This article is about the stock market decline on December 18, 2024. It is made up of notes and thoughts on December 19th at about 8:00AM. Stocks opened higher today, but there may be more to come.
Yesterday, the “markets” declined rather precipitously, with the S&P 500 ending down 2.97%. Of course, nobody actually owns the index itself, so everyone’s experience was a little bit different. If you’ve taken a business-minded approach, you probably faired significantly better. Fortunately, our portfolios have naturally avoided many of the investments that have become overinflated and crashed multiple times this year. When these market events happen, however, they tend to impact everything for the short term. Yesterday was what we call a a 90% downside day, the first since August 5th (>90% of NYSE operating stocks declined and at least 90% of the volume and points traded were in declining stocks). There are actually a number of these each year, and they aren’t cause for alarm unless you’re a short-term trader or haven’t adequately planned for your immediate cash needs. In fact, we generally have several corrections each year (1-2 that drop about 5% and 1 that drops about 10%).
Over the past couple of weeks, we’ve been experiencing a relatively quiet version of one of these corrections. Most companies have been consistently declining for about 10 days, but they have been buoyed by the excitement about AI stocks. Because the S&P 500 and other cap-weighted indices are so heavily concentrated on the biggest companies they don’t always reflect what is happening broadly. Yesterday’s action brings us into the territory of a meaningful correction of the 10% variety. It is possible it could accelerate, but 90% downside days tend to happen a the beginning or end of these corrections and we think this one is already a little bit extended. Moreover, the events that seem to have led to yesterday’s drop were neither surprising nor particularly significant. We’ll discuss a few key issues that are relevant to what’s happening in the markets. Keep in mind that the best thing to do is often the hardest: be patient and disciplined. If we manage your investments, we’ve designed them specifically to perform well in difficult conditions, and you own businesses we believe are extremely resilient and meet our rigorous financial requirements.
FED Rates
“Oops I did it again, I played with your heart, Got lost in the game…”
Oh Baby, Baby, who knew back in the 1990s that Brittany Spears was actually singing about Jerome Powell and the federal reserve.
The Federal Reserve announced yesterday that they were proceeding as planned with a .25% interest rate cut. They also left their official statement unchanged from their previous press conference, in which they explained that they would take a more thoughtful approach to future rate cuts. When Powell was asked to clarify that statement, he indicated that it meant that rate cuts would slow down in the new year. There are a few really key considerations here:
- I haven’t read a legitimate economic publication in quite some time that hasn’t fully prepared for this slowdown. This is definitely not a surprise to the markets and was already priced in before yesterday’s drop. Overreactions, however, have become ubiquitous with FED announcements. Nobody actually knows why.
- Inflation is still a problem, and even though it is more inline with money supply (the rood cause of inflation), there is more work to be done to reign it in.
- The Fed theoretically increases rates when the economy is booming and decreases rates when there are problems. IF (that’s a big if) the federal reserve senses the economy is doing well and that they are able to control unemployment and inflation, then they will slow down their rate cuts. ISN’T THIS GOOD NEWS?
- Since the Fed took center stage in the media during the QE response to the Great Recession, people have assumed that interest rates control the stock market. This is absolutely false (though the Fed officials would like you to believe it). The stock market is a vehicle for business ownership, and those businesses get their value from their profit margins and their ability to reward their owners with a dividend or an eventual capital gain. Sure, their ability to borrow money to invest in new projects can influence their margins, but it’s far from the main component.
- The Federal Reserve has significant political motivation because they haven’t done their job (under Trump 1.0 or Biden). Not only have they not paid attention to the fundamental duties of their mandate as well as the fundamental economic principles that allow them to steward the economic stability of the dollar, but they don’t even manage their own department with a basic sense of fiscal responsibility. Presently, they are borrowing money from the US treasury to pay their own salaries and cover their trips to Jackson Hole (when they just copy/paste their previous meeting minutes, a zoom call might suffice). Regardless of which side of the aisle we might find ourselves leaning, we should want a FED that understands its duties and carries them out with integrity, skill and transparency. The FED is completely dysfunctional and is enjoying its new-found place of prominence all too much. It needs major overhaul, which it will undoubtedly get in the coming year. The FED has complete control over who is allowed to join their press conferences, so reporters who ask difficult questions aren’t invited back. There is no transparency to the public on what’s is really going on behind the scenes.
The power dynamics are already going on. Powell was asked how he would respond if he was fired in 2025. He responded that he couldn’t be fired without cause. I suspect his performance and budget management would be sufficient if the new administration decides to go that route (they have not indicated this yet to my knowledge). Powell knows just how much his words affect market volatility, and we might simply read his unofficial clarification statement as a little bit of a political tantrum to show just how much power the FED is wielding at this present time.
Overall, the Federal Reserves less dovish stance should be a good sign for the markets in the weeks ahead.
Government Shutdowns are Good
Can we all agree that the threat of a government shutdown is now a holiday tradition? If it is, I’ll take it. It would be great if the Government was good at using its resources to make our country better, but when it can’t seem to balance a budget, keep its spending within a healthy proportion to GDP (less than about 19%), and our politicians’ main goal with the budget process is to implement non-budgetary legislation and increase their own salaries, it doesn’t feel like a budget should just be forced through.
Interestingly enough, the reduction in government spending that comes from a shutdown (if it does happen), is actually a good thing for the economy. This is especially true when our money supply is still out of control and inflation is still a problem. We can take solace knowing that the markets haven’t crashed because of a shutdown (going back as far as the year 2000).
The threat of a government shutdown may sound scary, but in reality, the Government isn’t a producer in the economy. They don’t sell a product, invent things, or make money providing services. The money they spend MUST come from productive segments of the American economy (taxing its citizens who profit from business activity). If this is out of balance its extremely harmful for economic growth. A temporary shutdown of non-essential government services, is actually helpful rather than harmful. IF the end result is a better compromise and can ultimately reduce spending and other negative partisan activity, then it can be very good.
Microsoft doesn’t need NVDA?
On December 13th, Microsoft made a statement that it doesn’t need more chips for its AI projects. Nvidia dropped a significant amount on the news (it is speculated that Microsoft is 13% of their sales). Other AI Stocks spiked and subsequently retreated, but the effect of Nvidia’s drop was felt more broadly because its exorbitant return, along with other AI stocks have played such a significant role in the S&P 500’s positive growth this year. When AI prices drop, the index funds drop in price as well (especially when there are other sectors correcting)… when people sell the index fund because its price is declining, it causes further decline in AI and every other company in the index. That means that everyone’s stocks decline a little bit in their prices.
This isn’t a surprise if you’ve been thinking about the sequence of how AI needs to be implemented. It did need a groundswell in chip manufacturing at the beginning, but that levels off, both as the major data processing centers become equipped with their basic needs and as the focus shifts to other supply challenges. Microsoft identified power in their specific comments about chip needs. The bottleneck has moved to something else. What’s more is that the AI craze is not because AI is a brand new invention, but because it is much more widely available to the public. Business services have used AI for years, so many of the major consumers of AI were already spending resources to use it before Chat GPT. We have been skeptical of the long-term legs to the craze for these reasons. AI will certainly have major implications on the economy and stock market, but these will take a few more years to play out. Nvidia’s value should have increased significantly because of their coincidental ability to be ahead of the spike in demand, but nowhere near as much as it did.
What does this mean for non-AI stocks? It means that we will see a redistribution of capital from companies like Nvidia to other sectors of the market. Some will reallocate to invest in power, others to financials, foods, or wherever they see the opportunity to invest and make money. Sector rotation and balance is very healthy for the market and is a natural part of the business cycle. For those not invested heavily in AI, this is a tailwind.
The Headwinds
All of that sounds very optimistic. We have a lot of economic challenge ahead of us in the coming years. national debt is still through the roof, we are still struggling with shortages in the workforce and personal savings is down while consumer debt has risen significantly. Except for consumer financial health, these are long-term problems that our leadership will need to make difficult decisions to solve. Whatever is left, will be up to the creativity of businesses to fix. These are not issues that show up as short-term market fluctuations like we saw yesterday, but in slower economic growth.
We have been watching these headwinds for quite some time and have positioned our portfolios in investments that we believe will perform well in these conditions for the long-term. If you have questions about your investment, please feel free to contact us anytime.
