Equity markets are attempting to recover from the sharp decline that saw a -14% return in the fourth quarter (weakest since 2011) and a -9% return in December (worst since the end of the financial crisis). Last week saw the second straight gain for the S&P 500 Index, gaining 8% from the low on Christmas Eve. The complexion of trading has changed as well, with intraday rallies in five of the past seven sessions, following a period where thirteen of fifteen days saw late-day declines. Bulls were comforted by three important drivers last week, including the Fed, trade and payrolls.
Fed Chair Powell took a noticeably more dovish tone in a panel discussion with former chairs Bernanke and Yellen on Friday, noting that the Fed is prepared to be flexible with policy, taking downside risks into account. He commented that the market is focused on risks and is “well ahead of the data,” but the Fed is listening carefully to the market’s concerns. This is quite different than the tone he took in early October and mid-December that resulted in sharp selloffs in the markets. This week could be another interesting one, with the minutes from the December FOMC meeting being released on Wednesday, and another speech by Chair Powell on Thursday.
Friday saw a sharp rally, helped in part to a much better-than-expected payroll report, with 312k gains versus an expectation of 177k. Wage gains continue to slowly improve, with average hourly earnings growth of 3.2% from a year ago, equal to the best level since the financial crisis. This Friday’s reading on CPI will be interesting to see if workers’ wage gains are being absorbed by other cost pressures, or if they can stimulate growth.
China: High level talks have begun in China, with President Trump noting that the talks are going very well. These are the first talks since the 90-day truce in the trade war was announced in December. Economic data in China point to a notable slowdown, with December factory activity shrinking for the first time in 19 months. Officials have made several policy adjustments to drive liquidity, but progress on trade is likely necessary to stabilize the economy. Reports show that Trump is set to hold talks with Chinese Vice President Wang Quishan at the World Economic Forum in Switzerland later this month.
Investor Sentiment: There are signs that the dramatic decline in investor sentiment and fund flows may have stabilized, as sentiment indicators ticked modestly higher. EPFR data show that equity funds have seen record outflows over the last six weeks, while government bond funds have seen record inflows. ICI data show that money market funds have seen $175B over nine straight weeks of inflows, the longest such streak since October 2008 at the peak of the financial crisis. BofA Merrill Lynch said in its Flow Show report that its Bull & Bear Indicator triggered its first “buy” signal for risk assets since June 2016 (Brexit).
The S&P 500 Index gained nearly 2% for the week, following a 3% rally the previous week. 2018 was a disappointment with the S&P 500 delivering the first negative return (-4%) since the financial crisis. Global stocks participated in last week’s rally and have solidly outperformed domestic indexes over the past month.
The recent optimism among equity investors is not shared by bond markets, as interest rates remain quite low and credit spreads reasonably wide. At 2.64%, the 10-year yield is nearly 0.60% lower than in early November. Commodity prices have bounced, with crude at $49 this morning, up from $43 at Christmas, as optimism on global growth has returned.
What to Watch
Like last week, investors this week will be influenced by trade, the Fed and economic data. Major concessions are unlikely to result from the meetings with China, but the tone will be important. Key economic data include durable goods, nonmanufacturing PMI, consumer credit and CPI inflation data.