What in the world changed?

December is supposed to be a good month for stocks. Instead it is threatening to be the worst December since the Great Depression. I do remember some particularly bad Decembers in my 20+ years of managing money — 2000, 2002, 2008 all stick in my mind as not a fun time to be invested. Those dates should jump out to you. They all were during a bear market. This led an advisor to ask me today if we’ve started a new bear market.

As I said back in January and again in October when this sell-off started, we do not know until after the fact when the bear market began. Remember the S&P 500 rallied 7% the first 4 weeks of the year only to lose 10% in 8 trading days in February. It then recovered and hit all-time highs by the end of September. Euphoria was taking over for investors. So what in the world has changed in such a short amount of time?

At the beginning of 2018:

1. Markets were extremely overvalued.

2. Investors were complacent following the least volatile year on record (and double digit returns)

3. The economy and stock market were a little over a year away from setting a record for the longest expansion / bull market in US history.

4. The Federal Reserve was entering its 3rd year of interest rate hikes and 2nd year of scaling back their QE-bloated balance sheet.

5. There were high growth expectations following the passing of the Trump Tax Cuts .

At the end of 2018:

1. Markets are still overvalued.

2. Investors are starting to get worried.

3. The economy is still expanding & we are still technically in a bull market.

4. The Federal Reserve is still raising interest rates and scaling back the balance sheet. 

5. Economic growth is falling back to average (or just below average) after 2 strong quarters.

The key change is #5. While it is not a very big change in growth expectations, when you combine an overvalued market, complacent investors, a very old economic expansion and bull market you get a HUGE drop in values. 

Click here to watch a tutorial on how changes in these variables can hurt stocks.

What really happened in 2018:

• Corporations spent their tax cuts on paying down debt (not enough), bonuses, dividends, and share buybacks with at most 1/3 of the benefits on long-term investments. This created a short-term boost to economic growth. 

• The fears of the on-going trade war caused a rush of manufacturers purchasing inventory before the tariffs kicked in. This not only sparked inflation, but created a short-term boost to economic growth (click here for my take on the Trade War and here for Cody’s reminder that this should have been expected.

• Both the tax cuts and trade war fears are INFLATIONARY. The Fed is deathly afraid of too much inflation and therefore must continue to hike interest rates to stop it.

• Even before the mid-term elections it seemed we had gotten as many of the the “good” Trump policies (in terms of sparking economic growth) as we could hope for. The president has now shifted to the “bad” Trump policies (those that divide the country, create unrest, or could hurt economic growth over the short-term.) The December showdown over the border wall funding with the new Democratic leadership served as a reminder that there will be little if any chances of more stimulus in the next two years.

• Corporations, governments, and households have far more debt than they had in 2008. For example, there is more BBB (1 step above junk) debt outstanding now than the entire investment grade bond market in 2008. As interest rates go up, the chances of a cascade of defaults increases. One thing that REALLY has me concerned is the fact the Financial sector has been one of the worst performers during this sell off. Through 12/24 it was down 26% compared to the 19% decline for the S&P 500. With the Treasury Secretary calling the largest banks to ask about liquidity, I can’t help but wonder what is happening inside the financial system.

This still feels more like 2011 than 2008 mostly because the economy is still growing. A bear market without a recession is not a big deal. The one thing that does have me concerned for 2019 is there is really no catalyst for the sell-off like we saw in 2011. The 2011 sell-off was sparked first by the EU/Greece credit crisis and then by the US Debt Ceiling circus when we lost our AAA credit rating. Once those issues were settled, it was off to the races again.

What you should be doing for 2019:

• SEM clients should watch this video. Sell-offs are normal and if your SEM portfolio was designed around your financial plan, true risk tolerance, and investment personality everything is functioning as expected. Our Tactical models took money off the table and are waiting for a better opportunity to invest again. Our Dynamic models also scaled back risk at the beginning of November and will adjust as necessary based on economic growth. AmeriGuard (our ‘strategic’ portfolios) is ready to scale back exposure at the end of the quarter if the statistical probability for continued selling is high.

• If you have buy & hold investments, do not have a solid, time-tested plan, or do not know where your investments fit with your financial plan, true risk tolerance, or investment personality, contact me today for a free portfolio review. or head over to WhatsMyScore.net for our free financial assessment. If this is a bear market you will need a behavioral coach on your side to take advantage of what could be some generational buying opportunities when it is over. Even if this is just a temporary scare, a nightmarish bear market is coming, possibly worse than the 2008 financial crisis (due to the exponential increase in debt the last 10 years.) Please do not get complacent.