As you can guess, December was a busy month for the Investment Policy Committee (IPC)! Based upon our view that many of the major economies around the world, including the US, are in the later innings of the economic cycle, we have continued our trend of reducing risk.
While our exposure to growth focused companies has served us well for the last several years, over the Summer we repositioned our international stock holdings to focus more on slower growth / higher dividend ‘value’ stocks, and away from what has been a multi-year focus primarily on ‘growth’. In August, we also sold the last of our holdings in ‘high yield’ bonds and shifted those assets to higher quality companies, higher rated bonds and bonds with longer duration.
We track technical indicators for the markets, and at the end of September with stock market at new highs, we shifted from our ‘invest-cash’ to our ‘hold-cash’ pattern. This change was also reflected in technical views for the energy / oil sector. On the 1st of October we took advantage of a sell signal and eliminated our exposure to energy / oil and shifted the proceeds from this sale into cash.
In our view, the declines that started in the month of October brought about a change we feel is likely to be predominant in the markets for the foreseeable future. This is an increase in volatility based on a change in investor view from the ‘glass 1/2 full’ to the ‘glass 1/2 empty.’
In the ‘1/2 full’ (risk on) view, the focus is on stronger future economic growth translating into strong corporate earnings. In the ‘1/2 empty’ (risk off) view, the focus turns to slowing global growth and lower earnings forecasts. Couple slower growth with higher rates of return for ‘safe’ investments (cash, bonds) and logical investors shift from ‘risk-on’ to ‘risk-off’ even though there is little change in the actual economic activity. (the level of the liquid in the glass is still at the 1/2 way point)
As December continued to unfold, and the technical condition of the markets remained negative, we continued with our ‘hold cash’ pattern. We also took advantage of tax loss harvesting; shifting a sizeable amount of money to cash. Also in December, we sold one of our alternative holdings, across all accounts, and shifted those assets to cash. Year-end capital gain distributions from several of our holdings have paid, and we have directed those assets to cash as well.
On December 19th we heard from the Federal Reserve announcing a widely anticipated 1/4 point rate hike, and at the same time they confirmed the likelihood of two more hikes (down from three) in 2019. Add together the comments from the Fed, concerns about Trump, China slowdown, tariff war, Brexit, the EU, another Government shutdown, etc. and the glass 1/2 empty / risk-off thinking became justified.
As December came to an end, the markets continued to set new lows and we have remained in our ‘hold-cash’ pattern. As 2018 wrapped up, we will likely be sitting on the largest cash position we have had in years. Clearly, the market has lost a confidence in the staying power of earnings and the health of the economy. Otherwise, stocks today look very attractive relative to just about any other risk asset.
With the decline starting in early October, the P/E ratio of the S&P 500 (using Bloomber’s measure; based on a 12-month trailing earnings from continuing operations) has fallen from a high of 23.3 last January to 16.4 currently. To put this into perspective, today’s P/E ratio is now below the 60-year average of 16.9. Looking ahead, the S&P 500 is priced at about 14.2 time 1-year forward expected earnings. In short, during 2018 the economy grew 3%+ and stocks have fallen from an overvalued level to a level where they are historically cheap.
As we move forward in 2019 we will continue to seek opportunities while remaining focused on our long-term investment objective of achieving a more consistent rate of return over full economic cycles.
We have proactively adjusted our investment allocations ahead of the significant declines seen in the last 3 months.
If you would like to learn more about Buttonwood and our Family CFO services, please give us a call today at 816-285-9000!