Welcome to the ETF Prime Podcast

Headlines, The Fed, & Investor Behavior

If 2018 was noteworthy because nothing in an investment portfolio seemed to work, 2019 is striking in that nearly everything is working.  Most major asset classes were positive in the first quarter, in stark contrast to last year when only cash and select areas of the bond market offered salvation.

Most investors will vividly recall the S&P 500 declining 20% from September 20^th to December 24^th of last year.  Since that time, it has risen 21% through the end of March.

The wild stock market action over the past six months provides yet another crash course (pun intended) on the importance of good investor behavior.  With stocks nosediving in December, investors were greeted with headlines like:

Stocks on track for worst December since the Great Depression – CNN, December 2018

Ron Paul: Brace for a market meltdown that may rival 1929 crash – CNBC, December 2018

Are You Ready for the Financial Crisis of 2019? – New York Times, December 2018

 

Even after a nice holiday week stock market bounce, 2019 kicked-off with more of the same:

2018 Was A Stock Market Crash Test. Don’t Be A Dummy – Forbes, January 2019

Hedge-fund veteran Mark Yusko is predicting a ‘dreadful bear market’ in 2019 – CNBC, January 2019

The Bad Stuff That the Stock Market Worried About Is Starting to Happen – Bloomberg, January 2019

 

It’s possible these frightening prognostications may prove correct, even if unlikely.  We don’t know, because nobody can predict the future.  But investors who overreacted to the most recent batch of headlines would have missed the S&P 500’s best quarterly performance in nearly 10 years and the strongest first quarter since 1998!

Investing is never easy.  Doomsday predictions have been a mainstay as stocks have soared to new heights from the depths of the financial crisis.  Some refer to this as stocks “climbing a wall of worry”.  Negative headlines create uneasiness, resulting in a number of investors sitting on the sidelines while more fully committed investors profit from a generally positive environment.  Speaking of “easy” and “headlines”, this seems like an opportune time for one of our favorite charts…

Source:  Morgan Housel

 

The point is there will always be a reason for investors to misbehave, which is why a disciplined investment plan is so important.  More on that in a moment.

Source:  Real Life Adventures by Gary Wise and Lance Aldrich

 

 

So What Caused This Quarter’s Stock Market Reversal?

While trade tensions and a slowing global economy were concerns last year, market declines were mostly attributed to an overly aggressive Federal Reserve.  The Fed hiked interest rates four times, including at their December meeting where they projected two additional rate hikes in 2019.  They were also busy selling assets (reducing their balance sheet) as they continued winding down their “quantitative easing”.  All of this despite indications of a softening economy.

However, at their January meeting, they began reversing course by holding rates steady and emphasizing a “patient” approach moving forward.  Fed Chairman Jerome Powell said “the case for raising rates has weakened somewhat”.  This was only a month after raising rates!  Then, in March, the Fed indicated there would be no further rate increases in 2019.  In the span of three months, the Fed flipped from hawkish to dovish.

There are two key takeaways for investors:

1. The Fed is one of the most powerful institutions in the world, with all of the latest tools and information at their disposal. If they can’t read the tea leaves and properly gauge economic and financial market health, how can investors be expected to?
2. Market reactions to policy decisions highlight the Fed’s influence. A 20% stock market decline followed by a 21% up move appears mostly tied to Fed decision-making.  Politics aside, there’s a reason President Trump – who holds what is generally believed the most powerful position in the world – has been sparring with the Fed over rates.  Ask yourself who holds more power?  There’s an old market adage, “don’t fight the Fed”.  Basically, when the Fed takes an accommodative stance, investors should go along for the ride.

The point is headlines, economies, and markets can shift so quickly that it’s difficult for even the Fed to keep up.  More importantly, investors have no control over Fed policy decisions which can have a major impact on the economy and stock market.  And… even if investors could correctly predict what the Fed might do, the economy and stocks don’t always react as anticipated!

Which brings us back to a disciplined investment plan.  We can’t control the headlines or the Fed, but we can control our approach to the financial markets.  New, scary headlines will populate financial media in the coming weeks and months – inverted yield curves, Brexit, the Mueller investigation, and more.  Our focus will remain on executing the investment plan we have in place for your specific situation – one that doesn’t involve reading the headlines.  Vanguard’s Donald Bennyhoff may have said it best:

“Perhaps we can best help investors by explaining that the headlines they should pay attention to are the headlines of their lives, not the headlines in the news.”