The last month of October was a tough one for the investors. The S&P 500 went down more than 6% in just one month. The widely followed index almost gave away the returns for the entire 2018. The two main reasons that have spooked investor confidence are:
- Fear of Fed raising interest rate quicker than the economy can handle
- Trade tensions between US & China
Rising Interest Rates
The Federal reserve has raised interest rates 3 times in 2018 and they are expected to raise rates once more in the month of December 2018. The benchmark federal funds rate now stands between 2.00 & 2.25%. Let’s understand how rising interest rates negatively impact an investors bullish case:
- Rising rates makes borrowing expensive which leads to demand softening. As a result of these rate hikes, consumers are experiencing a spike in Mortgage rates which recently hit a 7-year high and now stand at over 5.1% for a 30 year fixed mortgage. US Existing Home Sales have been declining since March of 2018.
- Rising interest rates make risk free investment options like CD’s, Treasury Bonds more attractive. 10-year & 30-year Treasury yield is at 3.21% & 3.45% respectively.
For the last decade, Stocks as an asset class haven’t had much competition. With interest rates near zero, investing in the stock market was the only viable option available to the investors. Now they have a competitor and so naturally, investors want to rebalance their portfolios by selling stocks and buying Treasury Bonds & CD’s.
Is the market oversold?
In my opinion, yes the market is in oversold territory. I understand that the interest rates have gone up but they are still not enticing enough for me to switch from stocks to bonds. For earning a 3.45% return (before taxes and adjusted for inflation), one has to tie up the money for 30 years and if we adjust the return for taxes and inflation (which stands at 2%) then we are hardly making any money. On the other hand, we can buy business like Google, Apple, Boeing, Home Depot and more companies like these which are growing at mid-to-high double digits and also return a respectable annual dividend.
Trade tensions between US & China
The trade tensions between US & China are temporary and will be resolved one way or the other:
- Businesses will move to other countries in South-East Asia like Vietnam and South Korea. On the last quarter’s earnings call, Home Depot’s management team told investors that washing machine manufacturers are already relocating to South Korea. A couple of weeks ago, CEO of Brooks Shoes, A Berkshire Hathaway company, told reporters on CNBC that they are looking to relocate manufacturing to Vietnam and that such move will be permanent. American businesses are very strong and resilient, if the governments of US & China don’t resolve the dispute soon then the business owners will resolve it for them, especially to the detriment of China.
- President Trump likes to win and he can’t win if the stock market at home is going down. So far he has maintained a tough stance on China but I think he wants a deal, he wants to resolve this issue as soon as possible so that he can start tooting his horn. He is coming to the half-way mark of his presidency and is gearing up for launching his bid for re-election. A deal with China, irrespective of its substance, will appeal to his base.
When the dust settles on these issues investors will realize that October was a great opportunity to do some bottom fishing. American economy is humming, small businesses are doing great and most importantly the consumer is feeling good. I would also argue that the American people haven’t realized the full benefit of the tax cuts yet. People will see fatter tax refunds next year due to change in child tax credit & increase in standard deduction limit. As an investor, I am excited to see how the market performs in the next 2-3 years and yes I am with the bulls. Happy Investing!
Disclaimer: These are my personal views and are for educational purposes only. Please do your own research before making any investment decisions or talk to a financial advisor.
