As of this writing, the S&P 500 Index is down another 2% on top of the over 3% drop on Tuesday (markets were closed Wednesday to celebrate the life of former President George H. W. Bush 41). Here are our thoughts on the latest sell-off:
Trade progress has been made. The initial reaction to the trade meeting between President Xi and President Trump at the G20 in Argentina was positive, with the United States suspending plans to raise tariffs to 25% beginning January 1, while the two countries reached an agreement to escalate talks to work toward a resolution over a 90-day period (so-called “trade truce”) ending around March 1. “We emphasized earlier this week that while not a resolution, a path toward progress on trade should be viewed favorably,” said LPL Chief Investment Strategist John Lynch. “Unfortunately, mixed messages have come from both sides in recent days, further weighing on investor sentiment.” The news of the arrest of a Huawei executive (Chinese telecom equipment provider) doesn’t help, but we don’t see that development derailing a deal, especially since Chinese officials expressed optimism after that news came out.
Risk of a Fed policy mistake ebbing. One of the main drivers of recent stock market weakness has been fears of a policy mistake by the Federal Reserve (Fed). Fed Chair Powell’s speech in New York last week delivered on our expectation that the Fed would not be as aggressive in 2019 as many market participants feared. The added flexibility is encouraging. Falling asset prices, slower economic growth overseas, tariffs, housing market softness, falling oil prices, and lower inflation expectations all add to the Fed’s “cover” to ease up on rate hikes—a more dovish Fed could be a positive stock market catalyst in early 2019.
Don’t take the yield curve signal at face value. The more predictive inversions (2s/10s and 3-month/10s) have not occurred, and even when they potentially do, stocks can continue to go higher for a year or two based on history. Also keep in mind that year-end calendar effects may be distorting the short end of the curve. Many banks tend to purchase Treasuries in December to position their balance sheets. Also note that low yields overseas are preventing long-term U.S. yields from moving higher. Bottom line, we view the flatness in the most predictive yield curves as suggestive of a modest slowdown in global growth, not an indicator of a recession forthcoming in 2019.
Oil’s problem is supply, not demand. OPEC agreed to cut production at its meeting in Vienna today but did not tell us by how much. Our initial projection was for a reduction in output of about 1.3 million barrels per day (bpd), but based on comments from Saudi officials in the past 24 hours, a smaller cut around 1 million bpd was looking more likely. We believe supply is a much bigger issue for oil than demand, so we would not view $50 crude as an indication that the probability of a recession in the near term has increased.
Stocks making progress toward putting in a bottom. We view this morning’s sell-off as progress toward a stock market bottom. We may be witnessing enough fear today to set the stage for the next rally based on support levels, breadth (a high percentage of decliners), above-average volume, put option activity (more hedging of stock positions), and other sentiment indicators suggesting a potential washout. A possible “triple-bottom” in the 2,630–2,650 range for the S&P 500 may be forming which, if it holds, would be encouraging.
A potential “death cross,” where the S&P 500 50-day moving average crosses below its 200 day, has historically been followed by above-average returns in the short term, so we would disregard those media headlines in search of clicks.
These issues need to be monitored, but they do not change our opinion that stock market fundamentals remain generally favorable. Although we are comfortable with the outlook for trade and monetary policy, we are also mindful of the impact that lower asset prices and the slowdown in housing activity and business investment can have on consumer sentiment and corporate confidence. Global growth has already slowed. All in all, we believe much of these risks may largely be reflected in lower stock prices, and we still believe the S&P 500 is trading below fair value.
All that said, we recognize the difficulty market volatility can have on investor confidence and encourage investors to focus on the many fundamentals supporting growth in the economy and corporate profits.
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