By Benjamin Lau, CFA, Chief Investment Officer
I dislike generalizations like “the market,” but last year deserves an exception. In 2018, every market was down, and the best investment was cash. Stocks at home and abroad were down, as were bonds (high- and low-quality) and commodities. Cash, as they say, was king.
The downturn started off as a rational recalibration by investors in the second half of last year – a transition from the higher-growth years of 2017-2018 to the slower-growth phase expected to occur this year and next. Unfortunately, the rational recalibration turned into a selling downpour. Fears from: (a) higher interest rates, (b) a trade war, (c) government shutdown, (d) global slowdown and (e) all of the above, overwhelmed investors over the holidays and created a sell-first-ask-questions-later mentality.
Yes, the global economy is slowing down, and America is (finally) feeling the effects from abroad and slowing down, too. China is slowing dramatically, so much so that major exporters to China such as Germany are feeling the pain. It looks like Germany narrowly missed the start of a recession in the fourth quarter. German economic growth managed a meager 0.2 percent gain. The slowdown has also led Chinese government officials to start taking measures to stimulate their economy through tax cuts (fiscal measures), rather than encouraging more borrowing (monetary measures).
China’s pain has caused grief throughout the emerging market complex and is now spreading through Europe. America may be the healthiest of the bunch, but it won’t be immune to the contagion. Manufacturing activity is often a good predictor of future demand and has been showing some signs of weakness along with the declining housing market. Profit growth for the largest American companies is declining but still remains positive (see below).
While we believe we are in the later parts of the economic cycle, it does not necessarily mean a major recession is on the horizon. Historically, it is quite normal for us to be in this late stage of the cycle for an extended period. Forward-looking signals such as consumer confidence, new orders for good and services, and building permits indicate the economy is slower, but resilient to the effects of higher interest rates and stock market volatility.
The current shock to the market feels like the mini-recessions we had in late 2015 with the energy implosion and 2011 with the European debt crisis. In both instances, the economy came to a standstill but was able to withstand the pain and recover rather quickly
Given that we do not see a recession as imminent, we think it’s too soon to rush and overweight safe haven assets such as gold and long-term U.S. government bonds. High-quality stocks still offer the best risk-to-reward tradeoff out there. With this pull back, stocks are on sale. Valuations for equities at home and abroad are much cheaper than just a few months ago. They’re cheap relative to long-term norms and interest rates. Growth-oriented assets – including industrial and financial sectors, as well as emerging markets – are particularly cheap.
There are many opportunities right now for long-term investors. Especially for those patient investors that have the dry powder to take advantage. As many of you might have noticed, we started to take on a more conservative stance in Q3, which was followed by raising more cash in Q4. We feel comforted by the dry powder we have built up. Opportunities will present themselves, but we prefer to wait until the storm clouds have cleared before jumping at them.