A recession this year? Not likely, if you believe fundamentals.
In the fourth quarter of 2018, markets behaved as if a recession is around the corner. Stocks fell 20% or more from September highs, Treasuries rallied, and expectations for the Fed went from one to two rate increases to a possible rate cut by the end of 2019. But we see markets as detached from the real economy. GDP seems solid (~2.5% growth in Q4 2018). The US consumer is doing well, with historically low unemployment, modestly growing wages, and healthy savings. 2019 corporate earnings are projected to grow in high single digits. And the US will continue to benefit from fiscal policy stimulus in the form of new spending and the continuing benefit of tax reform.
We are watching US consumer confidence and manufacturing strength (PMIs), both moderating from recent highs. And we have concerns globally with Chinese growth slowing and a lack of economic strength coming from Europe and Japan. We acknowledge the concern markets are expressing and would agree that growth will slow in 2019, but our interpretation of economic fundamentals is that they do not now signal a US recession in 2019. This leads us to expect a rebound in risk assets as long as recessionary fears prove unwarranted.
Is there a Powell Put? Speaking of behavior: In our opinion, part of the recent volatility has to do with the market throwing a fit because there appears to be a Federal Reserve Chair who is actually acting independently. For years the Fed has been extremely sensitive (we would argue too sensitive) to market sentiment; hence, the “Greenspan/Bernanke/Yellen Put.” Chair Powell seemingly wants to normalize policy in advance of the next recession and he sees the current solid economy as his window to do so. Therefore, another rate increase and continued balance sheet contraction was announced in Dec. along with possibly two additional (data dependent) increases in 2019. This policy is reasonable and we applaud an independent Fed.
Political dysfunction – The market also looks to be having a tantrum due to political dysfunction: the partial government shutdown, turnover in the US administration, continued Chinese trade tensions and European issues, such as the coming Brexit resolution and the Italian populist movement. Progress on any of these fronts should positively impact investor sentiment and markets.
Going forward – Expect volatility to continue. Remember, we average a 10% correction every eleven months and, since 1950, intra-year declines on the S&P 500 of 13.4%. Tolerating volatility is the price investors must pay for higher long-term returns.
Valuations look reasonable, with the market trading at 14.2 times estimated 2019 earnings, which is below the 10-year average of 14.6. Certain asset classes (emerging markets) and sectors (financials) do look particularly attractive.
In times of stress, understand what you own and why you own it, avoid emotional decisions, and stick to your plan. If your circumstances have changed and you require a strategy revision, consult with your Wealth Advisor.
– Mark K. Nickel, CFP, CIO
Name to Know for January
U.S. Trade Representative
Lighthizer was sworn in as the 18th U.S. Trade Representative (USTR) in May 2017. He has focused his career in international trade law, serving in both the public and private sectors. He is a key figure in formulating the Trump Administration’s trade policy.
Lighthizer is a noted China hawk, defending the use of protectionist tariffs and arguing for serious reform on intellectual property theft and technology transfer, among other items. With the March 2 deadline to reach a China trade deal looming, Lighthizer will serve a lead role in trade discussions and formulation of any subsequent policy changes.
US Equities: The S&P 500 lost 9.0% last month, the worst December since the Great Depression.
Global Equities: International outperformed US in December, with Emerging Markets and Developed ex-US down only 2.7% and 4.9%, respectively.
Federal Reserve: Futures are now implying a higher percent chance of a rate cut than a hike in 2019, clashing with Fed projections.
US Treasuries: 10-year and 2-year Treasury yields were 2.66% and 2.50%, respectively, as of Jan. 2. The 2/10 spread held between 10 and 20 bps for the duration of December.
US Credit: Investment Grade and High Yield corporate bonds yield an average of 1.72% and 5.26% over Treasuries, respectively. High Yield spreads widened over 115 bps in December.
Markets Rundown Source: Bloomberg
Each client’s investment needs, risk tolerance, and goals are different. This newsletter is not meant to be advice for any specific investor. Nothing in it should be construed as an offer to sell, or a solicitation of an offer to buy, any securities. This should not be used as the sole basis for an investment decision. Any opinions or estimates are subject to change without notice. For information about how any of this information applies to your personal financial situation, please contact your Wealth Advisor.
Past performance is not a guarantee of future results.
Although the information provided to you in this newsletter was obtained or compiled from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.
All investing involves risk, including the possible loss of principal. You should carefully consider investment objectives, risks, charges, and expenses of any investment before investing. Diversification and asset allocation do not guarantee a profit or guarantee against a loss.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market or economic developments. The bond market is also volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect can be more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks.