“The Worst December Since the Great Depression”
The headline above has been repeated consistently in the media recently. It is remarkable to see how our market, in the face of a growing economy, can show such downside volatility so quickly. The third quarter was one of the stronger GDP growth figures that we’ve seen in the last decade. Additionally, the expected growth rate for the fourth quarter is over three percent. We have taken to this forum in the past to issue concerns about the economy’s slowing growth and the markets’ overvaluation. That said, we believe the markets’ recent downward movement may actually be overstated and would not be surprised to see a rebound in the first weeks of January.
Despite the positive GDP growth and good quarterly earnings, we have witnessed a severe stock market correction over the last few months. The last 90 days particularly have seen the S&P 500 fall over 18 percent, the Dow Jones decrease over 16 percent, and the NASDAQ composite index down more than 21 percent. Several events have put all asset prices under pressure. Our bonds and preferred stock, as a whole, have outperformed the stock markets. But we believe improvement is possible. During times like this it is very important to maintain patience and not make act rashly. We are always looking to maintain our bonds until the maturity date. At maturity, it is expected that we will receive all of our invested capital back (plus the dividends and interest that we receive throughout the holding period). The only time that we would look to sell a bond or a preferred stock before a maturation date is when the credit risk of the company worsens. I can say comfortably that the credit risk of the companies that we have exposure to have not materially worsened and, in many cases, they have reported good quarterly earnings.
As mentioned earlier we have seen a broad selloff in all asset classes and there are reasons for this. To start with the most recent, the Federal Reserve increased short term borrowing rates another 25 basis points. This decision has shaken the White House and the markets respectively. We do find the negative response interesting considering that a December rate increase was anticipated throughout most of 2018. Again, the economy is growing, the unemployment rate is under four percent, and shrinking and inflation hit two percent earlier this year. An interest rate increase from the Federal Reserve is a logical follow on to these trends. If there is an economic downturn in the near future, having the ability to cut borrowing rates will separate the United States from the rest of the world. Separately, the continual trade war and a government shutdown does not create confidence in the market.
2019 should be an interesting year for the market and the economy. We continue to project growth even if though it is slowing. We expect many companies will alter their capital structures in ways that will benefit our assets (such as bonds). Most recently, businesses have been using net income (cash) to buy a historic amount of common equity shares (“buybacks”). At every point of an economic cycle managers of companies will stop buying back shares and focusing on solidifying their balance sheets. Generally, that means paying down or retiring bonds. Having businesses focus on our part of the capital structure is a good thing for us.
This is one of the primary focuses of our general investment strategy. It may be worrisome to investors to view their monthly statement and see unrealized losses but in most cases, we are planning to hold these assets to the maturation date. Therefore, movements in unrealized capital gains or losses are in reality just noise until maturity. As we hold until maturity, the businesses will pay us our contractually obligated interest or dividends. We monitor all positions on a daily basis and we stress test each one of the company’s bonds and preferred stocks that we own. The importance of holding our higher priority assets through maturity is paramount.
As always, our primary focus is working for you. Please reach to us with any questions!