December 6, 2018

The past two months of slow market decline have brought our firm’s returns down, from the first of the year, to approximately -5%. The real question is: what’s causing this short-term decline in what we believe is a very long-term secular market? We believe there are two main reasons.

First, the trade dispute with China has definitely spooked investors. Last night’s arrest of a prominent technology company executive in China whose father, her company’s founder, has apparently been engaged in transferring harmful technology to Iran, exasperated the fear over the Chinese trade dispute. The market moves strongly on fear as we’ve seen many times. Yet, rarely have we seen strong moves in a vibrant economy as healthy as America’s is now. But that arrest, and the pending extradition of that individual to the US, did not provoke an overt reaction from China. China is working diplomatically with Canada to try and stop that extradition. But China’s Trade Minister this morning made optimistic comments about China’s ability to reach a satisfactory conclusion within President Trump’s 90-day limit set during the G-20 conference in Buenos Aires. If that arrest event had been unsettling to the trade negotiation, I can assure you that the Chinese would have advertised that early this morning. Therefore, the extra fear induced in the market’s morning movements, and what is evident “capitulation selling” today (capitulation selling is defined as high volume selling across the board in nearly all securities), likely indicates we are at the market’s low point today – or will be in the very near future.

The second reason for the market’s troubles over the past month, and today, is the recent move of the 2-Year Treasury Bond yield above the yield of the 5-Year Treasury bond. This benign and non-harmful move has spooked worried investors into the fear that we are to see a yield curve inversion, which is more commonly defined as the 2-Year Treasury bond yield being higher than the 10-Year Treasury bond yield. For many, many valid economic reasons, I do not believe this will occur. But the fear that it could occur springs from the fact that yield curve inversions could occur in conjunction with an actual economic recession. While that is certainly true, it’s even more true that during actual yield curve inversions (which we don’t have now and are not likely to see) stocks, on average, have appreciated approximately 21% over a median 19 months following the yield curve inversion! Please see the graph below.

So, these two factors, China worry and a non-existent yield curve inversion, have caused an emotional reaction this morning which led to what I believe today is a final day of significant short-term losses. We have to keep in mind that the value of your investments will follow the economy’s growth long-term. But, short-term, you will see correction events like these past months approximately one to two times per year. The point where we will liquidate assets and dive out of markets, on your behalf, will be when we perceive an actual economic recession. It is nonsensical to allow these illogical short-term market movements to affect your piece of mind or your sleep. I am absolutely convinced, with all the economic evidence in front of us, we should conclude that this short-term negative return event will be followed by new all-time highs in the near or immediate future.

It is our belief that the Chinese trade dispute will end within the President’s 90-day deadline. That will cause a strong upside movement in the markets as the emotion and fear are drained out of the valuations of your securities. It is also our strong opinion that a yield curve inversion will not occur, but if it does, we’ve got a median of a year and a half to benefit from well above average market returns prior to any economic slowdown.

Smart investment involves buying great assets and great companies and turning off the willy-nilly meandering markets and the news. If we did not do that, then we would tend to buy high and sell low. That’s not conducive to the great long-term returns that our clients have historically obtained. Remember, while your account is down significantly in recent months, it’s only off approximately 5% from January 1st of this year. That could literally be reversed in a matter of days.

Lastly, our single largest portfolio industry segment, banking, has negatively impacted our portfolio values this year. This is related to the market’s fear of yield curve inversion because banks need to be able to lend money out to others at a rate higher than their short-term deposit rates. The difference between what they lend money out at, and what they pay for the money they have to lend, is called the net interest margin. The larger the net interest margin, the more money banks make. Banks stocks have been especially hit because, again, of an unwarranted fear of an interest rate inversion that has not occurred between the 2-Year and 10-Year maturity and is not likely to occur. Tomorrow, OPEC meets with Russia to clamp down on oil supply. That will likely cause oil prices to go up significantly, raising inflation expectations, and thereby drag interest rates higher so that the 10-Year bond, once again, goes well above 3%. When this occurs, you will see a dramatic move on bank stock prices. Current bank stock valuations are approximately half of the average New York Stock Exchange holding. What that means is that your bank holdings are selling at a very significant discount, with dividends above 3%, and, in my opinion, with an expected upside move of more than 30%! Short-term pain for long-term gain. That’s life and if we stay the course, it will be proven again for you in the valuation of your portfolio.

It’s always a pleasure to have the opportunity to communicate with you in these letters, but it’s even more fun for me, and the wonderful people I get to work with, to speak with you. If there are any questions, or if any other information is needed, please feel free to call me, or any of our staff. God Bless and Merry Christmas!

Warmest Regards,

C. Kelly Buckley, MBA, CFP
Managing Principal
Managing Director for Asset Management

Integrity. Commitment to Service. Standards of Excellence.

Spectrum Financial Alliance, Ltd., L.L.C (“Spectrum”) is a Registered Investment Advisor. This letter contains general information that is not suitable for everyone and should not be construed as personalized investment advice. Past performance is no guarantee of future results and there is no guarantee that the views and opinions expressed in this letter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. If your financial situation or investment objectives have changed or if you want to impose and/or modify any reasonable restrictions on management of your accounts, please contact our office at 859-223-6333.