In our November market commentary entitled “Shake or Break”, as well as periodic updates in recent weeks, we’ve spoke extensively about how the market’s October swoon and elevated volatility were not without justification. The sudden awakening by investors following conclusion of the 3Q can be linked to persistent worries that the economic strength being witnessed in the US for 2018 might be “as good as it gets”, set to fade as we anniversary tax reform; when paired with the lack of constructive progress between Trump and China over trade and the Fed communicating in a way that felt decreasingly data-dependent and instead on autopilot with respect to additional interest rate hikes it makes sense why so many market participants were in bad moods. We’ve stated throughout the duration of this corrective phase that the economic data in the US remained supportive and the probability of recession in the near-term would still appear remote. But the financial markets needed to quickly see a more conciliatory tone begin to develop from both Trump and Fed Chairman Powell before further psychological confidence damage and any meaningful stock market recovery could develop. That’s exactly what we received last week and financial markets responded strongly with their best week in two years.
The big economic-related news over recent days may seem subtle on the surface, but is quite significant. It began with Fed Chair Powell signaling the Fed Funds rate may not be that far away from what is considered to be “neutral” (neither restrictive nor stimulative) and acknowledging that financial conditions have tightened meaningfully while some inflationary pressures have ebbed (oil prices). This is in stark contrast to a statement he made in October which seemed to set off the 4Q pullback. It was the most direct evidence in recent weeks that the Fed sounds to be rethinking how many additional interest rate hikes will be needed after the all-but-certain adjustment anticipated before year-end. Markets cheered the U-turn by Powell with their best single-day performance in months. Prices continued in their recovery Friday with investors anticipating that a meeting between Trump and China’s Xi at the G-20 summit over the weekend might begin to repair what feels like cold-war tensions over trade. Markets are understandably concerned over the year-long hostility between leaders of the world’s two largest economies, and uncertainty was beginning to build for business leaders. Deteriorating business confidence is a big potential negative if it causes them to hold off on investing in plant, property, equipment, or human capital.
From an economic perspective, hard data continues to evidence support in the US, even if tighter monetary conditions do appear to be nibbling at interest-sensitive sectors like housing and autos. Consumers still appear to be out in full force so far this 2018 holiday shopping season; no signs of being fazed by fits in the financial markets. It’s no coincidence that investors tend to feel more cheery during the holiday season when consumption is robust, but the current 4Q period is so far the 3rd weakest for the US stock market since 1950. There is more wood to chop to erase the significant damage done to much of the equity market during October and November, but with markets both in the US and outside appearing set to continue their positive response to a more friendly message between US and China trade over the weekend, it would seem two of investors’ darkest clouds appear to be thinning – at least in the short-run.