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Retest of October lows, as bears are in charge

DEC. 10, 2018
  • Equity markets resumed their decline, as the S&P 500 Index retested the lows from late October. With the S&P down 10% this quarter, we are on pace for the worst quarter since the third quarter of 2011. Investors have taken a decidedly “glass half empty” approach, looking beyond what is reasonably strong economic data, instead focusing on trade and Fed policy uncertainty.
  • Friday was an example of the current mood for investors. The payroll report showed a continued healthy job market, with the unemployment rate at the lowest level since 1969 at 3.7% and wage growth is at the best level of the cycle at 3.1%, but the market sold off because the headline number was a bit light. Other economic data, including manufacturing and non-manufacturing ISM and consumer sentiment were strong. Perspective has been critical for the recent market weakness. Earnings and economic growth are decelerating, but from unsustainable levels. Bears are focusing on the fact that trends are slowing, while bulls point out that growth is still healthy. Right now, bears are in charge.
  • The path of the Federal Reserve is a driving force for investors, as expectations for rate hikes are being reset. Rates have fallen sharply in recent weeks, and there were points along the yield curve that inverted last week. The commonly-referenced 10-yr/2-year and 10-year/3-month spreads have not inverted but are at the flattest levels of the cycle. An inversion has historically been a strong indicator of a recession, but there is generally an 18-24-month lag before a market top, and markets have been strong during that period. Also, a flat (but not inverted curve) has been the best backdrop for equity returns. The “dot plot” continues to show one hike in December, followed by three additional in 2019. Nationwide Economics sees a total of three hikes over the period, while the Fed Futures curve now shows a greater than 50% chance of none or one total hikes, down from a 12% chance a month ago. Once unthinkable, there is now a 25% chance of no hike on December 19.

  • China: Beyond the rate environment, trade policy with China is the primary area of focus for investors. Last week started with optimism following the meeting between Presidents Trump and Xi, but optimism faded on skepticism over the timing and lack of detailed commitments.
  • Europe: There are conflicting reports from the U.K. on whether Prime Minister May will delay Tuesday’s vote on the Brexit deal, given the likelihood of its failure. She is being pressured to push for more concessions, though E.U. officials have been clear that a renegotiation is impossible. An E.U. court ruled that the U.K. can revoke Article 50, thus delaying or cancelling the Brexit and going back to previous terms. Betting odds now show only a 44% chance of a Brexit on March 29, 2019. The pound has fallen to an 18-month low in reaction to the uncertainty. Protests in France continued in reaction to climate-change related fuel taxes, sending President Macron’s approval ratings to roughly 20%. He is expected to announce a plan to cut taxes for lower-income families.
  • Oil: Crude prices halted their decline last week on word of a deal between OPEC and Russia to cut production by 1.2m bpd, though WTI has resumed its decline today to below $52. Domestic production continues to surge, while expectations for China are for slowing imports next year as the economy slows.
  • Domestic indexes lost 4-5% last week, with the S&P sitting at the low from late November, setting up an important week technically for the index. Last week saw reasonably indiscriminate selling, with growth and value down roughly equally, with small caps modestly underperforming. The bond-proxy sectors (utilities and real estate) led, as rates fell.
  • International markets were weak, though outperformed domestic, as their markets trade at substantial discounts.

What to Watch

  • Inflation data will be closely watched this week, with PPI on Tuesday and CPI on Wednesday, as it may impact the decision by the FOMC the following week. We also will see retail sales and industrial production on Friday, providing a broad view of the economy.


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