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Investor confusion as the holiday approaches

NOV. 20, 2018
  • Last week saw a pullback following a strong two-week period, as investors are displaying confused behavior that is consistent with the market forming a bottom. We saw similar activity in the spring of the year. This week will be interesting, as volume will likely be limited, causing exaggerated moves.
  • Investor attention has increasingly shifted towards the Fed. Recent data shows that the economy continues to be strong, but growth rates should moderate. Core CPI is running at 2.1%, which is nominally ahead of the Fed’s 2% target. Last week, Fed Chair Powell said that he is “very happy about the state of the economy now,” though an interview with Vice Chair Richard Clarida noted that we are close to the neutral range, and being at neutral “makes sense.” It generally takes 18 months for rate hikes to fully impact the economy. The Fed is signaling four hikes through next year, but the market is skeptical.
  • The global economy has clearly slowed, with third-quarter GDP growth disappointing in Europe and Asia. In Germany, GDP fell from the second quarter for the first time since 2015, though it did grow 1.1% from a year ago. Broader Europe decelerated to 1.7%, impacted by trade worries and geopolitical concerns, most recently in Italy. Growth in Japan decelerated to a 1.2% pace, though an earthquake and typhoons were likely to blame. For 2018, the U.S. should grow at 2.9%, Europe at 2.0% and Japan at 1.1%. For 2019, estimates are for the U.S. at 2.5%, Europe at 1.8% and Japan at 1.0%. For the U.S., that remains near the best levels of the expansion, while the rest of the world is slow, but still in expansion.

  • China: There were modestly encouraging comments by President Trump late last week and over the weekend concerning trade discussions with China. Chinese officials remain aggressive in using verbal support and policy adjustments to support markets and growth. Growth in retail sales and credit is a clear signal of stress, as growth continues to decelerate. The yuan continues to depreciate versus the dollar, which supports exports, but could impact confidence and cause the administration to push back with accusations of manipulation.
  • Brexit: A Brexit deal being reached between Prime Minister May and the E.U. is far from the end of the debate, as she is receiving criticism from the right and left in reaction to the deal. There is a push for a “no confidence” vote that would trigger an election or a resignation, putting the deal at risk with only 20 weeks until Brexit. Current betting odds have a 57% chance that the U.K. leaves the E.U. on March 29, down from 88% in late September.
  • Credit: Spreads continue to widen, with investment-grade and high-yield spreads near two-year highs. The primary causes are worries around the decline in oil prices and worries surrounding retail, though there is a broader concern around the possible overborrowing in recent years caused by a prolonged period of easy money. Also, there is a lot of “weak holders” of junk bond funds and ETFs, with a wave of inflows in recent years that are now underwater, resulting in outflows.
  • The S&P 500 Index fell less than 2% last week, and has returned 4% for the year. International indexes outperformed, highlighted by the EM index up 3%. Value stocks outperformed, as the high-beta technology “story stocks,” which primarily include FANG and the semis continue to struggle. Volatility remains volatile, with the VIX at 19, versus a long-term average of 15.
  • Interest rates have come down from their recent highs, as investors adjust expectations for Fed policy. Credit spreads continue to widen, as mentioned. Commodities are lower, with crude down 26% since early October on oversupply concerns. Natural gas is the exception, up more than 50% this year, with temperatures in the Northeast 25 degrees below average for Thanksgiving.

What to Watch

  • This week could see volatility, given the recent technical pattern and the lack of participation. Economic data includes housing starts, durable goods, consumer sentiment and PMI manufacturing and service. Anecdotal commentary around Black Friday may drive retailers.

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