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“The most important thing in life is to stop saying 'I wish' and start saying 'I will.' Consider nothing impossible, then treat possibilities as probabilities.”
— Charles Dickens, David Copperfield

2-8-19

February 8, 2019

The main purpose of the stock market is to make fools of as many men as possible.
– Bernard Baruch (1870-1965), American financier

Late last December, we began a letter to you that was to be titled, “We Stand Corrected.”  We believed then, as we do now, that the fourth quarter, specifically December, was a correction within a bull market, not an end to it.  As we entered January, markets began turning around and pundits of technical analysis increasingly stated we’d be retesting the December lows.  We didn’t believe that either, but the market gains had us drop our earlier letter writing attempt, if only because we could not take credit for something Mr. Market itself remedied.

Market corrections, in other words, declines of ten percent or more, have historically occurred every eight to nine months.  The lack of market volatility was unusual last year, and certainly wasn’t a new normal.  Earnings were strong in 2018 and should be accommodating this year, which suggests last month’s fall is not telling us to find the nearest mattress to stuff our greenbacks in.  What particularly intrigued us, ok, irked us, was all the recession rhetoric.  We watched with disdain as these market prognosticators tripped over themselves for a microphone to extol their pessimism.  Granted, after such a strong start to 2019, and earning season more than half over, the market should take a rest, even pull back some, but Punxsutawney Phil predicts an early spring, and we prefer the mindset of the glass being half full.

This isn’t to say we’re blind to our surroundings.  We recognize car sales are healthy, but trending lower, and inventories have increased.  We noted what a five percent mortgage did to the housing market, though, rates have backed off modestly.   We see economies in Europe and China slowing, if not in recession.  This is a material reason for moving from portfolios diversified across various equity styles, to those that are substantially, if not all, large cap.  We do recognize increased risk, but the sky remains above us, despite what the cock-a-doodle-do of certain analysts offer.   

Of course, the markets would not have performed so were it not for the Federal Reserve.  For almost all of 2018, the expectation was the Fed would raise interest rates three times in 2019.  This had the market increasingly spooked, but after the December meeting, the Federal Reserve suggested they may not raise rates to that degree this year.  

Many saw this as Chairman Powell succumbing to President Trump, but we believe this Chairman can read and understand economic data, and he did what he should have done.  Markets were further assured after January’s meeting that the Fed may not be the enemy once feared.  Today, the market is assuming one interest rate increase in 2019 and sometimes not even that.

The focus now: China trade and politics, and not just any politics, but nasty, bellicose fights that demonstrate we’re anything but civilized and advanced.  The only solace we can take in such rancid behavior from our politicians in Washington is that we’ve not devolved to bloodshed, as they did in the Ukraine in 2010, the physical fighting in the Italian Parliament last October, the chaos caused by literally hundreds of South Korean lawmakers ten years ago, and so on.  How fortunate President Putin must feel to see any opposition to his policies as short lived…no pun intended.

Last year should have been a banner year for the markets.  The fact that they weren’t, when earnings increased over twenty percent, is historical.  If earnings grow, but prices don’t follow, then valuations decline.  Today, with a market P/E of under 16, we are reasonably valued, we have an expectation of increased earnings this year, albeit at a far slower pace than last year, and we still have an accommodating Federal Reserve.  If the U.S. and China come to trade terms, the market may well retest last year’s high.  If so, we may modestly reduce overall equity exposure.  We’re positive, but not naively so.  

We are consistently grateful for your trust and support.

Kindest regards.

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