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Weak Snorting


My investment outlook is evolving.  Two months ago, the economic data was unrelentingly bullish.  Now, cracks have appeared (see both ISM reports).  This does NOT suggest the recession that investors fear.  Not all recessions are created equal.

The stock market has been propelled over the past year or so by rapidly rising corporate earnings (EPS).  The second and third quarters were up 20% on a year-over-year basis.  Fourth quarter growth is up around 15%, but next year’s estimates are in the neighborhood of 8%.  The Law of Large Numbers tell us that such high growth rates are unsustainable.  This is called a “growth recession,” where the rate of growth recedes or decreases.  It might even go to zero.  But, this does NOT mean a full-blown recession.  (More importantly, it does NOT mean a financial crisis either.)

As the stock market adjusts to this reduced earnings growth, it does not necessarily mean the beginning of corporate losses.  However, it does mean portfolios should be adjusted – just in case.  The essence of Modern Portfolio Theory is that a portfolio be exposed to all asset classes, but weighted on expectations.  This is a time to consider increasing your exposure to “value” stocks.  (People will always buy toothpaste and toilet paper.)  Also, technology stocks tend to suffer more than consumer staples during slowing stock markets

If you’re concerned that Republican losses in the mid-term election will embolden Chinese negotiators, prolonging the Trump’s Trade War, then this is a time to consider reducing your exposure to large-cap stocks, who are much more dependent on international trade. Also, those rising U.S. interest rates are normally more difficult for smaller companies.  This is a time to also consider decreasing your exposure to small-cap stocks and increasing your exposure to mid-cap stocks.  Plus, rising U.S. interest rates are harder on emerging markets than the U.S.  This is a time to consider reducing your international exposure.

There is an understandable tendency to hide in bonds during a weak stock market, but it is still too early to look at long-maturity bonds.  Although two-year Treasuries are pushing 3%, I would consider even shorter maturities.  I would not consider any bond funds with maturities longer than three-months.

 I don’t hear the roar of bears, only the snorting of tired bulls.  The end is NOT here!  A slowdown is NOT a crash, just an  chance to adjust.

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