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August Volatility Report

August Volatility Report

| August 23, 2019

Wow!  What a year!  Through July, we have had the 14th best start since 1926.  US stocks provided a 20.2% return.  And the bond market?  That had the 12th best start since 1926 with a return of 6.4%.  That is absolutely incredible.  Yet, even though the market started the year with a bang, August brought back what looks like some serious volatility - it’s not really that serious, it just looks different than sky rocketing straight up.  On August 14th, the Dow dropped 555.66 points during the day.  It may seem bad, but it was the 342nd most volatile day in the market.  We don’t really track the Dow here in the office, but if there are market drops most people look to the Dow because that is a very well-known, scary looking number.  The Dow closed that day at 25,479 so even though that number looks big, it only represents a 2.13% drop.  Even a 1% move up or down is over 250 points.  As that index grows, those up and down numbers will get to be larger and larger.  So, rule number one is don’t look at the absolute value of market movement, up or down.  It can be deceiving.

Even with that one-day number out of the way, August has not been fun.  As humans, we tend to feel pain much stronger than we feel joy.  In other words, we can lose that feel good feeling about the market from just one bad month.  The market (S&P500) is still up 15.05% for the year (08/15/19) and it’s still a great year, even though it may not feel that way right now.

So, what is really causing this?  Frankly, there are some great things that are going on and some not so great things going on, and the market is trying to figure out which is most important.

The negative headlines dragging the market now are China (trade), decelerating global growth, and the yield curve.  The tariff situation with China is a big deal.  They are the second largest country by GDP in the world, just behind the US.  If they slow down, there are trickle down effects across the world and the rest of the world is going to slow down. Europe is slowing down, Germany announced they are in a recession, South Korea and many other countries are seeing their growth rate decelerate.  I kind of equate it to an elementary school bake sale.  If only 3 kids bring money, it’s not going to be a very profitable event.  The majority of the school needs to be bringing money and buy goods or it just won’t work.  This needs to get fixed: Either the US bends, China bends, or we find some common ground.  China has more to lose in this game, but they know we have elections around the corner and they may try to wait this out to see what happens.

The yield curve inversion is an even more complex scenario.  What the yield curve inversion means is that the 2-year treasury actually yields more than the 10 year treasury.  Normally, people want to get paid more to hold debt for a longer period than a shorter period.  This anomaly has been a precursor to a recession in the past.  On average, the curve inverts about 14 months before a recession takes place.  The reason this works is that US interest rates are a benchmark for future US economic growth.  When people think a recession is coming (negative growth), they want to buy longer term debt with the hopes that the fed will lower interest rates.  So, selling short term debt makes that yield increase and buying long term debt causes that yield to decrease.  Today, it might be a little more complex than that.  Germany, Japan, Switzerland, France, Sweden, Netherlands all have negative interest rates.  That means YOU pay them to buy their bonds!  What if our 10-year bond has gone up in value (lower yield) because if you want to get a positive interest rate you have to buy US treasuries?  What if this supply and demand for our US debt is driven from a search of positive yield instead of an outlook of reduction in future growth?  It is a head scratcher for sure. 

For the month of August, the market has been focusing mostly on the above two paragraphs.  What it is forgetting to factor in is that we have record low unemployment.  Our inflation rate is stubbornly low.  Earning last quarter were better than we expected.  The forecast for next quarter earnings will be even greater.  Companies in our US markets are recording record buy backs of their own stock.  This is such a big deal that if they continue on at this pace, they will have bought back their entire companies.  Yield on the S&P 500 is greater than the 10-year treasury and it even eclipsed the 30-year treasury.  All of these are great things that are favorable to owning stocks.

Like all things, there is a good side and bad side.  We can look for either and find what we are looking for.  No matter what time frame we are in, there is always a reason to not be invested.  That’s the very reason they say that the market always climbs a wall of worry.  The one thing we know for a fact is that the market will go up and it will go down.  Knowing that, we also know the market has historically gone up more than it goes down.  We always want a greater future for ourselves, our children, our grandchildren, and society as a whole.  That drives innovation, investment, and growth.  Let’s focus on our goals and what our actual, individual plan is instead of what the market is doing today, this month, or this year.  The market will take care of itself in the long term.  Let’s put our focus on you and your goals instead of any short-term market movements.