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Alas, the stock market correction we have been calling for is finally upon us. The S&P 500 is down approximately 7% from its recent high and the NASDAQ is down approximately 4% from its high. Technically speaking, the definition of a market correction is when the market trades 10% below its twelve month’s high. Given the volatility that we’ve become accustomed to, we could very well see an official correction……by the time I finished writing this! As you know, we took profit from positions at the end of 2017 in anticipation of the correction that is now taking place. As we mentioned in our most recent commentary, though we were happy with our Model Portfolio’s solid performance last year, we felt that at the end of 2017, the equity markets simply got ahead of themselves and advanced to heights that we did not believe to be sustainable. At year-end 2017, large amounts of money flowed into the markets in response to the tax cuts pushed through by Congress. The thinking was that these tax cuts rendered the market a 15% discount to valuation. Investors, particularly “fast-monied” Hedge Funds, rushed into the markets pushing valuations to high levels. The heavy supply of available cash boosted the share prices of companies that had been the leaders of the bull market causing the market to be, in our estimation, overvalued. We moved to protect portfolios by trimming position in companies and Exchange Traded Funds that we had significant profits in. Although we continue to have confidence in these companies and funds, we felt that, in the near term, the markets had moved too high, too quick and became vulnerable to a pullback. We are believers in the age old theories that 1) “you can’t go broke taking a profit,” and 2) “pigs get fat, hogs get slaughtered.” So though we are long term investors who rarely sell, trimming positions every now and then makes sense.
Most corrections start with some type of catalyst. The question has been, what would be the catalyst that would create the correction we have been anticipating? Would it be a misfire in North Korea’s aggressive agitation? The Mueller Russian probe causing political unrest? Or perhaps, good ole fashion “irrational exuberance” (greed) in the public markets? January and February of the New Year continued to bring higher highs in equity markets. Then came March. Three key events occurred that created the perfect storm: 1) The Federal Reserve increased rates in an effort to control inflation, 2) the president decided to place tariffs on foreign steel imports, setting up a trade war with the likes of China, and 3) the long favored darlings of the market - the Tech Industry – have had some self-inflicted problems causing a crisis of confidence and calls for oversight. The latter two catalyst have caught everyone by surprise and thus sent tremors through the markets. It is well known that there are no winners in a trade war. One thing is for certain though, the United States will always lose. The bottom line is that the United States is no longer a manufacturing-based economy, but rather a service-based economy. While consumers enjoy the prices they see at the likes of Walmart, Home Depot, Apple and auto dealerships, like it or not, one must understand that the vast majority of these products were manufactured outside of the U.S. Though we understand the “America First” mantra, historically speaking, tariffs put in place in an attempt to level the playing field, has never proven effective. The knee jerk response will be that those nations impacted by the tariffs will launch retaliatory tariffs. At the time of this writing, China has announced the products that they will place tariffs on, sending the market down over 500 points. Thus the beginning of a trade war. Should a trade war rage, the net result will be hyper-inflation on both sides that will surely price consumers out of the market and bring commerce to a screeching halt. Several industries will virtually shut down and employees will be furloughed. State and Federal tax collection on goods sold will come to a halt and hurt the U.S. domestic economy. I can continue. Again, there are no winners in a trade war. We believe that cooler heads will emerge and the United States and its trading partners will come together and negotiate in a way that will avoid or limit a protracted trade war, and thus sustain the global economy. Until then, there will be some short term pain that will show up in sales, tax collection, employment, and closer to home, monthly account statements!
And then there is the Technology Industry. The Technology Industry has been, and continues to be the growth engine of the United States. That is where the majority of U.S. job creation has occurred, and, it has grown to be the second highest producer of tax revenue for the United States, second only to the Oil Industry. The industry however is not without challenges as it is still in its infancy. Facebook was recently outed for what some consider abusive use of personal data. Uber and Tesla’s autonomous car divisions experienced accidents, and finally, AMAZON has become the latest punching bag of the president sending the stock price into a tailspin. We have performed substantive reviews on both Facebook and AMAZON given these events and have determined that while both positions may continue to come under further selling pressure, we remain bullish on the companies’ long-term prospects. As for the overall tech industry, it will also be adversely impacted by the pending trade war as much of the industry’s business comes from China. The bright side is that this weakness is starting to create some attractive buy opportunities. We will look to take advantage of this phenomenon as we see fit. Stay tuned.
In sum, certainly the first quarter of the year – in particular March – has given market participants a rude awakening. Markets do not go straight up forever. A pause, and/or correction is often healthy in the long run. Although we’ve tried to prepare clients and portfolios for this occurrence, nonetheless, corrections can be painful. We seek solace in the fact that the economy remains strong, unemployment low, inflation in check and corporate earnings are growing. With this backdrop, barring the unforeseen, we do not anticipate a severe or prolonged selloff. We remain vigilant in protecting portfolios on the downside, while simultaneously scouring the market for opportunities to take advantage of.
Feel free to contact me with questions, specific concerns or just to say hello! As always, we appreciate your vote of confidence and thank you for your business.