Dear Valued Clients and Friends,
What a difference a week makes. On October 29, the Dow went as low as 24,122 in the middle of the day, and now, at press time, we closed Wednesday end of day trading at 26,180 – a full 2,000 points higher in just a tad over a week. And to what does the market owe this snapback rally? For one thing, the violence of the sell-off itself in October was wholly overdone … But also, as the earnings season’s strong news continued, and markets got the basic certainty they wanted out of the midterms, it gave markets all they need to rally. Are we out of the woods, as they say? Of course not! Many issues persist. But jump into this week’s Dividend Café for a fuller debrief on the midterms in my Politics and Money section, and frankly, for everything else, too. This week we talk jobs, diversification 101, market action this year, and yes, politics – lots of politics (we can’t get enough politics, can we?). With all that said, let’s get into it …
Dividend Café Video
Dividend Café Podcast
To what do we owe this rally?
The midterms did exactly what consensus view said they would do, only with a little extra padding on the Republican side of that. What I mean is this: the Democrats took the House, though the margin was less than many on the Democratic side of the aisle were hoping for (it was the 10th largest reversal of House seats in the last fifty years; 2010’s GOP takeover of the House remains the largest). That is not to say this is insignificant – the Democrats with a mathematical majority in the House will control a lot of committees now, and legislatively this gives them the ability to keep any legislation from getting done at all. Gridlock is less problematic for markets than you may think. On the Senate side, the GOP not only maintained its majority, but added to it substantially, and protected all but one of its vulnerable seats.
Partisans may each try to take the news from the election that they most like, and place the credit there for how markets behaved this week. But the fact of the matter is: Markets like certainty, and this week, the speculation and prognosticating about the midterms ended, and certainty took hold. The divisions of this country are as stark as ever (red got redder, blue got bluer). But fears of a blue wave and reversal of a market-friendly policy paradigm were proven to be all for naught.
Putting October into the context of Q3
What exactly was the horrid month of October following? A third quarter (July-September) wherein markets rallied 7%, where the VIX (fear index) dropped over 35%, and where there were NO +/- 1% moves at all for the whole quarter (2017 type non-volatility). October then ran into enhanced fears with China, enhanced distress in Europe, enhanced realization of the Fed’s determination to normalize monetary policy, and questions around the sustainability of S&P corporate profits. Rather than absorbing these developments in the midst of a sketchy market and high volatility context, the low vol/high return preceding period (Q3) created a platform to reverse from, rather than add to. Put differently, Q3 was so positive for risk assets; it made October be (and feel) even worse.
Jobs, jobs, jobs
250,000 new jobs were created in October, vs. 200,000 estimated. The unemployment rate sits at 3.7%. Wage growth year-over-year sits at 3.1%. It was a strong month, and once again, when taken in tandem with prior months, reflects a smoothed, accurate, and solid employment picture here in the states.
The nutshell of last week’s Div Cafe
The essence of last week’s commentary centered around my concern that business investment (capex) would see its momentum slowed by the trade war. The visual reinforcement of what capex meant to GDP growth in the last couple of quarters vs. the most recent really does color the recent market volatility.
* Cumberland Advisors, November FOMC & Election, Nov. 2, 2018
Set your watch to this!
Chances are, if we have a significant sell-off in markets (not the child’s play of a 1, 2, or 3% drop, but a 5-10% move in less than a month, as we saw this last month, and in three other occasions since late 2015), there was a big drop in China’s foreign exchange reserves somewhere tied up in it. China’s forex reserves declined $34 billion in October. I cannot state enough – the drop in Forex reserves do not cause turmoil in global risk assets; they merely reveal it. This distinction is crucial.
The drop in reserves points to China selling reserves to defend the Yuan against a rising U.S. dollar. That intervention is necessary to stem off capital flows out of the country (which escalate when the Yuan is dropping in value to the dollar).
And frankly, for those who believe either a temporary or especially a permanent trade resolution deal with China are needed to stabilize global markets, the drop-off in foreign exchange reserves is yet another data point arguing for the urgency of China acting in her best interest and making a deal.
Diversification means always being upset, and achieving your financial goals
There should always be something in your portfolio that is under-performing, or you are not invested right. There is something down you own when markets are up and something else you wish you owned more of when markets are down. This dynamic is intrinsic to proper diversification and is most often resisted by investors who instead choose the brilliant strategy of selling that which is already down to buy more of that which is already up. I offer no alternative to the frustration of diversification because I embrace it, love it, want more of it, and find nothing to be frustrated by in the reality that underpins disciplined diversification.
2018 and Asset Allocation
And so with basically flat but slightly positive returns in large-cap U.S. stocks year-to-date, how have things gone for globally diversified investors big picture? From global bonds to commodities to real estate to international equities, etc? This chart blew me away this week. 89% – no typo – asset classes across a wide array of macro options are negative on the year. This is the highest number of negative asset classes in over a hundred years.
A slippery slope down
What has caused oil prices to drop over 16% in the last month? Besides the first leg in which it was caught up in the sell-off of all risk assets, the fact of the matter is that oil had previously climbed on a belief that sanctions were coming against Iran that would take a good portion of their supply off market; the belief now is that such sanctions will prove to be much less robust than previously thought. Additionally, forecasts for global demand into next year have been ticking down, and sentiment in the speculative side of this has ticked down as well. I find the idea of speculating on any commodity price utterly inane, but to the extent one wants to know where the risk is bottled up, I would suggest the present oil price is susceptible to sudden spikes around headline events, such as when the Trump administration’s sanctions on Iran prove tougher than anticipated, and global demand proves stronger than expected.
Politics & Money: Beltway Bulls and Bears
- The markets rallied 550 points the day after the midterms, confounding those who thought the House flipping control would be a negative for markets. The fact of the matter is that consensus played out almost perfectly (the Dems took the House, but by a fraction of the flip that took place in 2010; and the GOP kept the Senate, actually outperforming expectations!). Our view is that markets just do not mind gridlock, and really never have.
- I spoke about the midterms and markets on CNBC very early the morning after the election.
- And then I spoke about the same topic on Fox Business just moments later.
- The President has signaled a lot in the last week or two as to what a deal with China may look like. I believe, and the markets need to believe, that with the midterms behind us, the President is more likely to pivot to a deal with China (assuming China is willing to make a deal). I do not take for granted that a deal will happen, but I do believe stocks are pricing in a “no deal” scenario, and not a “yes deal.”
- In Colorado, voters rejected the disastrous Proposition 112 which would have decreased access to recoverable oil and gas and dramatically hurt the energy production sector. The results of this vote caused a particular rally in the exploration and production sector with Colorado exposure, leading me to believe that the failure of this bill was not at all expected by the market!
- In California, voters soundly rejected a disastrous Proposition 10 which would have implemented rent price fixing on a plethora of income investment real estate. As was the case with a drug price-fixing initiative in 2016 (that also was defeated), the goal of the groups sponsoring the bill was to see it pass in California and then become a model for much of the rest of the country.
Chart of the Week
The heavy political themes this week make it appropriate to share the following chart as it pertains to why markets have liked the Trump administration so much since his election, and why markets responded to the relatively strong GOP showing on Tuesday night. Few things impact the business environment more than regulation (or inversely, deregulation).
Quote of the Week
“Equity diversification is virtually a character trait. It is the way we manifest humility – our confession that, although we have a very good idea what’s going to happen in the long run, we never know what’s going to happen next (nor does anyone else).”
~ Nick Murray
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I will leave it there for the week. I did a special Advice & Insights podcast on the midterm elections impact on markets, for those interested. I hope everyone can get some reprieve from national politics this weekend, and enjoy a bit of family, football, and friends (in whatever order you deem best). The entire Bahnsen Group team (over 16 of us) are out in New York City right now enjoying three days of meetings, discussions, and meals with each other – an annual off-site normally reserved for Palm Desert, but this year held in the finance capital of the world where we maintain our second office. It is a special privilege to work with the men and women of The Bahnsen Group, and we will be a better business after these meetings than we were before they started. To that end, we work.
Our office expansion in Newport Beach, by the way, will be done by the end of the month, and we have some new hiring plans to share as well. Lots of fun!
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
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This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.
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