This is a holiday-shortened commentary. We wish everyone a Happy New Year! Please feel free to contact us with any questions or comments. 

MARKET RECAP

You didn’t have to visit Disney to go on one world-class roller coaster ride this week. The chart below from Marketwatch says it all. Stocks got off to a terrible start to the week on Monday, dropping by 2.7%. Trading resumed on Wednesday, after Christmas, with the biggest one day climb in terms of points for the Dow, over 1,000 (but not in terms of percentages). Thursday started down and ended with another monumental comeback. And on Friday, stocks were mixed. But for the week, US equities were up by just under 3% and international stocks by just under 2%.

The technical action looked good from Wednesday on. And it was similar to what we have seen at the low point of other market downturns. But three days is not nearly enough to say that a bottom is in, and it might just be a fake out.

Where we go from here will be impacted by political decisions in Washington. To give the economy and the markets a fighting chance we have to avoid a fumble by the Trump administration, especially regarding the trade war in China and the government shutdown. We want global markets that will grow, not contract. The Fed will have to do its part and keep interest rates in line with how the economy is responding.

There was some good economic news this past week in the US. The preliminary retail reports showed a strong holiday season.

SCOREBOARD

Past performance does not guarantee future results.

The purpose of this commentary is to provide readers with a summary of recent market and economic news. It is not intended to provide trading advice. Investors should have a long-term plan and should consider working with a professional investment advisor. Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The information and opinions contained in this material are derived from sources believed to be reliable, but they are not necessarily all inclusive and are not guaranteed as to accuracy. Any forecasts may not prove to be correct. Economic predictions are based on estimates and are subject to change. Reliance upon information in this material is at the sole discretion of the reader.

HIGHLIGHTS

• Markets fall by 7.23% in the US.
• Fed increases rates by 1/4 point and indicate two more hikes next year.
• Government shutdown begins.
• Defense Secretary Jim Mattis resigns.
• There is extreme negative sentiment in the market.
• FedEx CEO comments on the worldwide slowdown.
• The end of quantitative easing.
• Oil is down 40% since October.

MARKET RECAP

Stocks got slaughtered as US equities fell by 7.23%. It was the worst week since 2008. The NASDAQ, which fell 8.4%, is now off by 21% since its August 29th high. The overall market is down by 18% since its September 20th high. The Dow is setting up to have its worst December since 1931. And the consensus is that more is on the way. Unfortunately, bear markets are part of normal market behavior (although infrequent), and the excess returns equity investors receive over time are attributable to the greater risk they take on in comparison to safer assets.

The Fed got most of the blame for this week’s fall. As expected, the Fed increased rates by 1/4 point on Wednesday. But the market was hoping for a “dovish” increase. That is supposed to mean the Fed would increase rates by 1/4 point, and then state that further increases would be dependent upon the data. Powell’s comments were interpreted as too hawkish, as he indicated another couple of hikes were in the current plans and there would be no slowdown in the roll off of the Fed’s balance sheet. To the Fed, the economy in the US continues to look solid.

The market might have taken a hit no matter what Powell said, after all, the market was down by 2% on Monday alone and had been falling prior to that. The Fed even backtracked on Friday, when John Williams, President of the Fed of New York, said that the central bank was closely watching the economy. Williams stated “[we are] listening to not only markets but everybody that we talk to, looking at all the data and being ready to reassess and re-evaluate our views.” That led to a big Friday rally that sent the Dow up by 350 points early, but the market couldn’t hold the gains and stocks ended down by 2.12%.

But there was more than enough other negative news to give the market a reason to decline. The government went into a shutdown mode on Friday as the White House and Congress could not agree on funding for the wall along the border with Mexico. Trump made an abrupt decision to draw down troops in Syria and Afghanistan, leading to the resignation of Defense Secretary Jim Mattis. Mattis becomes the latest in a long line of respected members of the White House team to leave. Early on in this administration, those fearful of Trump’s worst tendencies were told he was surrounded by a very competent team, but that argument is basically null and void at this point. Are there any “adults” left in the White House?

If there is any glimmer of hope it might be in the fact that everything is so negative. The last interim high on the S&P 500 was on 12/3/2018. In the 13-trading days since then, the index has fallen by 13.4%. An extraordinary drop in a short period of time. We found 8 other times since 1970 when the index has fallen by 13% or more in 13-trading days. Looking forward 1-year (see the right-hand column below), the market was up seven of eight times. We are not making a call on that, but pointing out what has happened in the past.

The CBOE Options Total Put/Call ratio reached its all-time high on Thursday of 1.82 (the calculation began in 1995). This indicates extreme negative sentiment as traders are buying lots of insurance (puts) to protect against further market declines. Below are the results when the reading has been above 1.50 going back to 1995.

FEDEX

FedEx can be viewed as a good bellwether on the world economy. On the earnings call, the company indicated that overseas economies are slowing down while the US still remains in good shape. FedEx mentioned the UK and Europe were in sharp slowdowns. FedEx sited bad economic choices as the primary reason for economic weakness, including Brexit, the immigration crisis in Germany, mercantilism and state-owned initiatives in China, and tariffs in the US.

CENTRAL BANK PURCHASES

One factor impacting markets is the end of quantitative easing around the world. Central banks are no longer pumping money into economies worldwide. The US stopped in October of 2017, and since then has been doing the opposite, effectively taking money out of the system as they let bonds mature without reinvesting the funds. Meanwhile, the European Central Bank will end its money-printing program at the end of this month, however, they will continue to reinvest the proceeds as bonds mature. Japan’s program remains in place. But overall, the net impact will turn negative by year-end.

OIL

Oil dropped by 11% for the week and is down 40% since October 3rd. The dramatic fall coupled with the sell-off in stock market leads some investors to believe there is something fundamentally wrong with economies worldwide. But it might be more of a supply than a demand issue. US production was up 16% in 2018 and should be up 11% next year (according to the Department of Energy).

SCOREBOARD

The purpose of this commentary is to provide readers with a summary of recent market and economic news. It is not intended to provide trading or investment advice. Investors should have a long-term plan and should consider working with a professional investment advisor. Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The information and opinions contained in this material are derived from sources believed to be reliable, but they are not necessarily all-inclusive and are not guaranteed as to accuracy. Any forecasts may not prove to be correct. Economic predictions are based on estimates and are subject to change. Reliance upon information in this material is at the sole discretion of the reader.

MARKET RECAP

It was another bleak week on Wall Street, stocks slid by 1.32%, which sounds almost mild by recent standards, but from midday Wednesday on, stocks gave up positive gains from Monday and Tuesday. International equities fared slightly better, falling by 0.51%. And bonds were up by 0.08%. The S&P 500 closed at its lowest level since April, the index is down by 11.28% since its high on September 20th.

Economic news was weak overseas but positive in the US (see further below). News that the US might be headed for a government shutdown hurt markets. Trump wants to build his wall for $5 billion but Democrats have offered $1.3 billion. Trump says he will shut down the government until he gets funding for the wall. Trump’s former lawyer Michael Cohen was sentenced to three-years in prison and a federal investigation was opened into whether the Trump inauguration committee spent funds illegally.

The VTI (US Total Stock Market) fell just below the support line we marked last week. See the red arrow below. Indicating a higher chance of another leg down.

ECONOMY

The debate rages on if a recession is knocking at the door, as in the next year or so. Outside the US, economies have been on stall speed for a while and might be getting worse. China reported that industrial production had slowed to its weakest point, +5.1%, since early 2016. The growth in retail sales in China, +8.1%, fell to the lowest level in 15-years. Note the numbers in China are still positive, but slower than what they are used to.

In Europe, Italy is close to a recession and in France, anti-government protests have resulted in a drop in business activity for the first time in two years. In England, the Brexit mess is hurting economic activity.  The composite purchasing managers index for the Eurozone fell to 51.2 from 52.7, still indicating growth (greater than 50) but clearly slowing down.

The US is in better shape, but the forecast is for slower growth compared to recent quarters. The IMF projects 2.5% growth in the USA compared to 3.5% in Q3 and 4.2% in Q2. However, economic reports that came in this week were positive, and the Atlanta Fed’s GDPNow model upped its estimate of Q4 growth to 3.0% from 2.44% last week.

November retail sales beat expectations. Sales were up by 0.2% versus an expectation of 0.1%. Excluding autos and gas, sales increased by 0.5% versus 0.4%. Online sales increased by 2.3%. Gas stations fell by 2.27% on lower gasoline prices.

Industrial production increased by 0.6% in November after falling 0.2% in October. Year-over-year, industrial production was up by 3.9%.

Unemployment claims dropped for the week to 206,000, much lower than forecasts and significantly lower than the two previous weeks.

BARRON’S COVER STORY

Amidst all the gloom, Barron’s cover story is titled “Why stocks could rise more than 10%” in 2019. Based on interviews with 10 strategists, the group has an average projection of an increase of 14%. Earnings on the S&P 500 are expected to rise by 5% to $172 per share, the strategists are mildly optimistic that US and China will reach a trade deal at the beginning of the year, interest rate increases should slow, and GDP should grow by 2.5%. A primary risk to the forecast is a breakdown of talks between the US and China.

STOCK VALUATIONS DROP TO FIVE-YEAR LOWS

International equity valuations are hitting five-year lows. According to FactSet, the forward price-to-earnings ratio is now at 13.3, down from 16 earlier in the year. The price-to-free cash flow ratio is at the lowest level in six years. While these valuation ratios are falling, earnings for companies in the FactSet World Index are expected to rise by 16% over the next year. Higher interest rates might account for some of the drop in valuations, as well as worries about slowing economies around the world.

CHINA TO OPEN MARKETS

It was reported on Wednesday that China was going to adjust their industrial policy so that it becomes friendlier to foreign businesses. China would back off their policy to become the world leader in technology and manufacturing by 2025 and the country would become more open to foreign companies. Tariffs will be lowered on auto imports and China would increase their purchases of US agricultural products.

SCOREBOARD

The purpose of this commentary is to provide readers with a summary of recent market and economic news. It is not intended to provide trading or investment advice. Investors should have a long-term plan and should consider working with a professional investment advisor. Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The information and opinions contained in this material are derived from sources believed to be reliable, but they are not necessarily all-inclusive and are not guaranteed as to accuracy. Any forecasts may not prove to be correct. Economic predictions are based on estimates and are subject to change. Reliance upon information in this material is at the sole discretion of the reader.

MARKET RECAP

Well, the week got off to a good start, but it turned vicious as stocks tumbled by 4.56%. International stocks were down 3.13%. It was the worst start to a December since 2008.

Stocks rallied on Monday, up by 1.17%, on the news that at the G20 summit, the US and China had agreed to a 90-day delay in the implementation of the next set of tariffs.  Furthermore, Trump sounded very optimistic that the two countries would reach a final deal. But that ended the very next day when Trump declared that “I am a Tariff Man,” stocks fell by 3.27%. The market was closed on Wednesday due to the funeral of former President George H. W. Bush. On Thursday, it was reported that Meng Wanzhou, the chief financial officer of Huawei Technologies, a very important Chinese technology company, was arrested in Canada on a request from the US for alleged violation of Iran sanctions. Meng is also the daughter of Huawei’s founder. Stocks opened down on the news and then fell as much as 2.88% before staging a furious rally and essentially ending the day unchanged. The rally did not carry through to Friday when equities fell another 2.36%, close to the Thursday low.

If you boil it all down to one factor, investors are worried that a recession is on the way in the next year or so. But such worries do not always turn out to be true. Two recent examples, remember January of 2016 when the weak Chinese yuan and collapsing oil prices spooked investors. And the debt ceiling crisis in 2011. Neither resulted in recessions. Not to mention all the concerns about Europe earlier in this decade.

That is not to say there is no recession on the way. There are certainly signs that the economy is at least decelerating. The Atlanta Fed’s GDPNow model currently projects growth at 2.4% this quarter. 

TECHNICALS

The overall US market is now pushing dangerously close to a support level it has bounced off two other times since late October (see points 2, 4 and 6 below). On the Monday rally (point 5 below), you will see the market failed to push through resistance, same as it had previously at points 1 and 3. So if the market can hold support here, it would appear that we are in some kind of consolidation pattern between $134.60 and $144. We looked at a couple of past bear markets with a somewhat similar pattern. In 1973, stocks fell through support on the third test which led to an acceleration of the bear market. In 1981, stocks held support and consolidated for another 8 months, before continuing their downtrend. There is also the possibility that the Friday low marks the bottom of this correction. The truth is nobody knows.

At least one small signal of technical strength is that the S&P 500’s cumulative advance/decline line has been holding up, putting in two recent higher highs and higher lows (Bespoke Report 12/7/18).

YIELD CURVE

Investors also freaked out about a slight yield curve inversion between the 2 and 5-year treasury bonds. A yield curve inverts when a shorter-term bond yields more than a longer-term bond. In this case, as of the Friday close, the two-year bond yielded 2.72% and the five-year was at 2.70%. In the past, an inverted yield curve has forewarned of a recession. But economists normally compare the 2-year against the 10-year, or the 3-month against the 10-year, not the 2-year and 5-year.

In any case, what does a yield curve inversion mean for the economy and for investors? Aswath Damodaran, a Professor of Finance at New York University, after running the numbers, concludes that the “…predictive power [of an inversion] for the economy is weak and for the market, even weaker. The other thing is that we are taking rules of thumb developed in the US in the last century and assuming that they still work in a vastly different economic environment.” You can find Professor Damodaran’s commentary here.

JOBS

Job growth came in at 155,000 for November, short of the consensus of 198,000. The three-month average is now 170,000, which is the lowest number in a year. The 155k increase shows growth, but at a slower pace than we had previously seen. This is in line with other cautionary signals that the economy is decelerating, such as slightly initial claims for unemployment, declining housing activity, and a flatter yield curve.

Initial claims for unemployment insurance fell by 4,000 to 231,000. The four-week average is 228,000, the highest level since April. The trend now has turned up since September 15. However, historically the number is still very low. And this is not the first time that the trend has turned up. It has happened many times over the last few years, only to resume its downward trajectory.

PMIs

Markit released its monthly report for composite PMI data for 23 countries in November, and the numbers came in somewhat positive. Overall the report showed an increase of 0.3. Emerging markets led the gain, up by 0.6 on average, with many countries showing a 1+ gain, including India (+1.5), China (+1.4), Brazil (+1.1) and South Africa (+1.3). Developed markets did not fare as well, down by 0.1. The Eurozone was down by 0.4 and the flash report for the US fell by 0.5. Overall all, of the 23 countries, 18 were above 50, indicating they were in an expansionary mode.

ISM

The Institute for Supply Management’s Non-Manufacturing Index was also positive. The November reading came in at 60.7, the second highest level since August of 2005, indicating above-trend expansion.

TRADE DEFICIT

American companies are now paying record amounts in tariffs, as the latest round in Trump’s trade war with China has begun kicking in. Yes, we said “American companies” are paying the tariffs. Not China. Tariff collections totaled $5 billion in October. Trump loves this extra revenue, stating “We are right now taking in $billions in Tariffs. MAKE AMERICAN RICH AGAIN.”

But while revenue to the government is up, the tariffs are causing real pain to American business. The tariffs also have not helped the trade deficit, which was one of Trump’s big complaints. In fact, the trade deficit is getting larger. The US trade deficit just reached its highest level in 10-years. That is because imports have remained steady, even in the face of the tariffs, while exports have plunged.

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QUESTIONS/COMMENTS

Contact us with any questions or comments.

HIGHLIGHTS

• Stocks explode higher on dovish comments by Powell.
• Trump and Xi to meet on Saturday, with hopes that a deal can be made.
• Initial jobless claims hit a six-month high.
• GM announces job cuts.
• Economic Surprise Index has fallen to a six-month low.
• 2019 earnings projections have declined for seven straight weeks.

MARKET RECAP

The market exploded higher, US stocks surged by 4.60% and international stocks were up 2.01%. It was the best week in seven years. Stocks were helped by comments from Fed Chair Jerome Powell, and hope that President Trump and Chinese Leader Xi will reach a deal of some sort to forestall the next set of scheduled tariff rate increases. With the rally, equities were up by 1.95% for November and are now up 4.42% for the year.

Back in October, Fed Chair Jerome Powell set a hawkish tone when he said that the Fed was “a long way from neutral.” That set the perception that the Fed was dead set on a series of interest rate increases every quarter.

On Wednesday, Powell, speaking at the Economic Club of New York, shifted to a more dovish position, stating that interest rates are just “below neutral” and that there “is no preset policy path” regarding future interest rate increases. Powell went on to say that the Fed’s decisions would be based on economic data. That is just what the market wanted to hear, and equities burst higher, closing up by 2.3% on the day.

The rally was also good for the market from a technical perspective. Stocks did not put in a lower low (see the red line below) and broke through the high from the two-day rally a couple of weeks back (see the blue line). However, we would not give the all clear yet, there is still economic data out there that is mixed at best.

JOBLESS CLAIMS HIT A SIX-MONTH HIGH

It is too early to say this is the start of a trend, but, initial jobless claims came in at 234,000 this week, the highest reading in six months. Over the past several years, whenever there was a hint of a slowing economy, the fallback was that the labor market was extremely tight and that jobless claims were ridiculously low. At 234k, jobless claims are still very low historically, but the number does represent a recent high in initial unemployment claims.

GM ANNOUNCES JOB CUTS

GM announced that it will cut up to 14,800 North American jobs due to weak sedan sales. This is the first set of large job cuts since the last recession for the company. GM CEO Mary Barra said she wanted to take action ahead of the next downturn, “The industry is changing very rapidly. We think it’s appropriate to get in front of it while the business and the economy are strong.”

President Trump was not happy. He threatened to take away electric-vehicle and other subsidies that benefit GM. Those subsidies shouldn’t be there in the first place but that is another issue. Trump is of the belief that GM has an obligation not to cut jobs due to the government’s help in saving the company during the last recession. While heartbreaking, Barra is making these moves to keep the company financially secure so that they won’t have a repeat of a near-death experience the next time the auto industry falls into a major slowdown.

SURPRISE INDEX

The Citigroup Economic Surprise Index for developed markets has now fallen to a six-month low. The Index measures whether economic statistics are meeting the consensus projections. The index has been falling consistently since September.

EARNING PROJECTIONS

Stocks are selling at a reasonable valuation based on forward-looking earnings. The S&P 500 is priced at 15.67 projected 2019 earnings. The problem is that earnings projections for 2019 have now been revised lower for seven consecutive weeks. Per Refinitiv, earnings for 2019 are now projected at $176.15, down 1.53% from the high on September 7 of $178.90.

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