December 17, 2018 Letter to Clients

I hope you and your loved ones are enjoying a joyous holiday season, in good spirits and excellent health. If you are finding time to watch your favorite holiday movies you may recall our letter from earlier this year in which we compared the anticipated market performance of 2018 to that of a movie sequel of 2017, the sequel is not bad but not nearly as good as the first. That cautious optimism going into 2018 proved to be warranted as the stock market has taken investors on a less than joyful ride as of late, which will be the topic of this last letter of the year.

Keeping Things in Perspective: Survey the Landscape

Despite some resolution from the midterm elections last month, volatility has continued to plague the market as macroeconomic and geopolitical factors have weighed heavily on stock market direction. The recent sell off in the stock market has been fueled by uncertainty over global trade policy, rising interest rates and other headlines that have been surfacing in the news. The hefty dose of fiscal stimulus from the tax cuts of last year and a healthy consumer kept the U.S. inoculated from the slowed growth of China, Europe and the rest of the world for most of this year; however, the potency is fading leaving the markets and the economy more reactive to the slowing global economy and continued interest rate hikes from the Fed. While these issues are the same ones the market has wrestled with at different points this year, the market is struggling to find its footing as these issues are now coming to a head simultaneously.

Don’t Listen to Headlines: Study the Bottom Line

Mixed messages surrounding the ongoing trade tensions with China have caused anxiety and uncertainty in the markets. Even with the recently announced 90-day cease-fire for the proposed tariff hikes set to increase from 10% to 25% on $200 billion of Chinese goods, the markets have reacted with turbulent market swings as they await greater evidence that the U.S. and China are serious about resolving their trade differences. But the recent market activity is not a result of something critically wrong with the economy. So far this year, the U.S. has imposed tariffs on about half of all Chinese imports into the U.S., amounting to approximately 0.3% of world gross domestic product (GDP) according to the International Monetary Fund’s (IMF) latest estimate of output. Still, the current amount of imposed tariffs isn’t nearly large enough to offset this year’s projected growth as the U.S. economy is expected to deliver 3% real GDP growth in 2018. While we do expect global growth to slow in 2019, it is important to note that economic and earnings fundamentals remain positive.

We often hear the terms earnings reports and earnings season discussed when listening to financial news and market commentary. It is beneficial to understand their relevance and the role they play in the stock market as they are strong indicators of the general health of companies tracked by major indices. So, what are earnings? Simply put, a company’s earnings are its profits. Earnings season, which happens four times per year, is Wall Street’s way of evaluating those profits, much like a school report card. Generally, when companies report strong earnings the stock price moves up, and vice versa. These numbers ultimately drive individual stock prices, and by extension, the overall stock market.

We track the earnings reports from the S&P 500 as it includes 500 of the largest companies whose stocks trade on either the New York Stock Exchange or the NASDAQ, and they are often a barometer for the health of the economy. As of the date of this letter, 99% of companies have reported earnings for the third quarter of 2018 with the earnings growth rate estimated to deliver over 25%. This is an improvement in earnings relative to the third quarter of 2017, with over 77% of companies reporting earnings above analysts’ expectations. However, as we have seen in the markets lately stock prices are not getting the boost they typically do when companies report better-than-expected earnings. The record-breaking sales of Black Friday and Cyber Monday, delivering $6.2 billion and $7.9 billion in online sales respectively, provided a post-Thanksgiving bump; however, the festive cheer of the holiday season has been notably absent from the equity markets so far in the fourth quarter due to growing concerns over U.S.-China trade policy and other political theatrics.

As we enter 2019, we’ll also be monitoring the Federal Reserve (Fed) as they attempt to reach a neutral level for its benchmark federal funds rate, what banks charge each other for overnight loans. The Fed’s job is to try to steer economic growth forward while keeping inflation in check without over stimulating or choking growth. Although the Fed has signaled in the last few weeks that they are closer to neutral in, we expect they will still raise interest rates one or two more times between now and mid next year, which is less than previously expected. This typically translates to an increase in the overall markets and should benefit investors in the short and long-term.

Investing with Discipline

Many of us still can’t shake the memory of the Great Recession of 2007-2009 and the effects of its severe market downturn. It was for many a storm of unemployment, foreclosures, evictions, and bankruptcies. And with the recent rout of market volatility, many investors are asking if the next recession is around the corner. In recent years, the stock market has churned sharply and entered several corrections on the back of booming corporate profits and strong economic growth before hitting new highs. While volatility is expected to continue as it is a normal part of the investing cycle, we expect the markets to find their footing as uncertainty subsides over the trade differences between the U.S. and China and if the Fed signals rates are at an appropriate level. While we do see a recession potentially occurring in the future, we do not expect it to happen within the next 2 to 3 years based on our research and conversations with leading economists. More importantly, the environment we are in currently is not the same as it was during the Great Recession. Messy markets such as these are frustrating, but they also serve as an important reminder. While market losses can be disconcerting, allowing emotions to drive decisions and reacting to where you think the market is headed may compromise long-term returns.

The Importance of Staying Invested

The graph below shows a hypothetical example of $100,000 invested prior to the 2008 Financial Crisis, and how three different investment approaches faired during the downturn and through the recovery into 2018. Keep in mind that the example below uses index data to illustrate this principle and does not represent actual performance of an account or investment. It does, however, demonstrate that stocks have proven resilient in the past and have generated positive returns over the long term. As Warren Buffet once said, “Be greedy when others are fearful.”

Stayed the Course: Invested $100,000 in January 2007, ending with $238,447
Exited the Market & Reinvested After 1 Year: Invested $100,000 in January 2007, ending with $155,356
Exited Market and Invested in Cash: Invested $100,000 in January 2007, ending with $55,125

Markets respond to numerous forces, making timing the market complicated and risky. Investors who panic during a downturn often miss gains early in the recovery as their initial reaction is to get out of the market. When investors sell out of the market during a downturn, it can prove disadvantageous as they often miss out on opportunities and do not know when to get back into the market. Market volatility is also largely out of our control.

As your advisor, it is important that I do not make knee-jerk reactions to market volatility as this can hurt clients’ portfolios in the long-term. While it may be tempting to concentrate on losses, great opportunities are created in ugly market pullbacks as it creates opportunities for investors to buy low. I have seen many volatile periods throughout my career, which has taught me that none of us can predict what the market will do in the short term. As an investor myself, I too weather the same market volatility and experience the same ups and downs in the market, but my experience has taught me that we must contain our emotions in both times of market rallies and market declines. To abandon sound long-term financial plans over fears surrounding short-term issues is counterproductive to creating wealth over time. Your financial plan is in place for a reason, and it is important to remember that the market indices such as the Dow Jones and the S&P 500 are not an accurate gauge of your individual portfolio performance. Our approach is to perform extensive research behind the scenes and make sure that we focus on sound fundamentals, maintain balanced portfolios and employ good asset allocation specifically designed to meet each investor’s needs. Every investor handles market corrections differently and I understand it can be difficult to ride out volatility, but we must stay disciplined and maintain perspective so that we may invest intelligently with your financial goals in mind.

There’s a mythical phenomenon in the stock market that you hear a lot about this time of year referred to as the Santa Claus rally, which is a historically bullish time for stocks in the closing days of the year and the first days of the year following. With stock prices and valuations being as low as they are currently, this is something we could see occur before the end of the year as this has occurred in markets such as these in years past, and certainly something we are hoping to see for our clients.

We always strive to do our best for our clients’ portfolios during all market conditions, and while we focus on the short-term issues, we continue to look ahead in the markets and position portfolios accordingly. It is important that we follow a carefully planned set of guidelines as it results in a higher success rate than those who act on their emotions. As your financial advisor, it is my job to help guide our clients through this turbulence and I am here as a resource to address any concerns you may have. I invite you to contact our office so that we may address any questions and discuss our approach in safeguarding your financial future. We will be sending out another letter in the beginning of 2019 describing what we expect to see in the markets next year.

We would like to extend our gratitude for the continued trust and confidence you place in LePage Financial Group, and we wish you and your family a very happy holiday and wonderful New Year.

Sincerely,

Steve LePage

Indices mentioned are unmanaged and cannot be invested into directly. These are the opinions of Steven LePage and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal.