Market hot streak comes to an end
Through January 31st, the S&P 500 gained 6.0%, nearly a year’s return in 4 weeks, as investors enjoyed the “sugar high” of the December corporate tax cuts.
Reality returned this week as the S&P 500 dropped 3.4% over 5 days (but remains up 3.9% on the year). The headline tonight no doubt will be “DOW drops 1,100 points from record high” (small print will read, “But remains up 3.9% on the year”).
As we discussed in a few of our commentaries last year, “a prudent tax policy would have been: raise taxes, spend half the extra revenue on debt reduction (create room for deficit spending in the future) and the other half on infrastructure projects (jobs AND economic development.)”
Instead we had a tax cut when the jobs market is already close to full employment, but meanwhile no reduction in spending, so the national debt just continues to increase. A tight job market means an uptick in inflation, while an increasing national debt “crowds out” other borrowing, also driving up rates.
As a result, interest rates took a lurch higher this morning, with the 10 year treasury at 2.85%, the highest level since December 2013, and before that since June 2011. No doubt the yield will continue to rise as we regard 4-4.5% on the ten year as “normal” in an environment of 2-3% inflation.
Higher interest rates mean lower stock prices, at least until earnings catch up. Thankfully, earning for Q4 2017 were strong with gains of 16.0%; earnings for Q1 2018 also looks strong; with estimates averaging 15.2%.
Bottom line: the market is doing exactly what we expected. We’d rather have a modest sell-off now, than a more substantial sell off later.
What are we doing for our clients?
Since January 2nd, we have been rebalancing our client’s portfolios starting with those furthest out of balance. It will probably take us until the end of March to complete that process as we are reaching out to clients one at a time to discuss the fact that dialing down risk (typically by reducing stock allocation by 5%) means taking profits on taxes, which means having to pay capital gains tax.
In a perfect world, we would have rebalanced 100% of clients at the high for the year on January 26th. In practice, we’re always early or late. Big picture: if we leave a couple of percent on the table by not exactly nailing the perfect moment to sell, we’re still keeping our clients on track with their overall financial plan.