“Toto, I’ve a feeling we’re not in Kansas anymore…” – Dorothy, (The Wizard of Oz)
The first six weeks of 2018 have been simply incredible. These short few weeks rank among the most extraordinary times in the financial markets that I can recall over the past 30 years. In January 2018 I had seemingly countless conversations with friends and colleagues who all expressed their exuberance over the meteoric rise in their investment portfolios. In fact, it seemed that virtually nothing could – or would go wrong in the markets! A global economic expansion fueled growth in gross domestic production in virtually every market. Reported corporate earnings were handily besting analyst estimates. Interest rates were low and not threating to increase rapidly. Stock market volatility was historically low. What a wonderful world indeed.
But what a difference a few days make! While the Dow Jones Industrial Average had posted an astounding 5.8% increase in the month of January 2018 alone (A more than 90% annualized return), it even more quickly entered “correction” territory (a 10% decline in value) in only 5 short days in February 2018. You can see on the chart below just how dramatic the “returns” were in January, followed by the even more dramatic “correction” last week. Suddenly my financial market conversations all seemed to center around the right time to “get out” of the markets!
It sounds silly, but last week I actually found myself longing for the “good ole days” of unwavering upward performance – which in actuality were occurring only last month! As painful as it might be to watch a sudden and dramatic decline in the markets, I hope that a little sanity and perspective will ultimately rule the day. Here’s what I see: The fact of the matter is that even after the recent decline, the Dow Jones Industrial average is basically back to where it began 2018.
I hate to say it, but I probably needed a reminder that markets do not move in one direction forever. Things change. And things can change rapidly. One of my favorite quotes concerning day to day market uncertainty comes from legendary investment commentator Louis Rukeyser who prophetically said, “Markets will fluctuate.” He continued saying that, “Sometimes they ‘fluc’ down, other times they ‘fluc’ up.” How true.
So what caused the sudden shift in investor sentiment? Well, personally I believe in large measure the markets simply “got ahead” of themselves in January. They went up too far, too fast. There are some other significant drivers for sure, but at the core of the matter – the markets were too hot. Simple. All of the good news that I noted at the beginning of this writing remains to this day, except for one point – the rate of change in interest rates has increased significantly.
The chart below shows the yield on the 10-year Treasury bond. Since the end of 2017 when the 10-year rate was 2.405%, rates have increased 45 basis points (0.45%) to 2.857%. That might not seem like a significant change overall, and that rate is still very low by long-term historical standards. But consider this rate of change in percentage terms. Since December 2017, the yield on the 10-year Treasury Bond has increased nearly 19%. Almost everyone would agree that is a very significant change.
The impact that this increase in rates will have on the economy, in the long run, is not known with certainty. But generally speaking, we know that higher interest rates make it more expensive for consumers and corporations to borrow money, which in turn has the effect of reducing economic activity. Will this increase in rates cause a significant downturn in the economy? I don’t think so, no. But If rates continue increasing at this rate, borrowing for anything (cars, homes, student loans, consumer credit…) could get really, really expensive. That could hurt. And because it can hurt, that in my view is largely why the markets chose to retreat last week. 1) The stock market had enjoyed an absolutely fantastic (too fantastic) increase in the previous several weeks and 2) Investors became increasingly concerned that rising interest rates would slow economic growth (and company earnings) in the future.
So what should we do? Buy the dip? Sell everything and safeguard our portfolios in cash? I wish I could say for sure what the markets will do tomorrow or the next day, or next year. But I can’t. I really don’t think anyone can. But what we all can do is execute our own predetermined investment plan. That is how to succeed in the long run, and that is exactly what we should all be doing right now. Of course, this means you need to actually have a plan to execute. The time to think about an investing strategy is not when the markets are gyrating wildly. The time to think about what to do in times like these was actually long, long ago. A time when you developed your own investing strategy with trusted advisors in the calm reflection of your long-term financial goals and needs.
Keep calm. There are plenty of beautiful places in the world. Even outside of Kansas.
About the author: Paul B. Lasiter currently serves as Vice President of Finance and Debt Capital Markets at Pepperdine University. He was Vice President and Chief Financial Officer of Pepperdine University from 2006 - 2017. He has also served as Pepperdine University’s Controller from 2002 to 2006. During his tenure as CFO, Mr. Lasiter was the chairman of the Retirement Plan Committee, overseeing over $476 million in assets. Paul earned his B.S. in Accounting from Pepperdine University’s Seaver College in 1988. He also completed the Presidential and Key Executive Program at Pepperdine University’s Graziadio School of Business and Management in 2005, earning a Master of Business Administration degree. Paul began his career in public accounting with KPMG Peat Marwick and later served as Senior Vice President and Corporate Controller for Imperial Credit Industries, a publicly traded diversified financial services company. Mr. Lasiter is a Certified Public Accountant, a Chartered Global Management Accountant and has over 29 years of banking, finance and investment experience. Mr. Lasiter has also obtained certifications as an Accredited Fiduciary Investment Manager and a Certified Trust and Financial Advisor.