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Removal of Election Overhand Causes Relief Rally

NOV. 12, 2018
  • Markets continued to recover from the very difficult period in October, with a second straight week of gains. We have recovered more than half of the decline, with the first back-to-back 2% weeks since 2015.
  • The midterm election removed the uncertainty that was overhanging the market, and the resulting split in Congress was viewed optimistically, as gridlock is unlikely to result in unpopular laws being passed. Wednesday was the third-best move for the S&P 500 Index for the year. Following the midterms, the market tends to do well through the end of the year and over the next 12 months. The health care sector was the best performing sector, rallying 4% last week, as a divided government is unlikely to materially change the current health care laws or place price restrictions. Technology (primarily FANG) lagged on the perception that regulation on data privacy and competitive pressures may be an area of bipartisanship.
  • Fed policy is an increasing topic of conversation, despite the fact that that policy has not materially changed this year. Last week’s meeting was uneventful, with no move in Fed Funds and no changes to the “dot plot.” There were no significant changes to the statement. The current dot plot suggests one more hike this year and three more next year. The market has consistently underpriced this possibility, with the curve only showing a 24% chance of four or more hikes by the end of 2019. This is unchanged from a month ago despite rising inflation. Wage growth is above 3% for the first time this cycle, and core PPI last week was up 2.6% from a year ago, near the highest level since 2011 and above the Fed’s 2% inflation target.

  • China: There are reports this morning that the Trump administration will expand the trade dispute to include export controls and other measures to counter intellectual property theft. This is another sign that tariffs are only one of the tools being employed. The government is aggressively trying to manage the decline in asset values, telling banks that at least one-third of new loans have to go to non-state companies, potentially accelerating an already problematic bad loan situation. Presidents Trump and Xi will meet at the G20 later this month, but there are no indications that a breakthrough will be reached.
  • Oil: Crude prices have fallen by 20% since the high in early October, with oil and the broader commodity index roughly flat for the year. The past month has seen a perfect storm of rising domestic inventories, increasing OPEC production and exemptions granted on the Iranian sanctions. Also, there were reports last week that Saudi Arabia is beginning to study what would happen if OPEC ceased to exist. Over the weekend, the Saudis hinted that they are discussing a proposal to cut output for OPEC and non-OPEC producers by 1m bpd, moving prices modestly higher this morning. It will likely be difficult to convince Russia of this plan. As recently as a month ago, prices were 50% higher than a year ago, and now just 7%, potentially helping to moderate headline inflation.
  • Holiday season: With “Black Friday” less than two weeks away, analysts are beginning to forecast growth. The economic backdrop, including low unemployment and improving wages, is supportive. The National Retail Federation predicts a 4.1% increase, while Deloitte is more optimistic with a growth estimate between 5-5.6%. Trends have shifted more towards early purchases, with 40% starting before November. Also, online will likely grow at 4x the rate of in store, with 60% expecting to make online purchases.

What to Watch:

  • The government is closed for observation of Veterans Day, so there is no economic data. Through the end of the week, we will get CPI on Wednesday, retail sales on Thursday and industrial production on Friday.


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