“New beginnings are often disguised as painful endings”

- Lao Tzu

The Federal Reserve has been raising rates, and neither the bond market or stock market is happy.  Yields are substantially higher than they were a year ago and while this generally means that economic growth is improving and inflation is modestly increasing, the stock market has not taken the advent of higher rates well.  From its recent peak to trough, there has been a decline of around 10% in the S&P 500.  Also concerning investors is political uncertainty, with a change in leadership happening in the House of Representatives.  In spite of volatility within the bond market and the stock market, U.S. economic growth is improving at a 4.0% rate, well above its recent averages, and the unemployment rate is falling, signaling continued strength in the job market.

Of course, we are referring to 1994, but the narrative outlined in the preceding paragraph applies equally to both that year, over two decades ago, and 2018.  They say history doesn't repeat itself, but it often rhymes, and we draw out the parallel to 1994 for a few reasons.  

First, whenever markets experience heightened volatility, it is important to acknowledge that this is par for the course for investing.  To benefit from the added returns that stocks deliver above bonds or cash, you must also accept the volatility that accompanies the ride.  Like 1994, and many other years, markets have stumbled a bit on their way to positive returns over a multi-year period.

Second, as investors, we anticipate periods of market volatility, but we do not just stick our heads in the sand when drawdowns occur.  Rather, we seek out as much information as possible to ascertain whether or not we are in the early stages of a larger decline, or whether it truly is the pause that refreshes.  With respect to the current economic and market environment, we do not see widespread warning signs that a recession is imminent.  At WhartonHill, we track a wide variety of indicators to regularly check the pulse of the economy and asset markets to help us determine whether or not more risk lies ahead.  These indicators include trends within the job market, credit lending, valuations, and investor sentiment, among other factors.  At present, the vast majority of these signals are positive.  Of course, from time to time the market moves ahead of the economy and forewarns of a coming slowdown.  However, at the current moment, the data simply isn’t showing it.

Lastly, we do think 1994 provides and interesting parallel to the present.  Similar to now, back then, the economy was quite a few years into its expansion and the market had enjoyed very strong returns prior to rate hikes introducing added risk to stocks.  A sudden decline in stocks provoked fears of a Fed induced economic slowdown.  However, after a reset, the economy and the market continued to grow for the next five years. 

On the political angle, the 1994 election occurred in the middle of Clinton’s first term and saw a divided government enter congress, much as Tuesday’s election saw Democrats regaining control of one side of Congress.  While the current political climate is much more volatile than the environment in 1994, one thing remains the same – governments and elected officials come and go and shifts in political leadership are par for the course.  In fact, historical data shows that stock market returns tend to be better after an election resulting in a split congress. 

Source: Investor’s Business Daily

Source: Investor’s Business Daily

Over two year periods after an election, the S&P 500 has gained 16.9%, on average (about 8% a year).  After a vote which resulted in a split Congress, the average gain was 18.7%.  In the current environment, though the Democrats taking control of the house may prevent further tax cuts from occurring, it could push Trump to pursue infrastructure spending, which would provide fiscal stimulus to the economy.  Overall, we believe the effects on the economy from a split Congress will be balanced and not skewed in one direction or the other.

Looking at the economy in general, we continue to believe that a recession is not imminent and there are reasons to continue to be cautiously optimistic about stock market returns.  Of course, we will continue to closely monitor the underlying fundamentals of the economy, corporate earnings, and consumer health, and would not hesitate to shift our portfolios towards a more conservative stance should the data dictate such a move.

As always, please feel free to reach out should you have any questions about the current market environment or your portfolios.

Investment advisory services offered through Independent Financial Partners, a Registered Investment Adviser

WhartonHill Investment Advisory is not owned or controlled by Independent Financial Partners

The opinions voiced in this material are for general information only and are not intended to provide specific investment advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

All data via Wall Street Journal, Morningstar, and Investor’s Business Daily