Wealth Chatter Blog: 

How about the earthquake recorded off the coast of Ocean City this week? A 4.7 magnitude earthquake struck the Atlantic Ocean on Tuesday, 136 miles off shore. Several folks from Ocean City to Virginia Beach reported a slight tremor and there was no tsunami – good.

For me, it was the best timing: a baby quake reported at the precise moment that I was writing our 2
019 investment outlook blog featuring earthquake tremors as an investment metaphor!

Four years ago, I attended an investment conference in Palm Springs and visited the southern pole of the San Andreas fault. I was expecting to see a large ground crack, but the fault is actually a massive geological rock outcropping, comprised of high walls, ridges, crevices and canyons located deep in the heart of a California desert. It was a memorable experience.

The San Andreas fault runs the length of California and is a seam between two tectonic plates. It’s unique in that it is the only geological fault in which the plates collide instead of sliding against each other. Millions of years of plate bumping has created impressive rock formations and beautiful desert oasis streams – see my picture – but it also causes earthquakes.

Geologists believe the southern end of the San Andreas fault is overdue for a major earthquake. There have been tremors but not a major earthquake in this region for over three-hundred years and the underground stress is continuing to build. 

Some geologists estimate that a major earthquake will occur in the next thirty years along the southern San Andreas Fault. If it were to happen, the earthquake could cause untold damage to the southern California metropolitan areas. 

As I reflect on the investment drama that transpired in the fourth quarter of 2018, I liken it to an earthquake tremor. Not a small tremor, but not a full-fledged financial earthquake either. 

Get this: 2018 will go down as first year ever in which not a single asset class posted a return of at least 5.0% during the year (Per WSJ). And 4Q18 will go down as one of the worst quarters in modern times. 

But why? The flashpoint was a hawkish speech by the Fed Reserve chairman in early October that immediately soured investment sentiment. After a rough October, retail investors began to do what they always do – panic sell – which compounded matters. Sprinkle in year-end tax-loss selling and you get a truly ugly market rout, the worst stock market in December since 1931 and the first stock bear market in over a decade.

Stepping back to look at the big picture, the 4Q18 bear market event was obviously overdone. To be sure, the US economy is on its best run since the 1990s. Solid GDP growth, good wage growth, record low unemployment and solid corporate profits – that’s typically a tasty recipe for stock investors. 

That’s not to say a market correction wasn’t in order. Concerns over a global recession, tightening monetary policy, slowing corporate profits, the US-China trade drama, even the government shutdown all would justify a stock market correction – but certainly not a major market quake. 

Looking back in history, you don’t see US stock bear markets when the US economy is performing this well.

It’s still too early in 2019 to declare the 4Q18 bear market over, but the strong start to January is encouraging. Based on solid economic fundamentals, we believe a nice rally in US stocks and other risk asset classes for the first half of 2019.

What are the exogenous variables that could drive 2019 investment outcomes for risk investments? Here’s our top three.

1. Fed Reserve: The Fed Reserve has been feverishly working to push up short-term interest rates to their “natural level” and many believe the current Fed Funds Rate of 2.50% is pert near it. We expect the Fed to put the brakes to future interest rate increases. Two more rate hikes are expected in 2019; we predict one and wouldn’t be surprised by zero. The US stock market will respond favorably to fewer rate increases.

2. US Sino Trade Conflict: Ironically, the epic bi-lateral trade brawl with China is hurting China much more than the US – so far. The Chinese economy is weak and they too need to cut a trade deal. Higher new tariffs on a broad range of Chinese imports were scheduled to begin in January, but they were was tabled until March as the two sides keep working toward any trade agreement they both will sign. 

For political reasons, Trump desperately needs a China trade deal; any deal with do, so long as he can call it a “deal” (like NAFTA). It will be a binary outcome: Get a trade deal, a US stock market rally; no trade deal, more stock market volatility.

3. Corporate earnings: While 2019 projected US corporate profits will be down over 2018 due to the one-time boost in 2018 from the 2017 tax act, US GDP growth is expected to reach 2.5% in 2019. Don’t forget about the robust volumes of corporate stock buybacks, which continue uninterrupted and is helping to sustain corporate earnings growth.

In fact, we expect US corporate earnings to grow 10% in 2019 – nothing to apologize about and certainly not bear-market inducing.
To summarize, we are calling the recent sell off a market tremor, encouraging investors to remain calm and stay invested in what could turn out to be a decent year in 2019. 

By the same token, the recent unpleasant market volatility, is a wake-up call, hopefully to help shake off the considerable investor complacency that has built up since 2009.

In fact, looking out past 2019, there are many factors for investors to fret. Once the US economy does eventually reverts to a recession – and it will – then all the ill-conceived economic, government and monetary policies since 2008 will finally rupture and likely cause a major market earthquake. 

In the meantime, it would be folly to sit out 2019, so stay diversified and stay invested.

Until next time, be well….Tim

www.harvrock.com


**These are the opinions of Tim Sutherland and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal.