Barron’s front cover over the weekend (12/15/2018) read “2019 Outlook: US Stocks Could Rally More Than 10%”; while the New York Times front page (12/15/2018) was “The Best Place to Put Money? Your Mattress” and in the Style Section (same paper/date) read “Are You Ready for the Financial Crisis of 2019?” Quite divergent headlines on the same day.
The question on most investors’ minds is if the stock market pullback is a signal about the economy? Is a near-term recession imminent? There is no shortage of doomsday forecasts, as it seems the news only offers negative ideas. Yes, there are signs of slower business activity (business leaders are uncertain of the rules of operation given tariff issues), but overall US economic growth remains robust. And there are many supply-side effects of the tax cut of late-2017 yet to be seen which should further boost domestic growth. Global growth is slowing on several fronts. Yet, if reflationary policies develop in China and the Eurozone, these could pave the way for better than expected global growth in 2019. The US-China tariff resolution could resolve a big investor worry.
With 10 trading days remaining in 2018, the S&P500 again finds itself down -10% from the highs a second time. More than 50% of its constituents are down -20% or more from their respective 52-week high. Investors are fretting over enormous volatility, with a lot of back and forth movement. This current pullback is not deeply oversold compared to 2011 and 2015/2016 drawdowns. Maybe that’s because the economy is stronger but confused by tariff policy talk and the path of Fed rate increases. Policy directives and direction are front-and-center for investors.
Remember, “Tariffs may shake the market, but interest rates could break the market.”
Still, global monetary policy is accommodative, and even US interest rates are below historical normal. The Fed should be commended for raising Fed Funds this year out of negative territory following emergency conditions of 2008. At the same time, they should be well aware what the financial markets are saying through recent market action: “Fed, you’re out of runway” on the current path of regularly raising interest rates.” The economy still could function with higher rates – it has runway remaining. But the financial markets are saying “take a break and monitor the situation; you’re running out of time.” If the Fed pauses and avoids a policy error, stocks could provide the best returns if/as economic growth surprises to the upside. The focus this last full week before the holidays is the Fed. They are in a tricky spot. We believe nobody wants mistakes or to be credited with ending the current economic cycle.
It’s tough to be bullish, or even optimistic. Yet, several reasons exist to keep in mind:
- Fed understands the risk of blindly focusing on raising rates, affecting domestic and global economic growth with a lag.
- Administration understands tariff impact on the US and global economy (business confidence), including China; and it views the stock market as its indicator of success.
- Reward for risk (“equity risk premium”) is large (high), translating into attractive return potential for the next 12 months.
- Damage of recent market action takes time to repair and recover; involves time, price and investor sentiment. At market lows, investor sentiment displays high stress/fear.
Let’s offer a partial “Investor’s Wish List for 2019” (prepared by Strategas Research Partners):
- A Fed pause
- A trade deal with China
- Greater regulatory oversight of algorithmic (computer program) trading
- More capital spending and less financial engineering (by corporate America)
- Real pro-growth policies in Europe
- Stock splits = greater volume from real money investors
Perhaps all of this is too much to ask for, but this is a Christmas list and Santa doesn’t seem to mind stretch-goals – just ask kids.