November looks set to continue the volatility from October, with markets whipsawing between gains and losses not only day-to-day, but even during intraday trading. Investors appear to be on edge as the negative newsfeed continues to pour in, from an economic contraction in Japan, a slowdown in Europe, oil markets collapsing, Brexit fears, and inflation picking up. Economists and market pundits now believe that growth for this cycle may have peaked this year, as the tax cuts provided less stimulus than anticipated and the Federal Reserve has continued to tighten policy. Perhaps the most significant driver of equity market volatility has been the recent rapid decline in oil prices, which have dropped over 20% in a matter of weeks. As the most important global commodity, oil prices reverberate throughout the world economy, with impacts ranging from individual consumers’ wallets, producer countries’ output, price inputs for industries and transport, high yield bonds, as well as inflation. Further complicating the picture is determining which side of the equation is driving the price drop, supply or demand. Supply side concerns reflect geopolitical tensions from sanctions and OPEC, as well as Russian and US production and refining capacity, while demand side issues could provide further evidence of a slowing global economy or simply efficiency gains in autos. Our thought for now is the price move reflects a combination of all the factors mentioned, but that prices have likely dropped too far too fast, and that a reasonable rebound could materialize in the near term.
While the oil story and other recent economic indicators show global growth does appear to be slowing down meaningfully, that does mean a contraction is imminent nor likely. While the rate of growth may slow, we believe it is highly unlikely that a contraction is near, given the strength of the consumer, employment, wages, and corporate profitability. A slowing from double digit revenue and profit growth to single digit returns, while not exciting, does not mean earnings are falling off a cliff or that stocks are overpriced. Furthermore, moving to cash in an environment where inflation is rolling at a steady clip of over 2% and rising, makes being on the sidelines an unattractive alternative. A balanced approach, we believe, will be able to achieve returns over and above inflation, and meaningfully higher than the yield on bonds at the present time. While the volatility may continue to be gut wrenching, without episodes such as these, it is difficult for true value to be discovered. We continue to urge clients to hang in there!
This week, as part of year-end planning, we have taken some action to harvest losses in some positions that have been particularly hard hit this year, namely emerging market funds. In an effort to reduce the overall tax liability for our clients, as well as focus the exposures we are optimistic on moving forward, we sold and reallocated one of our core ETF (exchange-traded fund) positions within emerging markets, increasing the allocation to areas we find more compelling. Additionally, we sold some minimum volatility funds that have held up well in the recent downturn and reallocated the proceeds to funds that are better positioned for a rebound, which is our base case. Again, seeing declines on your statement for several months never feels good to anyone. However, we encourage you to stay focused on the long run, where over time, spectacular results can be achieved through patient, steady portfolio management and the courage not to sell everything at the first sign of market stress.