatile, markets can overcome the challenges it now faces out of the gate in 2019. The first quarter of the New Year will be key in determining if we can celebrate at our next year-end holiday parties on a more positive note to close out 2019.

2019 CAVU OUTLOOK: