The three key themes in the current market environment - a rise in volatility, inflation, and investor sentiment - are characteristics of a business cycle in its later stages. Taking Warren Buffet's rule #2 "Don't Lose Money" to heart, they make a comprehensive case for a late-cycle investing game plan which includes shifting away from stocks towards cash, % bearing assets and commodities and commodity-related stocks. - Robert Zurrer for Money Talks
Theme # 1 – Rising Volatility
Investors have been spoiled over the last two years with record low levels of volatility in virtually every asset class, causing some investors entering 2018 to throw caution to the wind as euphoric levels of greed crept into the market. The title to our quarterly newsletter was "Records Were Made to Be Broken" and the recent market decline has ended some of those records already. Using S&P 500 data going back to the Great Depression, the US stock market set a new record of going 311 days without a 3% decline and 404 days without a 5% decline. We are unlikely to repeat these feats any time soon as we believe investors should anticipate a more volatile environment going forward as we transition through a major turning point in global monetary policy.
In the aftermath of the Great Recession of 2007-2009, we saw central banks respond with unprecedented stimulus using zero-interest-rate-policy (ZIRP) and quantitative easing (QE) to expand their balance sheets to unimaginable levels. The collective result of these actions was an end to the Great Recession and the beginning of new liquidity-fueled economic expansions and bull markets around the world.
The global liquidity tide of easy money began to slow down first with the US Fed ending its QE program in 2014, eventually raising interest rates in 2015 for the first time since 2006. Along with a steady increase in rates, the Fed is also on track to shrink its balance sheet to the tune of an estimated $420 billion this year and $600 billion next year. Though President Trump has enacted a stimulative tax cut, as Dave Rosenberg recently pointed out (Lunch with Dave, 12/28/17), estimates project $140 billion in stimulus for economy-wide earnings this year with additional gains of $80 billion next year—a small offset to the liquidity drain from monetary policy.
Further adding to the monetary liquidity drain will be the European Central Bank (ECB), which is slated to end its QE program later this year. According to Wells Fargo, the combined purchases of the world’s two biggest central banks—the Fed and ECB—will turn negative beginning this summer and only accelerate in the second half of the year.
Source: Advisors Perspective
Furthermore, when we look at the annual growth rate of the top seven central banks' balance sheets, we see that it will likely turn negative in 2019 for the first time since 2015. If you can recall, 2015 into 2016 was a very tumultuous period with back-to-back double digit declines and fears over a major market top in the works.
For the better part of the last decade stock prices and central bank balance sheets have been joined at the hip so anything to upset the apple cart should not be dismissed. As the global liquidity tide starts to go out over the next year, we are likely to see who has been swimming naked (as Warren Buffett famously remarked). This should also add to further volatility, a common characteristic seen in the later stages of the business cycle.