At the end of October, one could almost gather that a some modest relief was returning to the financial markets as the ugly but much anticipated US midterm election drew near and uncertainty over its outcome would be no more. As it turned out, election day generally went as predicted by political pundits – that Democrats would take back the house, but Republicans could hold their majority in the Senate. The fracture of Republican control renews what is often referred to as political gridlock. Citizens will often complain about gridlock or political dysfunction, but investors see it more favorably because the probability of significant policy changes are perceived lower when political parties are at odds with each other. In this day, it also mostly removes the possibility of Democrats pursuing impeachment of Trump or a wholesale rollback of policies implemented during his first two years (which would not in any way be market friendly). On the split-power result, US equities enjoyed a strong start to the week and post-election bounce on Wednesday. That bounce, which led some to cheer that a hoped-for 4Q rally might now get underway, were cooled Thursday and Friday as the Federal reserve reiterated its intent to continue raising interest rates. Still, the strength by markets early in the week was enough to help the S&P500 conclude firmly in positive territory for the week with an advance of +2.2% on the S&P500.
From a fundamentals perspective, there remains much to be “thankful” for as we approach that namesake time of the year. Corporate earnings continue to come in with undeniable strength, but are sprinkled with some more tempered forward guidance. The US economy also still appears to be growing on a nominal basis in mid- to high-single-digits. Unemployment and wage growth figures showcase strength and interest rates are still not at a level where they should create issue for consumers or businesses or hinder spending. Oil prices have also retreated meaningfully in recent weeks, which is helpful from a consumer confidence perspective… but some fear the decline and with other input commodities holds a more threatening message about where the pace of the economy might be headed. Optimism over easing trade hostility between the US and China seems to be quickly fleeting as doubts again rise that anything meaningful will occur quickly. “Second-derivative” or “peak growth” concerns (the notion that the US economy is so strong that it can only slow from here) are not going away anytime soon, but at the same time are not enough for the Fed to abandon its communicated preferences… yet. Slower growth, with a Fed that seemingly remains committed to tightening, admittedly increases the risks of a policy mistake “breaking” the economy and ending this already long expansion cycle. So while the US economy can arguably tolerate higher interest rates than current, investors appear unwilling to test it.
Since the start of 4Q, the global news flow has turned decidedly more pessimistic. Bears seem to still have the upper hand following the relentless slide in October. From a contrarian perspective, the lack of euphoria and fear suggests the cycle has more fuel still in the tank. But domestic and foreign markets continue to be shaken by rising inflation, trade spats, a moderating Chinese economy, emerging market volatility, decelerating US GDP growth, a European soft patch, and a still “hawkish” Fed. We find ourselves in the camp believing that time remains for the current expansion, but it would be naïve to expect that midterm elections in the rearview mirror suddenly removes all the bricks available for masons constructing the wall of worry. Last week we published our commentary for November; we feel it does a nice job capturing the thrust of what the markets are wrestling with while at the same time offering a powerful historical backdrop that is hard to ignore.