From your Gilbert & Cook Investment Team
The downward slide of U.S. and global equity markets came swiftly in the first 12 trading sessions of 2016 (1). The worst start to a year ever. During a streak of tumultuous days like this, it is important to separate fear from facts. Sentiment from fundamentals. Emotion from discipline.
If supported by an extreme change in market fundamentals, the extent and trajectory of the January slide would say there is a high probability of a near term U.S. recession. The Investment Team at Gilbert & Cook does not share this view. The U.S. economy has created an average of 217,000 jobs per month for the past 4 years (2). Unemployment currently sits at 5%. (3) The Housing Affordability Index is near a 40 year low (that’s a good thing) as measured by the average mortgage payment as a percentage of household income. The consumer is strong.
Preliminary reading from the Bureau of Economic Analysis has the U.S. posting full year 2015 gross domestic product growth of 1.8%. A slowing pace, but not a retreat. The International Monetary Fund’s most recent global economic forecast for 2016 is +3.4% growth. A far cry from any recessionary fears. Slow and steady growth is healthy. Capital is deployed prudently in such an environment.
Headlines out of China would have you worry that a slowdown in their economy will pull the U.S. into recession. Again, not the case in our view. All U.S. exports account for 9.3% of our GDP and China is less than 2% (4, 5). If China exports went to zero our GDP in 2015 would have grown by 1.76% instead of 1.8%. And our strong U.S. dollar makes imports from China relatively less expensive.
The Federal Reserve, albeit with fleeting conviction, started raising rates in December and paused in January. We believe the Fed has telegraphed a gradual rate increase plan because they see a sustainable economic expansion in the U.S. When Alan Greenspan raised rates 17 times from the summer of 2004 to the summer of 2006, Fed funds started at 1% and finished at 5.25% (6). The S&P 500 index was up +12% over that same timeframe (7). Chairman Janet Yellen of the current Fed would like to see a longer term target of 3 to 3.5%. Still fairly accommodative from a historical perspective. And by many estimates, it will take several years to approach that target.
Low oil prices have been a double edged sword for some time. On one hand, the energy sector (representing 10% of the S&P 500 index) has seen profits crater. But on the other hand, the oil recession is a boon to consumers and businesses utilizing cheaper energy. A very tough argument if you live in Houston, but earnings in the other 90% of the S&P 500 have continued to expand nicely. Unlike the housing industry in 2008, energy businesses going through profit contraction help other areas of the economy. Oil consumption has actually continued to expand, but a glut of supply is depressing oil prices.
Fear based selling is heightened by those investors with too much of their portfolios devoted to risk based assets. A disciplined and well allocated portfolio matching investments with goals and time horizon allows for staying power during periods of “normal” price volatility. As many of you have heard us explain in person, the S&P 500 index has had an average pullback of more than 14% each year for the past 36. Nothing in the near term has been outside of those normal swings. We view conditions as positive for equity investors over the long term, but there will be short term testing of those convictions. Our goal as a firm is to help create confidence in the things we and our clients can control. Please don’t hesitate to call any member of our team for answers specific to your situation.
1 - S&P Dow Jones Indices
2 - Bureau of Labor Statistics
3 - Federal Reserve Bank of St. Louis (FRED) https://research.stlouisfed.org/fred2/series/UNRATE?utm_expid=19978471-2.Y0NpAPxIQfK_8K7-O4DTQg.0&utm_referrer=https%3A%2F%2Fresearch.stlouisfed.org%2Ffred2%2Fsearch%3Fst%3Dunemployment
4 - International Monetary Fund
5 - Federal Reserve Bank of St. Louis (FRED)
6 - Federal Reserve Bank of New York
7 - S&P Dow Jones Indices