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First Quarter 2018 and What Lies Ahead

The first quarter brought the first stock decline (about -9%) since the second quarter of 2015. We’ve had an amazing 10-quarter run that included a rise every month in 2017.

This quarter’s decline started with great excitement and dismay. The Dow Jones rose 5.67% in January, only to be followed by single-day declines of 500 to 1,000 points. While those numbers sound shocking, in perspective these drops were not terrible, with percentage declines of only 2% to 4%.

The total decline from the market high to the bottom of the first quarter drop was around 10%. Declines of at least 10% have occurred, on average, once a year for the last 117 years, going back to 1900.

We do not believe the current conditions predict a serious stock market decline at this time:

Critical to our opinion at Samara is our view of inflation and interest rates. History has shown a general decline in inflation and interest rates since 1981 (37 years). This decline was primarily driven by the immense growth in technology which decreased production costs. We expect this trend to continue.

Demographics have also played a role. The average age of people in the U.S. is increasing as the large percentage of baby boomers is reaching retirement age. The effect of this is less demand for goods and services since, on average, retirees spend less.

Given these factors, we believe inflation and interest rates will continue to be low. For the stock market, going back to 1950 (using the S&P 500 Index), the average 1-year return has been 12.5%. Given current stock valuations, we don’t expect to see returns that high going forward.

We are concerned about, and are watching closely for a “Flat Yield Curve”. Generally, long-term interest rates are higher than short-term interest rates. When short-term rates are rising, as they have been lately, it’s because the Federal Reserve is raising rates to slow the economy.

While the Fed controls short term rates, long term rates are set by the market. Long-term rates will decline when the general market expects an economic slowdown. If declining long-term rates meet the rising short-term rates, we will have a “Flat Yield Curve”. As you can see in the chart below, the presence of a “flat yield curve” has preceded 5 of the last 5 recessions and significant stock market declines.

While we are not there yet, we are monitoring this indicator closely and will contact our clients if action is warranted.

We do not believe investors should attempt to time the market. We believe in establishing an appropriate allocation to stocks based on future cash flow needs. Stocks are an excellent source of future growth. Investors do not want to put themselves in a position to have to sell stocks to raise needed cash during bad times.

Samara Speaks

At Samara, we primarily invest in US companies:

Political and Legal Systems

The U.S. possesses a political and legal system that supports capitalism. Our political system is democratic and our legal system supports property rights.  For individuals or businesses to confidently deploy their capital goods, they must be able to count on a system that protects their legal right to own or transfer private property.

Significant Natural Resources

With approximately $45 trillion in natural resources, the U.S.  ranks number two in the world, surpassed only by Russia’s nearly $75 trillion.

Geographically Protected

The U.S. is protected on the east and west coasts by two large oceans, and we have friendly borders both north and south.

Over short periods the US may not perform as well as some countries but our opinion is it will in the long run.

Sources:
Bloomberg.com         Ycharts.com
Federalreserve.gov  Crandallpierce.com