1st Quarter 2019: Lost in the Woods

Lost in the Woods

On a recent Saturday morning, my youngest son, Charlie (11), announced that he was going on a solo expedition in the woods on our farm. We were enjoying our family breakfast when he filled us in on his plans for the day. “I’m gonna build a shelter, shoot my BB gun and do some exploring. I’ll be gone all day but I’ll take some snacks and you don’t need to worry about me.” My wife, Alice, immediately protested, “Gone all day? By yourself? It’s 34 degrees out there! Where exactly will you be? How far from the house? How will I know you’re okay? What if you get lost out there?” While our other kids and I traded amused glances, Charlie and his mother tussled over his plans for the duration of our pancake breakfast. Finally they settled on a compromise. Charlie doesn’t have a phone so Alice supplied him with a whistle. “When you hear me yell from the front porch, just blow this whistle to let me know you are okay. If you don’t blow the whistle, I’ll be coming out there to find you.” Charlie agreed.

I was scheduled to be away from the house for an event that day. When I walked outside to get in my car, Charlie was piling his provisions in his old Radio Flyer wagon. Among other things, his stash included his BB gun, a hatchet, some twine, a hammer and a few nails, a pair of binoculars, his slingshot, an old blanket, a camouflage hunting stool, his Harry Potter book and a squirrel call. His snacks consisted of an apple, some vanilla wafers and a can of Cheerwine (my wife is from Salisbury, Cheerwine’s headquarters, so there is always a six-pack in our fridge). Charlie was wearing his boots, jeans, camouflage jacket and his blaze orange hunting cap. He had two knives on his belt and I did note that he had the whistle on a string around his neck. He was definitely the tough little man in that moment and I could tell he was pumped up for his big day.

Late that afternoon I was making my way back home on I-77 when my phone rang. It was Alice. “You will NOT believe what happened!”

Charlie had been true to his word. He’d dragged his wagon into the woods at 9 a.m. that morning and was still gone four hours later. The whistle-blowing arrangement had worked fine. Alice would step out on the porch every thirty minutes or so and yell at the top of her lungs, “Chaaaarlieeeee!” And he’d blow his whistle. All was good. But then around 1 p.m.—I think you know where this is going—she called for him and got no response. “I immediately panicked,” Alice said. “Before I could get my shoes tied I had decided that he’d been dragged off by some scary man in the woods. I NEVER should have let him go into the woods alone!” As Alice described it, she bolted for the woods in the direction of his latest whistle calls. She didn’t go far before she found his campsite. He had built a shelter—a basic lean-to, made mostly from dead oak branches that he had leaned against the trunk of an old fallen cedar. Inside the shelter, she saw his book, apple, slingshot, empty Cheerwine can and binoculars, all spread neatly on the old blanket he’d used to make a floor. His BB gun was leaning against a tree, his blaze orange hat was hanging on a broken tree limb, and the topper: there was a small campfire beside the shelter. I said, “A campfire?” “Yes! And it was still burning!” Alice said. “What in the world,” I thought. “How did the little guy know how to build a fire?”

As you have likely surmised, our fearless frontiersman was nowhere to be found. Of course Alice had been yelling for him non-stop since his original failure to blow the whistle. Alice told me that she had proceeded to dash around the campsite in ever-widening circles, stumbling over brush and fallen logs with her heart in her throat. After a few minutes that probably seemed like much longer, she heard the faint sound of a whistle. And then, there was Charlie, trudging toward her through the woods with his little hatchet in his hand, smiling. “Calm down, Mama. What is wrong with you?”

Speaking of being lost in the woods, the recent behavior of the stock market has many investors feeling that way. Wouldn’t it be nice if we could blow a whistle to stop the action long enough to figure out what’s going on? I went back and read my commentary of just six months ago (Q3 2018) when the market was near an all-time high (the high was on September 20th of last year). That commentary included excerpts pulled from the commentaries written during the dark days of the financial crisis of 2008/2009.

My intention in sharing all that gloomy financial-crisis history was to encourage investors of today to keep their emotions in check and to remember that not all markets are bull markets. Just three months later, my Q4 2018 commentary was the polar opposite! As you’ll recall, the market plunged almost 20% from the September high to its close on Christmas Eve—“Merry Christmas,” right? That Q4 commentary encouraged investors to keep the discipline, stay the course, don’t get scared out of the market, etc. And now here we are three months later at the end of Q1 2019 with the market up more than 20% since the December low and within spitting distance of its all-time high again. I suppose the case can be made for again reprinting the gloomy commentaries of the financial crisis. But I’ll spare you.

The rally-decline-rally behavior of the market has many investors asking questions. Specifically, where are we in this long business cycle? Are we nearing the end of the ten-year advance in the stock market or does the bull have room to run? What’s all this conversation about an inverted yield curve? Will the trade dispute with China have a major impact on the US economy? How worried should we be about Brexit? Why the abrupt about-face on rate increases by the Fed and what does this mean for market predictions? While we think Yogi Berra was right when he said, “It’s tough to make predictions, especially about the future,” here are a few thoughts that might be helpful as you ponder the many questions out there.

Old Age? At 117 months, this is the second longest economic expansion in recorded history. Even older, the bull market has been running for 120 months now, the second longest run in history. Is the end near? Possibly. But expansions and the bull markets that accompany them usually end as a result of economic events, not as a result of old age. In most cases recessions (defined by the US Bureau of Labor Statistics as two consecutive quarters of negative GDP growth), are caused by economic events including inflationary pressures, spiking interest rates, commodity price shocks, deflating asset bubbles or excess

Inverted Yield Curve: You may have heard that the Treasury bond yield curve became briefly inverted last month and that historically this has been a good predictor of an economic recession. An “inverted yield curve” is a complicated way of saying that shorter-term interest rates (on two-month borrowing, for example) are higher than longer-term interest rates (for ten years, for example). When shorter-term rates are below longer-term rates (a normal curve), banks can lend profitably as they borrow at lower, short-term rates and lend at higher, longer term rates. But once the curve inverts, the absence of profitability leads to a reduction in lending, contributing to a recession. In today’s environment, shorter-term rates have been pushed up by the actions of the Fed while longer-term rates have fallen primarily as a result of market participants predicting a weaker economic environment going forward. As Matt DeVries briefly discusses in Market and Economy, this indicator has been pretty reliable. Our takeaway from this data and from the fact that the Fed abruptly pulled the plug on its rate increases is that we are in the later stages of our current expansion.

The Other Stuff: As for Brexit, the China trade dispute, weakness in Europe, domestic politics and the kitchen sink of other issues we are currently worried about, we hang our hats on the fact that the market is usually efficient. That is, most of what can be known about these issues is already factored into stock prices. As they say, “If it’s in the headline, it’s in the price.”

Corporate Earnings: Ultimately market prices are driven by corporate earnings. And of course earnings are impacted by everything mentioned above. After growing at a frenzied pace over the last three years, S&P 500 earnings peaked in the third quarter of 2018 and now are expected to decline slightly in the face of moderate wage inflation, higher input costs (including higher interest costs) and friction resulting from trade disputes. First quarter market action points to investor confidence that companies can continue moving forward. We’re watching closely. We hope these comments are helpful. Spring is here! Enjoy those dogwood, redbud and cherry blossoms but don’t get lost in the woods! Thank you for choosing Bragg Financial.