As we noted in these pages at the beginning of last week, we find it simply remarkable how quick the market’s mood can change against a fluid and stressed environment like the recent two months. Entering the week, the stars seemed to be aligning for those hopeful a more dovish Fed and collaborative tone between the US and China over ongoing friction about trade might develop. As recent as last Monday, optimists were starting to feel as if the storm clouds were receding during the final week of November, and a much longed-for Santa Rally in December might be starting to take shape. Then, with seemingly little warning, the bears were awakened again with declines throughout the balance of the week. The carnage began to unfold Tuesday, with blame by the media mostly being attributed to investors having second thoughts about the trade truce with China, although less recognized was a troubling development in Europe with British Prime Minister May suffering a setback in her government and undermining the Brexit proposals. We also believe that the inversion of the yield curve among some shorter maturities likely triggered indiscriminate and heavy risk-off program selling of US equities exacerbating any fundamental concerns. Despite the tail end of a strong multi-day rally on Monday, and the market being closed in honor of the passing of the 41st President Bush on Wednesday, the major US indexes still found themselves -4.6% in the hole to conclude the first week of December. From a psychological standpoint, the market backdrop is feeling increasingly pessimistic. Most challenging however is for investors to try and keep in mind how quickly the environment could take a turn for the better again seeing as how so many of the worries are “man-made” and policy-related.
From a news flow perspective, it is astonishing how quickly any progress that was achieved at the G20 meeting between Trump and China’s Xi over trade was undermined by both the media and its skeptical reports in the days that followed, and then an arguably self-inflicting wound in the US’s requested arrest of Chinese Hauwei’s CFO by Canada for violation of sanction infractions. Irrespective of whether claims of corporate wrongdoing are justified (and it sounds as if there is at least some merit to the arrest, not by just the US but also key trading partners in Europe), the arrest of a ranking Chinese technology company does not paint a picture of improving relations or prospects on trade and is significant symbolically. Then Friday, markets looked to open softly; and even appeared desiring to be more friendly following the latest monthly employment report for November. The particulars of that report, were arguably as supportive for US equities as could be; from our perspective it would have been hard to draw up a report in a way that could be any more “perfect” or unlikely to upset the financial markets further. Wage growth was positive but not robust; the unemployment rate remained steady; jobs were added to the economy, but not a too fast or too slow pace. The markets reacted favorably to start, but an apparent lack of buyers as the day progressed morphed the markets into a further slide to conclude the week back down at recent lows. With the action of the 3 days last week, a full-unwind of all the recovery progress enjoyed during the final days of November was complete.
So where do we go from here? The current market tone reflects undeniable and deepening pessimism, despite what in many respects looks oversold relative to what fundamentals of a still growing domestic economy and rising corporate earnings otherwise support. It also seems that the number of worries the market is having to digest is simply producing too much uncertainty. Most feel man-made and policy-related (Trump/China, Fed tightening, Brexit, etc). In that same regard, we haven’t even mentioned to this point how negative are the winds building against the Trump Presidency but love or hate him, the recently renewed rising betting odds of a 1st term impeachment are not market friendly. All of this is conspiring to put on ice on what to this point in the 9-year bull market was a practice of “buy-the-dip” which prevented past worries from manifesting themselves into a crisis of confidence. The flattening (or inversion) of the yield curve is also most troubling when one considers its message that no additional hikes are needed or appropriate at this time; yet the Fed is widely expected to hike rates when it convenes next week. The yield curve has received significant attention throughout the year for historically offering a perfect leading signal of economic recession occurring sometime over the next 18 months. Some would argue the information contained in the yield curve is less meaningful this cycle due to the influence of quantitative easing, but with so many other worries front and center few are willing to subscribe to the thesis that “its different this time”. All told, our level of optimism is feeling challenged too; the economy still has the potential to endure but policymakers would be wise to heed the messages being delivered via financial markets or else the erosion of confidence will continue and concerns of recession (albeit unlikely to be anywhere near as severe as the financial crisis fueled one 10 years ago) will end up being self-fulfilling.