Government and Markets Woefully Out of Sync; Santa Nowhere to be Found – Week Ended 12/21/18

With just 5 trading days remaining in 2018, Santa is missing, failing to deliver any holiday cheer more familiar to investors at this time of year.  Even a lump of coal might feel better at this point.  Instead, the ill-behavior of financial markets would suggest that something very bad is happening to the global economy.  On the heels of a -1.2% slide during the week ended December 14, the selloff intensified with the S&P tumbling another –7.0% for the week.  It was the worst week for US equities in 10 years, and stocks are now off more than -12% for the month.  Smaller-size US companies are generally faring even worse with the Russell 2000 small-cap index down -15% for the month and crossed the bear market threshold of -20% from its peak.  The tech-heavy Nasdaq is also officially closed in bear territory on Friday (12/21) from its peak after leading the charge throughout most of the last two years.  But regardless of size, US stocks are decidedly negative for 2018 to varying degrees.

The reasons for the malaise are many, but the main focus heading into last week was the US Federal Reserve’s 2-day meeting where it was widely anticipated to hike an additional quarter-point and fourth time for 2018.  But all month, markets seemed to be yelling out to the Fed that they are out of runway for additional rate hikes at this time; monetary policy adjustments need to be slowed from their previously-forecast pace.  That message communicated through market volatility was so loud and the erosion of sentiment so swift that there was hope that Chairman Powell would announce a rate pause, rather than just a “dovish hike”.  Had that occurred, we suspect US equity markets (and likely those around the globe) would have leapt higher and allowed Santa to emerge at least through the end of 2018.  Ultimately however, the two-day meeting concluded with a hike and an only incrementally more dovish written statement – it was clearly not dovish enough judging by market reaction.  More troubling however was Jay Powell’s “performance”  during the Q&A press conference that followed: markets heard a stubborn, tone-deaf Chairman who admitted inflation remains below the Fed’s target but appeared more intent that further normalization of monetary policy is appropriate.  What the markets were hoping to hear was that additional hikes may need to be abandoned entirely if data does not begin to improve and/or uncertainty over trade is not resolved.  The decidedly risk-off tone prevailed through the balance of the week.

From the market’s perspective, the Fed is at growing risk of committing a mistake with the potential to dramatically slow the pace of the economy.  To be clear, we remain of the perspective that the US economy is more than strong enough to endure the additional hike announced last week and not experience a recession because of it alone.  However, financial conditions are changing so dramatically and so quickly that liquidity is being strained that it may begin to impact confidence among businesses who otherwise have cash to spend.  If/as confidence erodes, the natural tendency is to hoard cash rather than invest in plant, property, or equipment.  At the same time, the trade spat between US and China remains a source of uncertainty that could throw a wet blanket on business spending and is also tightening financial conditions.  And a Government shutdown over partisan political divisions does little to inspire confidence that policy makers are able to do the “right thing”.  And the political dysfunction extends beyond the US, with numerous ongoing European uncertainties also receiving attention.

All the reasons aside, the markets are deeply oversold and conditions are ripe for a meaningful near-term bounce.  In fact, when conditions are this oversold history suggests forward performance over the next 1, 3, and 6 month periods is firmly positive (even if the decline being witnessed is part of a bear market trend).  But the opportunity for a bounce is likely being delayed between now and year-end as investors have meaningful incentive to harvest losses in their portfolios for tax efficiency purposes; that creates selling pressure.  We are pursuing some adjustments along these lines as well.  At some point, perhaps not very far off, a focus on longer-run fundamentals such as firmly positive economic growth and corporate profits should reassert itself – and as they do, stocks are arguably “on sale” as we enter 2019.  For the time being, investors and officials (Fed and policymakers) are way out of sync.

Final thought: The challenge to any long-term client investor is to recall the “buckets of time” framework we utilized when establishing your investment objectives and asset allocation.  To the extent you were thoughtful with us in that decision, we retain both sufficient short- and intermediate-term liquidity to provide for any money needs and need not abandon allocation to long-term growth assets during their “rainy day”.  Storms, always uncomfortable, are part of investing; we have been tempered toward risk throughout 2018 and believe we are positioned with higher-quality assets for this stage of the economic cycle.  We believe these rational thoughts can help avoid damaging action based on emotion as this storm, too, shall pass.


We wish you a joyous Christmas, and all our best as we approach a New Year in 2019.

Posted in Blog Post.