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Steve Rossi - Economic Column

January 15, 2019

S Rossi 2014
The First Rule of Thumb in a Market Reversal: Don’t Panic

By Stephen A. Rossi, SVP, Senior Equity Strategist – CNB Wealth Management

Published on January 4, 2019 in the Rochester Business Journal

The month of December was a brutal one for investors, with the Dow Jones Industrial Average and the S&P 500 indices falling more than 10%, and the Nasdaq and Russell 2000 indices falling approximately 12% and 14.5%, respectively, as of 12/27/18. International markets fared a bit better for the month, with the emerging markets, Europe and Japan falling about 6.5%, 8% and 11%, respectively. From each of these indices’ all-time highs, the situation wasn’t any better, with large U.S. companies generally down 14% to 19% from their peaks, and emerging market, European and Japanese companies broadly down between 35% and 48%. At this point, we may be getting close to a market bottom, based on one key contrarian indicator: a handful of nervous clients are requesting that all of their equities (i.e. stocks) be sold… at exactly the wrong time.

Fear and greed are powerful psychological forces that cause most individuals to make very poor investment decisions. Fear results in panic and generally leads people to sell after the market’s already down. Greed results in euphoria and generally leads people to become more aggressive after the market’s made a strong advance. Lately, fear’s been the dominant force, but what exactly is causing this emotion?

One of the biggest factors contributing to the market’s recent anxiety is America’s current trade war with China and others. This year alone, the U.S. has imposed tariffs on washing machines, solar panels, steel and aluminum across the board, with additional tariffs imposed on Chinese goods valued at $250 billion. Unless we come to a rational compromise with our trading partners, additional tariffs on automobiles and another $467 billion of Chinese goods will be implemented by the end of 2019. In the midst of what appears to be a global economic slowdown, higher prices passed on to consumers as a result of this economic game of chicken could ultimately exacerbate the problem.

Notwithstanding the slowdown mentioned above, investors have become increasingly concerned with recent Federal Reserve Board actions, including the number of future interest rate increases and the speed at which it winds down its massive balance sheet of Treasury bonds and mortgage-backed securities. Although the Fed raised its overnight lending rate for a ninth time in December, it did temper its outlook for additional rate hikes in 2019, generally moderating its expectation from 3 more hikes to 2 on a “data dependent” basis. What the market wasn’t so thrilled about was the Fed’s intention to continue letting Treasury bonds and mortgage-backed securities roll off its balance sheet without reinvestment, regardless of the underlying economic circumstances. Raising interest rates tends to slow the economy by making it more costly to borrow and invest. Failing to reinvest maturing Treasury bonds and mortgage-backed securities generally does the same. Failing to reinvest maturing bonds implies less demand in those markets. Less demand implies lower prices and lower prices imply higher interest rates – a definite impediment to growth.

Aside from other acts of aggression by Russia (i.e. annexing Crimea and recently firing on/seizing three Ukrainian naval vessels), China (i.e. militarizing the Spratly islands in the South China Sea) and others, the most recent cause for concern is the current Government shutdown - particularly if the President can’t get funding for, or otherwise compromise on, his plans to build a wall separating the U.S. and Mexico. Obviously, a Government shutdown would create disruption and uncertainty, conditions that the financial markets never receptive to.

And so there it is – the fears of the day that are causing all of the angst for investors which, in some cases, are compelling them to do exactly the wrong thing (i.e. sell low). There’s a widely available cartoon that depicts an investor who sells whenever the market’s down (i.e. fear) and buys whenever the market’s up (i.e. greed), cleverly instructing the individual to “repeat until broke”. At this point, however, and with forward price to earnings multiples generally at or below their long-term averages, now is not the time to hastily sell out of your investments. As has been proven many times before, financial markets ultimately reward patience during troubled times. Unless your goals have materially changed, sit tight, accept that cyclical bear markets occur within secular bull markets, and remember not to panic.

To see his column in the RBJ, click here.