Market Update – March 21, 2019
In our January market commentary, we discussed the need for patience, that things weren’t as bad as the fourth quarter and December of 2018 suggested. It felt like the Federal Reserve and the Trump Administration took away the punch bowl by increasing uncertainties around interest rates and a trade war, resulting in the steep sell-off.
We are happy to report that after experiencing the worst December since the Great Depression and the worst quarter since the Great Recession, markets have roared back year-to-date. What a roller coaster ride. Has the punch bowl been returned? What’s next?
Fed Reserve Monetary Policy
The uncertainties of U.S. interest rate policies have calmed down. In fact, during their March 20th meeting, Fed officials scaled back their projected interest-rate increases this year from two to zero and said they would end the draw down of their large balance sheet in September. This is the balance sheet accumulated during the Great Recession to stabilize markets (i.e., QE or Quantitative Easing). The prospect of the balance sheet being reduced and its impact of rising interest rates – considered a Quantitative Tightening (QT) tool – was a concern for markets. The Fed’s announcement suggests that they aren’t going to tighten conditions. The punch bowl is back.
Wednesday’s news sent Treasury yields to the lowest level in more than a year. Odds makers now suggest a rate cut in 2019 is even possible, albeit a low probability. The Fed’s wait and see attitude amidst full employment and stable inflation is calming to some and worrisome to others. Those worried suggest that the U.S. may now be economically slowing like the rest of the globe. Reading between the lines, we note that economic indicators tied to current situation are subdued, yet leading economic indicators look more appealing. Based on these expectations for subdued interest rate hikes we are adjusting fixed income allocations in some portfolios.
The second major issue of uncertainty involves trade policy. It appears that a U.S./China trade agreement is getting closer. Hence, the markets have turned to a risk-on mode for most of this year. However, in recent days new stern language from President Trump has caused some downside pressure. At the end of the day, the base case outcome is probably already baked into market prices. A more pro-growth outcome could serve as an upside surprise. Nonetheless, the markets have received misdirection from our administration before, so an actual miss versus expectations would put pressure on markets.
Domestic Economic Path
While these developments feel good, there are still concerns that warrant a measured approach. Global growth is slowing and despite near full employment, stabilizing energy prices, controlled inflation, sentiment in the U.S. needs to pick up. As the following exhibit highlights small business confidence has dropped.
Exhibit: NFIB Small Business Confidence
Providing we have positive economic growth reports over the next few months, the U.S. will enter its longest economic recovery ever. Add this to the longest stock market run – neither of which feel all that great – and it suggests we need additional investment by corporations to sustain this expansion. The following exhibit highlights the length of this economic expansion, yet its lackluster cumulative growth relative to other long cycles.
Exhibit: Current Longest Economic Expansion Significantly Less Robust Than Other Long Cycles
This brings us to capital expenditures (i.e., capex). Companies have three choices in spending the cash flow or earnings they received from recent tax breaks and repatriation of cash overseas. They can increase dividends or buy back shares, which financially produce better stockholder returns (all other things being equal). Neither of these policies are pro-growth. Alternatively, they can invest these proceeds into plants, equipment, employees, etc., which are pro-growth. Companies increased capex in the first half of 2018, then pulled back reigns in the second half of 2018 based on the uncertainties discussed. With more clarity and certainty developing, it will be important to watch capex going forward.
Providing we keep climbing the wall of worries and animal spirits return, then capex could help elongate the current economic expansion and prop up market prices. The following exhibit highlights the length of the current capex expansion and its subpar nature.
Exhibit: Current Capital Expenditures (Capex) Expansion Significantly Less Robust Than Other Long Cycles
Intoxicated with Ineptness (Brexit Revisited)
Speaking of geopolitics, Britain continues to fumble along on their path to an orderly exit from the European Union (EU). While governing can be very hard, British politicians appear to have had too much punch. They appear irresponsibly drunk at the wheel and forgetting of the passengers (citizens/economy) they are charged with caretaking.
Allow me to check my leash on the ineptness. It has now been nearly three years since some populist politicians often relying on fabrications helped force a British vote to leave the European Union. As postmortem shows, the election itself had a low turnout and many that voted didn’t know what they were voting for. With all their problems to draft an orderly exit with few damages to the British economy, it is surprising (perhaps not) that politicians haven’t posed a new vote to the populace, which polls show are now more educated and largely against Brexit.
Instead, British politicians continue to debate the details of a hard Brexit (no economic negotiations to temper the damage) or a soft Brexit. Many that voted for Brexit wanted to stop immigration and protect manufacturing jobs. Ironically, Britain’s economy is largely driven by the service sector that will be damaged more than any jobs saved. In fact, many corporations that have manufacturing jobs have plans to or have already moved out.
Our July 2016 market commentary was titled, “Geopolitics: Is Anger the New Hope?”. The answer is no.
Prime Minister Theresa May has been weakened by numerous rejections and challenges from Parliament over her withdrawal plan. The U.K. has until March 29th to finalize its Brexit plans, but the most likely outcomes are a last-minute extension or a hard Brexit that could be very disruptive to all parties involved. A new referendum, which seems like a smart consideration, is a very low probability.
While the outcome is fluid and too difficult to predict, markets have had time to adjust. It is also worth noting that our fourth prediction of increasing fiscal spending is starting to support markets. Sticking with Europe, the ECB has provided a variety of monetary stimulus packages. And while recent Eurozone 2019 GDP growth estimates have declined from 1.7% to 1.1%, Europe is starting to witness some economic surprises and strong equity market returns year-to-date.
Exhibit: Eurozone Economic Surprise Index Accelerating
We continue to closely monitor the markets and will be providing more commentary in the days and weeks ahead. In the meantime, if you have any questions please don’t hesitate to contact your TC Wealth Partners/Trust Company of Illinois advisor. And, feel free to follow me on Twitter and LinkedIn.