The equity markets bounced back this week after somewhat soothing comments from the Fed chairman and hopes that this weekend’s meeting between the U.S. and China might start a thaw in trade tensions. For the week the S&P advanced +4.8% while small-cap stocks gained +3.0%. It was the best week for the S&P in eight years. The international markets were similarly positive with the developed EAFE up +1.6% and emerging +3.3%. Bond yields dipped slightly and intermediate-term Treasury bonds gained. +0.5%. High-yield and bank loans were up +1.1% and +0.1% respectively.
Despite the gains this week, 2018 is shaping up to be a modestly negative year for investors. The chart below from Deutsche Bank shows that 90% of the major asset class have lost money. Stocks, bonds, commodities, etc. are all in the red, albeit by modest amounts.
This year’s performance comes after 2017 when you couldn’t help but make money. As you can see above, basically everything made money last year, something we haven’t seen since 1900. We probably should average the returns of 2017 and 2018
Along the same lines, Pension Partner’s shared this great chart showing how investor sentiment has changed over the years. The squiggly line shows the difference between investors calling themselves bullish versus those of a more ursine persuasion. At the beginning of 2018 the reading stood at the highest level in many years, something that is typically viewed as a contrary indicator. The latest reading shows a good amount of bearishness out there.
So did the market go up this week because the Fed said something constructive. Of were too many people clustering on the bearish side of the boat? Probably a bit of both (Charlie’s blog post is worth a full read here.)
More Signs of Softening Global Growth
Continuing the theme from our comments a couple weeks ago, more evidence is building for a softer growth environment.
New Home Sales
October’s report was weak – new home sales were down 8.9% in October. Granted, August and September were revised higher, but there has been a clear softening the last few months. The chart below from Calculated Risk shows the downtrend for both new and existing homes.
Just as importantly, the inventory of unsold homes continues to build. The month’s supply of homes increased in October to 7.4 months from 6.5 months in September. This is a meaningful overhang and is leading to price cuts in many markets.
It was widely reported this week that GM will cease production at seven plants worldwide and lay off thousands of workers in an effort to slash $6bn in costs. Four of the factories to be closed will be in the US while another one will be in Canada. The closures will require cuts to about 15% of GM’s North American workforce, or 8,000 salaried workers. Another 6,000 temporary staff will be laid off or relocated.
GM and Ford have been hit hard by steel and aluminum tariffs. The two car makers have said increased raw material prices cost them $1bn each, because their largely-domestic suppliers raised prices following the tariffs. Also, consumers are buying far fewer cars. A few months ago Ford basically stopped selling sedans in North America (with the Mustang being the notable exception) and is choosing to focus on trucks and SUV’s. GM is basically moving in a similar direction.
The country’s gross domestic product grew at an annualized rate of 2% in the third quarter, a significant slowdown from the 2.9% pace recorded in the second quarter. Consumer spending, which until recently has been a major engine of growth, rose at an annualized rate of 1.2%, the weakest pace of increase in more than two years.
Growth in China’s vast manufacturing sector stalled for the first time in over two years in November. The official Purchasing Managers’ Index fell to 50, the weakest reading in 28 months.
The Fed’s preferred measure of inflation eased more than expected in October to hit its lowest level in eight months. The core personal consumption expenditures price index (PCE) rose 1.8% last month compared to a year earlier and down from 2% in September, as you can see below (blue line).
A softer growth backdrop combined with lower oil prices is pulling down inflation expectations to their lowest level all year.
The Fed is Data Dependent Once More
Lower growth and inflation expectations have raised expectations the Fed might start communicating a more accommodative message. This is why Chairman Powell’s talk at the Economic Club of New York got so much attention this week. His comments back in October that rates were a long way from being neutral spooked investors at the time.
This time around two words made all the difference. On Wednesday he said the Fed’s benchmark rate was “just below’ neutral. Investors heard this and bought back stocks they hated just a couple days ago.
Yea, this is slightly crazy, right?
Did he really say anything new? What does ‘just below” mean? Of course, there are no clear answers. But investors interpreted it to mean fewer rate hikes in 2019. Maybe only two, and not the three the Fed is currently promising. But of course, we are all guessing.
What you can probably say with some certainty is the Fed is data dependent. If the growth and inflation data continues to soften, the Fed will probably stop raising rates in early 2019. If things bounce back they will keep on keeping on. In essence Powell is saying he will continue to do their job and tailor policy to what the underlying economy is doing (for more see our comments on Thursday).
The Art of the Deal?
Going into the weekend investors are focuses on Argentina. President Trump will meet China’s Xi Jinping this weekend at the G-20 meeting. Trump maybe hinted at a deal when he was quoted as saying: “I think we are very close to doing something with China. But I don’t know that I want to do it.”
I guess that’s a hint? Who really knows anymore.
Larry Kudlow is also quoted as saying there is a good possibility there will be a China trade deal.
But the hurdles are high. Key sticking points include issues such as intellectual property theft, forced technology transfers, both tariff and non-tariff barriers, etc. It is asking a lot to have a meaningful discussion about complex trade policy issues over starter salads and lobster bisque. And of course, we can’t rule out someone (I’m looking at you Peter Navarro!!) lunging at Xi with the bread knife!!
Don’t Let a Crazy Dog Control Your Life!!
We started this piece with a chart showing the wild fluctuations in investor sentiment. Warren Buffett has written extensively about ‘Mr. Market’ and how there is little correlation between market swings and business values (this is a good recap for those unfamiliar)
Josh Brown at Reformed Broker shared a similar analogy in an interview he did this week ():
BROWN: And I’m now going to give you my favorite analogy. So a woman is walking through Central Park, and she’s got a dog. What’s a very active kind of dog?
VANEK SMITH: Oh, like a Jack Russell terrier or something like that?
BROWN: Fine. Jack Russell Terrier is great. If you just looked at her, what is she doing? She’s taking normal steps. She’s going in a straight line. She’s walking, you know, upright at a moderate pace – nothing terribly exciting. Then let your eyes pan down a little bit. Look at the dog. The dog is going crazy. It’s chasing birds. It’s digging up clumps of mud. It’s running at trees. It’s peeing all over the place. The dog is the stock market. The woman is the economy. The dog is chasing butterflies, then it’s sniffing itself, you know. So if you’re just watching the dog, you’re not watching the economy. You’re watching the manifestation of hundreds of millions of people’s greed and fear with buying and selling. But you’re not watching an actual representation of how the economy’s doing. So it’s important to understand that, yes, the stock market leads the economy and, to some extent, reflects the economy…
VANEK SMITH: Yeah, they’re connected, like the dog and the…
BROWN: Yeah, the dog’s going to walk in the general direction that the woman walks the dog. So the economy and the dog – or the economy the stock market are somewhat connected. But they do not look the same. They do not act the same even if they’re walking in the same direction.
Have a good weekend.
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