The high-level market consolidation that we saw through the first 3 quarters of 2018 gave way in the fourth quarter to a complete consolidation of the 2017 gains and a pretty shocking correction, primarily in December. Although valuations were not particularly stretched at the peaks, they weren’t cheap either with the forward P/E on the S&P 500 peaking out at 17+. By the Christmas Eve low, that multiple had fallen to a much more attractive 13 times forward earnings.
Certainly, there was a lot of whipsawing of prices with the bull’s argument around low interest rates, low unemployment, and generally strong US economic data largely offset with the bear’s argument over the fear of rising interest rates, the US-China trade spat, and a host of other self-inflicted events. But the magnitude and the velocity of the selloff in December really was puzzling given the underlying fundamental strength of the US economy.
Our belief is that investors realized some sizable gains earlier in the year from the 2016-2017 “Trump-Bump Rally.” So once the December melt-down was under way, investors aggressively began a tax-loss selling campaign to help alleviate their 2018 realized tax bill. That selling generated more selling. As prices deteriorated, margin calls kicked in, which generated more selling to meet the margin calls. Added to that, most hedge funds had a pretty difficult year as well. According to a New York Times article in July, 2018, the average hedge fund was only capturing about one-half of the performance of its relevant index through the first half of 2018. As most hedge funds allow their investors to liquidate only at the end of the year, that disappointing performance likely generated even more selling in December. The magnitude and the power behind the rally off those Christmas Eve lows really does suggest that the selling exhausted itself once those calendar events were closed. Thus, we look forward into 2019 for opportunities as well as dangers.
As you are undoubtedly aware, we are currently in the midst of a partial government shutdown. Insofar as Culver Investment Company, LLC manages your account(s) with a keen eye towards macro-economic trends, we are finding the job somewhat tricky as most of the macro-economic data regarding the US economy is produced from, apparently, “non-essential” government agencies. That is, most all of the government data regarding the US economy, from GDP reports to unemployment and housing data, are simply AWOL during the shutdown. We are therefore even more reliant on the 4th Quarter, 2018 earnings reports that are currently being reported daily from virtually all publicly traded companies.
Thus far, we have seen really encouraging data on this front. Though most of these earnings reports at this point have been limited to reports from the large financial institutions (Bank of America, Goldman Sachs, JP Morgan, etc.), those reports have been well received. US banks continue to enjoy very healthy balance sheets and are also starting to see dramatically improved bottom line earnings as a result of all the cost cuts they have implemented over the past several years. In addition, these large lending institutions are seeing widening loan margins (higher profitability) from the higher interest rates they are demanding. A healthy banking and financial sector are a prerequisite to any healthy and expanding economy as those financial intermediaries will provide the funding and capital to feed the expansion. Therefore, we are encouraged that the current economic expansion likely won’t peak out from a lack of liquidity or the ability to find financing.
The other big item with the potential to impact the US, as well as, the global economies is the ongoing trade negotiations with China. We have written and speculated on the possible outcomes of this matter in past writings and in meetings and conversations with you, but the reality is that these outcomes are essentially unknowable at this point. We do believe that both sides do recognize and understand that both the US and China are better off together than apart. Therefore, we continue to look through all the daily noise and press briefings around this subject and focus on the most likely outcome. That being that the US will ultimately press China to close the trade deficit with the US by importing US goods at much higher levels. President Trump has made that trade deficit his focal point. We feel he will be able to declare victory in these negotiations if he can achieve that kind of concession from the Chinese and the trade war will ultimately wind down.
On a side note, we are not so optimistic that closing the trade deficit with China will benefit the US, and may be quite a detriment, as the US economy is largely a services-based economy anymore. It would therefore be extremely difficult for US manufacturers to meet the production demands associated with such a trade deal without dramatically ramping up our manufacturing capacity in an extremely short time frame. Such a dramatic shift would undoubtedly create very large dislocations and imbalances in the US economy and very likely create both wage and price (inflation) pressures, especially with unemployment already at historic lows. We feel that a marginal shift by US producers away from Chinese labor and likely more towards India, Vietnam, and other well-developed, but still cheap, labor markets would be the better strategy.
But that is all speculation well ahead of the horse at this time. We will ultimately get a trade deal with China or we will not. We will then look for the opportunities as well as the pitfalls.
As always, please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us. This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).
2017 Form ADV Notice and Offering – the firm’s 2017 amended Form ADV Part 1 & Part 2 filings with the Securities Exchange Commission was filed timely 03/08/2017. If you would like a copy of this important disclosure document, please contact us at (303) 442-3670 or email@example.com and we will be happy to deliver it to you at no charge.
Mark P. Culver
 Stuart, James B., New York Times, July 12, 2018
Culver Investment Company, LLC
360 Interlocken Blvd
Broomfield, CO 80021
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