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 | February 2020


                                      
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Thanks to a late month slide, the S&P 500 total return index narrowly finished lower for the first time since August, losing 0.04% in January. 

The market had been so strong that it took a coronavirus epidemic, a Senate impeachment trial, and an inversion of the yield curve to cause the first 2%+ pullback since early October. 

We will examine where the market has been, and what we believe lies ahead.
THE RETURN OF VOLATILITY

From Wednesday, January 22 to Friday, January 31, the S&P 500 declined nearly 3.7% intraday. On a closing basis, the retreat measured 3.1%. As we noted above, this is the first pullback exceeding 2% since the market launched higher over three months ago in early October.

Coincident with the sell-off, the House impeachment managers began their presentation to the Senate on January 22. While removal from office was never really in question, the specter of a long, drawn out trial with extra witnesses and documents was still very much a possibility. Over the weekend, leaks from the John Bolton book manuscript heightened those fears, and the market gaped down on Monday, January 27.

In handicapping the 2020 election in November, pundits considered a relatively quick acquittal best for President Trump's chances and a continuation of his economic policies, while a long, drawn out trial to be the worst outcome. So the Bolton leak may well have caused some worry in the market. With the forecasted acquittal of President Trump this Wednesday, this issue should no longer impact stocks.


In addition to the impeachment trial, the coronavirus scare came to a head in latter January, with China suspending travel in and out of Wuhan on January 23. The US began evacuating nationals from the area on January 26. As of January 31, there are nearly 10,000 cases worldwide and 213 deaths. At this stage, the virus appears less deadly than SARS, but more contagious.

Any disruption to the Chinese economy impacts stocks across the globe. Many companies rely on the Chinese manufacturing chain and are negatively affected when those plants shut down due to health concerns. In addition, companies selling perishable items like food and beverage are impacted far worse than companies selling durable goods. For example, if a Starbucks customer stays home on January 24 instead of coming to buy a coffee, Starbucks will never have a chance to make that January 24 sale again. If an Apple customer stays home January 24 instead of coming in to buy headphones or a laptop or a phone, he can make that same purchase a couple of weeks from now when conditions improve.

Fears of a potential pandemic worsened on the last trading day of the month, as the World Health Organization declared the virus a global health emergency.

In addition, the US raised its China travel advisory to level 4 - Do Not Travel. The market responded by selling off more than 1.7%, making a new year-to-date intraday low, and giving back all the gains for the month. Because virus contagion/containment is so hard to predict and worst-case scenarios can be fairly dark, the market reacted negatively to the uncertainty.

As a result (not a cause) of the initial selling, investors rushed into bonds for safety. This helped cause various portions of the yield curve to invert briefly last week, beginning on Monday. The important 10-year/three-month curve inverted on Thursday intraday for the first time since October, with 10-year treasuries yielding less than T-Bills.



The inversion deepened last week when Chairman Powell kept the Fed Funds rate unchanged. Per Bloomberg, falling yields triggered other market dynamics such as mortgage convexity hedging driving yields down further.

As we've written before, yield curve inversion historically warns of a recession six to eighteen months in the future, although some economists like Brian Wesbury of First Trust believe structural changes in how the Fed manages interest rates negate the predictive power of inversions. Wesbury contends that prior yield curve inversions typically resulted: 

" ... when the Fed took too many reserves from the system, which is not the case today. Instead, today's inversion is based completely on the market 'pricing in' rate cuts. This is not your father's yield curve inversion."

Indeed, the futures markets now expect a Fed rate cut by June. Before the late January sell off, no rate cut was forecast for the year.

Bottom line, with the market going nearly straight up for three months, stocks were due for a breather. While we anticipate more volatility in February until the coronavirus is contained, we currently view this pullback as another buying opportunity.
A SPRINKLE OF SEASONALITY

With the market kicking off 2020 with a bang initially, the so-called January First Five Days Barometer suggests there is an 80% chance that the year 2020 ends positively. In addition, over 80% of election years since 1928 finished higher for the year. You don't need an expert to tell you that a portion of the electorate votes their pocketbook and that incumbent politicians have incentive to cater to them.

Aside from some cautious guidance from global industrial firms such as Caterpillar, we see nothing so far in corporate earnings that would lead us to believe that 2020 should be an exception to the rule.

One seasonal indicator that has not worked this year is the January Effect, which holds that small caps typically outperform large caps from mid-December through mid-February. For the year, the Russell 2000 trails the S&P 500 by approximately 3%.

While it is slightly troubling that small caps are not at least keeping up with the S&P, we would need to see a lot more to turn bearish on this stock market.
IN CLOSING

We attended the TD Ameritrade national advisor conference in Orlando, Florida this past week. As we continue to sharpen our best practices and prepare to upgrade our client experience, it was a good meeting with a lot of helpful information.  More shortly!

On a parting note, after following the back-and-forth of the impeachment proceedings over the last several weeks, we are reminded of a Simon & Garfunkel lyric from a song called The Boxer:

"Still a man hears what he wants to hear and disregards the rest..."

To your financial future, 

Marty Kerns
President & Chief Executive Officer
Parker Binion
Chief Investment Officer
About Kerns Capital Management

A family wealth advisor, Kerns Capital Management, helps professionals, including their friends and family, achieve financial independence.  We have developed a proprietary process called T he OnCourse FORMula which is designed to grow and protect their wealth, engage outside professionals as their lives and needs change, and to put all the pieces of their financial puzzle together.  

At KCM, you won't find investment managers who create static portfolios, park their clients' money and move on, checking back only to collect their fees.  Instead, you will find innovators.   We believe portfolios can be managed to grow capital while effectively managing volatility and risk. In addition to traditional diversification techniques, a key component of our risk management process is the firm's Bear Market Hedge strategy that strives to protect client portfolios from catastrophic life changing losses during periods of extreme market risk.   

As an investment manager, we seek to exploit market inefficiencies in equities, credit and volatility, both long and short.  We apply the same attention to risk in the deployment of capital that has guided us since our inception as a fiduciary investment manager to corporate pensions, trusts and high net worth individuals. KCM was founded in 1996, and is based in Houston, Texas.

For more information, please visit www.kernscapital.com or contact Martin Kerns or Parker Binion at 1 (800) 945-2125 or  ir@kernscapital.com.
IMPORTANT DISCLOSURES

Performance data represents past performance and is not a guarantee of future results.  

The S&P TR 500 Index is an unmanaged composite of 500 common stocks. This index is widely used by professional investors as a performance benchmark. Total return includes reinvestment of dividends. You cannot invest directly in an index. The Dow Jones Industrial Average is a price-weighted average of 30 of the largest and most widely held stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depository receipts, common stocks, real estate investment trusts (REITs) and tracking stocks.

The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the US bond market. Wikipedia