During WWII when fighter pilots would return from a battle, they would often put additional armor over the parts of their plane that had sustained bullet holes, such as the wings. It took a statistician named Abraham Wald, however, to realize the flaw in this logic. He realized that if the planes had returned with an above average number of bullet holes in their wings or side then those parts of the plane could endure more damage than the more integral parts such as the engine – the part of the plane where the non-returning pilots were presumably hit. The returning pilots were distracted by what was most visible rather than what was most impactful.
As we continue to enter the late stage of this bull market, it is clear that many investors are focused on the eye-catching damage that geopolitics is having on the market rather than focusing on the market’s engines. To be fair though, let’s address both:
The Headlines - Geopolitics:
- Impeachment: On September 24th, Nancy Pelosi announced that there would be a formal impeachment inquiry of President Trump. While such an inquiry will likely enliven both Republican and Democratic voters, it is unlikely to lead to the removal of the president as long as Republicans continue to retain a majority in the Senate. More importantly, however, from an investment perspective this process is unlikely to have a large impact on the market. Although we admittedly don’t have many data points, both the Nixon and Clinton impeachment process did not alter the trajectory that the market was taking prior to the impeachment announcements. (1)
- Trade Conflict: Although the trade conflict does have very concrete effects on the economy and the stock market, we believe that investors are pricing in too large of an effect. In particular, investors seem to be holding their breath with an expectation of an extreme outcome; namely, a deal that addresses all the unresolved issues or a disastrous no-deal scenario. In reality, both the US and China leadership have short-term incentives to come to the table. For example, President Trump does not want the trade war to upset the economy further going into the election year while President Xi Jinping would like to bring in American agricultural exports again as China now has a 10-million-ton deficit of pork due to the African swine fever currently infecting its livestock. (2) That being said, neither side will likely be able to address the main conflict points which revolve around intellectual property, foreign investment, cyber-security, and human rights. As a result, we expect the US China tensions to continue over the long-term.
The Market “Engines”:
- Corporate Earnings: Analysts now expect the corporate earnings of companies within the S&P 500 to decline by -4.1% compared to this time last year. If these predictions are accurate, this would be the third quarter in a row that corporate earnings have declined. (3) While this does indicate that the market is slowing down, it does not necessarily mean that we are headed for an immediate recession.
- How to Invest: We are in a unique period when the global economy is slowing down but the stock market has not declined in correlation. As a result, investors should use this time to diversify their portfolios. In particular, investors that cannot afford to ride the market through a correction should increase their exposure to bonds. Since bonds provide a steady stream of income and are often less volatile than equities, they are able to provide more safety. In fact, in down markets bonds have been the best performing asset class, returning 9.2% across all bear markets since 1972. (4)
- Interest Rates: In our previous newsletter we discussed the effect that lower interest rates will have on the economy so we will not focus on this too much more except to say that the trend continues. Since July, the Federal Reserve has continued to lower interest rates as have the other monetary leaders around the world. The result is that it is now harder for investors to get substantial returns in their bank savings accounts.
- How to Invest: In our previous newsletter on this topic we focused on how individuals can adjust their investment portfolio (See “July Investment Commentary”). However, investors can also adjust their non-investment wealth. For example, with the lower interest rates, banks such as Chase and Bank of America are paying close to 0% on any money that sits in their savings accounts. This is a problem because with inflation the cost of goods and services is still rising at a 1.7%. This means that individuals are actually losing money in real value by having their savings sit in the bank.
- As a result of this poor return, we have had a striking increase in the number of clients asking to open “money market accounts.” These are accounts where cash can earn around 1.2% - 1.9% annually without paying any additional fees or taking unnecessary risk since the money is not invested in the stock market. This yield of these money market accounts does adjust with the interest rates as well but is likely to continue being significantly higher than that offered by the larger banks.
- Demographics: 2018 was the first time in world history that people 65 or older outnumbered children under the age of 5. This aging trend is even more pronounced in Europe, Japan, and the United States where one in four people will be over 65 by 2050.(5) More developing countries such as China are also beginning to face issues as their populations age. As more individuals in these countries enter retirement, they will continue to reallocate their investments in order to achieve the income level they need to live.
- How to Invest: The lower interest rates will make it harder for these retirement age investors to achieve a reasonable return by saving in their bank accounts or investing in bonds alone. As a result, they will need to invest in the stock market with a focus on stable companies that have a history of paying dividends in order to meet their income needs. We believe dividend-paying stocks will be strong performers over the long-term due in large part to this demographic shift. Additionally, dividend-paying stocks have the benefit of adding protection in the near-term if there is a correction in the next three years. In fact, in the last 5 market corrections, S&P 500 companies that had increased their dividend for 25 years or more consistently outperformed the wider market. (6)
As we enter the final months of 2019, we are likely to see continued changes in the market environment. The above commentary is just a reminder not to over fixate on the headlines that are posted on news channels and social media. By focusing on the many “engines” of the market, a smart investor can invest with a long-term perspective.
As always please do not hesitate to reach out if you have any questions about your investments, money market account, financial plan, or overall goals.
Wishing you and your family a wonderful holiday season,
The Glen Eagle Investment Team
1. Fortune Magazine: “Would the Stock Market Care If the President Was Impeached?” 09.28.19 2. Bloomberg: “Pork Shortage: China Faces Deficit of 10 Million Tons” 10.07.19 3. Investing.com: “S&P 500 Earnings Season Preview: Risks Abound” 10.08.19 4. BlackRock: Student of the Market: October 2019 5. United Nations: “Global Issues_Ageing” 6. ProShares: “Dividend Growth Suite – Drawdowns & Recoveries” 02.2019
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.