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Monthly Market Commentary: December 2018

Marco Fragnito | Managing Principal

KEY POINTS:

  • The Federal Reserve holds the key to the direction of the equity markets.
  • Domestic and international political uncertainty in combination with trade disputes continues to contribute to market volatility.

EQUITY MARKET

After a difficult October, investors braced themselves for potentially more weakness in major market indexes. With rising interest, political uncertainty both in the US and Europe and continued trade disputes investors had good reason to be concerned. Further adding to the negative momentum was the worst Thanksgiving-week performance for the S&P 500 since World War II. November looked to follow through to the downside, just like October, until Federal Reserve Chairman Jerome Powell changed his stance on interest rates in his speech to the Economic Club of New York. In his speech on November 28, Chairman Powell said that interest rates were just below the neutral rate versus his previous assertion that we were “a long way from neutral”. This change in his stance sent Treasury yields lower and stocks surging, with the Dow Jones posting its second-best session of 2018. The next day with rumors swirling of a truce in the ongoing US-China trade dispute the major market indexes managed to finish the month slightly to the upside. For November, the S&P 500 rose 1.79%, the Dow Jones Industrial rose 1.68%, while the NASDAQ Composite rose .34%.

In international markets, European markets continued to sell-off on uncertainty surrounding Brexit. Asian markets moved higher as renewed hope for a deal or at least a truce on the ongoing trade dispute between the US and China. A temporary truce was agreed to between President Trump and Chinese Premier XI in Argentina at a meeting of the G20 for at least the next 90 days.

FIXED INCOME

Following a strong employment report to start the month, showing wages rising at 3.1% in October, Treasury yields traded near the highest levels since 2011. As the month proceeded, we saw several mixed economic releases combined with a flight to safety due to equity market weakness pushed yields lower. While consumer and small business sentiment remained buoyant, the housing market statistics continued to come in weaker than expected and with interest rates continuing to rise investor saw little reason to expect that sector to turn around any time soon. Yields where further propelled lower with Chairman Powell’s about-face. Yields on 10-year Treasury Notes saw their largest decline since August of 2017. The situation in fixed income markets was not entirely positive, we saw yields on US investment grade corporate bonds rise on concerns of an economic slowdown and the impact it could have on corporation’s ability to meet their obligations. Inflation continued to remain muted and seemed headed lower in coming months as most commodities saw declines, especially with West Texas Intermediate (WTI) crude, which saw prices drop 22% in November.

MARKET OUTLOOK

While equity markets managed to put in a gain for the month of November, individual securities and portfolio’s continued to struggle. Numerous market sectors dropped into bear market territory, defined as a drop of 20% from the highs, such as Technology stocks. Despite Federal Reserve Chairman Jerome Powell’s change of heart, we continue to believe so long as the Fed Chairman and its board members continue to articulate a path for higher interest rates, equity markets will continue to be on the defensive. In the short term, any further negative news could put even further downside pressure on equity markets; however, with the Fed chairman finally taking notice of the market’s weakness, we see early signs of a potential market bottom. As we stated in our recent market commentary, any indication of the interest rate hiking cycle coming to an end or pausing will send markets higher. We continue to maintain a very neutral stance towards equity markets in general and have moved asset allocations in portfolios accordingly.

Where we have changed our opinion in the last 30 days is in the area of fixed income. We now believe that for aggressive bond investors a short-term trading opportunity exists in longer term bonds. We expect longer term rates to fall reflecting an economic slowdown and a more dovish Federal Reserve in the coming months. For the longer term we remain on balance negative towards longer dated maturities in both US Treasuries bonds and corporate bonds. We are recommending fixed income securities that can benefit from a pause or even a decline in short term rates. In sum we believe that the Federal Reserve holds the key to the direction of the equity markets and until that becomes clearer, we remain defensive in our portfolios.

If you have any questions please contact us directly at 949.472.4579, and feel free to forward this report and our contact information to anyone who might be interested.

Sources: Wells Fargo Investment Institute, “Five Key Risks for the Equity Market” November 20, 2018. Wells Fargo Advisors, Dan Wanstreet, “Monthly Market Commentary,” December 5, 2018.

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The opinions expressed here reflect the judgement of the author as of this date and are subject to change without notice. Information presented here is for informational purposes only and does not intend to make an offer, solicitation, or recommendation for the sale or purchase of any product, security, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here. The information being provided is strictly as a courtesy.