Monthly Markets Memo - January 2019

World Money Small.jpgby Dan Zalipski, CFA 

The Fed raised interest rates as expected in December.  Investors were expecting the Fed to pause any additional rate increases after December’s move, but the Fed forecasted two more rate increases in 2019.  Investors were concerned that continued rate increases could spell trouble for the economy as it was already starting to show some potential signs of slowing. 

The resulting volatility was intense as the S&P clocked in its worst December ever with a 9.5% loss.  The Fed had been a source of volatility since early October when Fed President Jerome Powell gave the impression that interest rates still needed to be increased multiple times to get them to the coveted neutral rate, where they are no longer stimulating, but also not suppressing economic activity.  Later in the quarter he lightened that stance, saying that neutral position was closer than what they had previously stated.  Finally, Powell made a public speech on January 4th, less than a month after raising interest rates, where he said the Fed would be flexible and patient with both additional rate increases and their ongoing efforts to reduce the size of the balance sheet.  On that same day, the December jobs report revealed a surprising 312,000 new jobs added during the month, well above the forecasted 177,000.  With the Fed providing relief, and the jobs report suggesting fears of a slowdown may be overstated, the S&P surged an eye-popping 4.96% in one day. 

With the Fed out of the way (for now), investors are turning their attention to the other potential issues dragging on the market.  The first being the ongoing trade dispute with China.  Negotiations continue with optimistic progress.  China has indicated they’ll be reducing tariffs on auto imports and will be purchasing more U.S. agricultural products.  There also seems to be some progress in the negotiations surrounding some of China’s more criticized practices involving their joint ventures and intellectual property theft.  China’s latest economic reports reveal a country struggling with their own slowdown as the trade dispute lingers on.  Some believe this may motivate the Chinese to strike a deal before the pain increases.  The situation is volatile and warrants continued monitoring.

As we work through earnings season, investors will get a better picture of our economy and how it fared through the fourth quarter.  Looking forward, 2019 earnings growth estimates are expected to decline as the stimulative effects from the 2017 tax cuts begin to fade, with estimates ranging in the mid-to-low single digits.  Equally important, investors will also be focusing on the forward guidance companies provide as a glimpse of what may be in store for the broader economy.

For now, the fundamentals remain positive.  Unemployment is low, inflation is contained, and the S&P’s valuation is sitting below its 25-year average.  The latest activity reports on the manufacturing and service sectors took a surprising dive in December.  Both sectors continue to expand, but their pace has slowed.  Broadly speaking, this pattern of slower growth can be seen throughout various sectors of the economy, such as housing and autos.  Very similar developments can be observed in the international markets.  GDP forecasts for 2019 are in the mid-two percent range.  This is a decline from last year, but well above the two consecutive quarters of outright negative GDP growth, which is a technical indicator of a recession.  We continue to believe that as long we see relative strength within the underlying fundamental drivers of the economy, concerns of an imminent recession are premature. 

“With the muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves” – Jerome Powell , Chair of the Federal Reserve

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