The last week’s market highlights:
Quote of the week:
“Cheers to a new year and another chance for us to get it right.” – Oprah Winfrey
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :
- U.S. economy: A slowdown, not a recession
- Global economy: Amid lower expectations, emerging markets could surprise to the upside
- Policy watch: Fewer tailwinds, stronger headwinds
- Fixed income: Rates likelier to rise than fall
- Equities: Late cycle but good value
- Asset allocation: A neutral stock-bond view
A December to remember—but not in a good way.
Heading into the fourth quarter of 2018, equity investors were moving with some glide in their stride. Amid a six-month winning streak, the S&P 500 Index had just notched its best quarter since 2013—extending its year-to-date advance to a healthy 10.6%. Gauges of consumer and business optimism were at or near multi-year highs.
But the good times didn’t last. Fueled by fears of slowing global growth, the S&P 500 dropped 6.8% in October and a further 9% in December en route to a 13.5% fourth-quarter drubbing, more than erasing its earlier year-to-date gains. Also during the quarter, earnings estimates for S&P 500 companies were revised downward.
Segments of the fixed-income market also felt the pain. High-yield (HY) corporate bonds were hurt by falling oil prices, which often reflect declining demand and thus stoke worries of a fading global economy. (Energy issuers make up about 15% of the below-investment-grade bond market.) For the quarter, HY lost 4.5%, as spreads reached their widest levels in nearly 2½ years.
What drove this growth scare and poor market performance? Here are four contributing factors:
- Concerns about higher interest rates. Minutes from the Federal Reserve’s September and November meetings revealed a commitment to continue raising interest rates. And as expected, the Fed hiked in December. Markets behaved as if the Fed had committed a policy error. Equities in particular sold off as investors hoping for a more dovish message questioned the wisdom of any further tightening given the degree of market volatility and fears that the U.S. economy could fall into recession.
- An inverted yield curve. Markets were spooked in December when a portion of the U.S. Treasury yield curve inverted, with 2- and 3-year yields moving slightly higher than 5-year yields. Historically, an inverted yield curve has been seen as a harbinger of recession.
- Uncertainty in Washington. President Trump frequently criticized Fed Chair Jerome Powell for raising interest rates and reportedly polled advisers on whether to fire him. This unprecedented move, had it occurred, would have roiled markets. Moreover, the sudden resignation of Defense Secretary James Mattis, who was viewed as a stabilizing influence within the White House, unnerved U.S. allies wary of a sudden shift in U.S. Middle East policy.
- Lowered global growth forecasts. For example, the International Monetary Fund trimmed its 2019 GDP outlook for the U.S., China, Japan, and the eurozone.
As we see it, diminishing corporate profit margins present the biggest obstacle to an extended stock market rally in 2019. Companies may well face a double whammy of higher costs, some as the result of the U.S.-China trade dispute, and a decelerating Chinese economy. To illustrate, on January 3, Apple cut its fourth-quarter revenue forecast due to weaker iPhone sales in China—unsettling news that sent global equities tumbling.
A breakdown in U.S.-China trade talks and a resulting increase in bilateral tariffs would pose another major headwind to an equity rebound. Markets were temporarily placated when, at the December G-20 Summit, Trump postponed his plan to raise tariffs from 10% to 25% on $200 billion of Chinese goods—an increase originally scheduled to take place on January 1. If the two sides make progress, we expect them to continue negotiating past the March 1 deadline. In the meantime, uncertainty remains.
A December to remember—but in a good way.
Investors finally received some good news on Friday, as December’s far-better-than-anticipated employment data sparked a furious equity rally.
U.S. employers added 312,000 jobs last month. Moreover, payrolls for October and November were revised upward by a combined 58,000. Taken together, these results were almost double the forecasts for an increase of around 182,000 jobs, which itself would have been more than respectable at this stage of the economic cycle.
Of even greater importance was a jump in the labor force participation rate (LFPR) to 63.1, its highest level since March 2014. With more people entering the workforce, the unemployment rate rose to 3.9% from November’s multi-decade low of 3.7%. Hand-in-hand with the higher LFPR was December’s 0.4% improvement in average hourly earnings, which brought its year-over-year rise to 3.2%—the fastest annual pace since 2009.
While we’d put this employment release in the “wow!” category, we think it’s important to set expectations. Payroll gains of this size are not sustainable after almost 10 years of economic expansion. January’s results may be well below forecasts because of the ongoing government shutdown and the likelihood of some “mean reversion.” For the balance of 2019, we’d be quite satisfied with monthly jobs growth in the 175,000 range.