Market Observations for January 2019

Brad McMillan, Commonwealth’s CIO, recaps market and economic news for December. It was another bad month in a string of bad months, with U.S. markets down about 10 percent and international markets faring only a bit better, down 5 to 6 percent. A combination of bad news, from a government shutdown, to the ongoing trade war, to the Fed’s decision to raise rates, was enough to shake investor confidence just in time for the holidays. Still, the fundamentals continue to look strong. Has the damage been done? Stay tuned to find out. Follow Brad at blog.commonwealth.com/independent-market-observer.

 

2018 Market Drawdown: Is This Still Normal?

Presented by Mark Gallagher

As we look back on the year, the market continues to drop. Plus, the major U.S. stock market indices are now in or approaching bear market territory (i.e., down 20 percent or more). As such, there is a real concern that this drawdown signals something even worse ahead. Worry levels are rising. And as the worry levels rise, the problem gets even worse.

A vicious cycle
Worry is both a cause of and a result of the drawdown—creating a vicious circle. Worries send stocks down, which in turn generates further worry, and so on, and so on. On top of the market volatility, the unprecedented dysfunction in Washington has generated additional concerns. Overall, there really does seem to be a lot to worry about and many reasons for stocks to keep dropping.

With this level of worry, the bad news is that the decline could continue for a while—and even get worse. The good news, however, is that despite all the worry, the economic fundamentals remain sound. This should act to limit the damage and hasten the recovery.

Worry versus fundamentals
It is important to distinguish between worry (which waxes and wanes) and the fundamentals (which change much more slowly). Worry and its flip side, confidence, can change quickly, even if there is no real reason, and then change back. We have seen that many times so far in this recovery. Because of that, drawdowns driven by worry can be sharp, but they also tend to be short as long as the fundamentals remain sound.

This is where we are today. Worry is spiking, on fears of an economic slowdown and disturbing political news, and stock prices are dropping. But the economic fundamentals remain sound.

Consumer spending, which is more than two-thirds of the economy, continues to grow strongly, buoyed by confidence at levels last seen in the dot-com boom and strong job and wage income growth. Real people with real jobs are working, making money, and spending money. Businesses continue to hire and invest. The government, despite the temporary shutdown now underway, continues to act as an economic stabilizing force. In other words, even as Wall Street wobbles, Main Street remains solid.

This is important. With Main Street solid, the worry that is driving Wall Street crazy will ultimately subside. With a solid economic base, there is real support under the financial markets. Although confidence can vary, and worry can take markets down, a solid economy should limit the damage and hasten the recovery.

Have we seen this before?
We have seen this before: in 2015, in 2016, and earlier this year. We saw a more severe version in 2011. In all those cases, solid economic fundamentals here in the U.S. took the markets back up after severe drawdowns. In fact, even as bad as the drawdown has been so far, by historical standards, it is still within normal parameters. Severe drawdowns happen every 5 to 10 years, so we are roughly on schedule. Such drawdowns certainly are not fun, but neither are they necessarily a harbinger of crisis.

The real fear is that this decline is a sign of another 2008 crisis. This is where the strong economic fundamentals are especially important. We simply do not have the risks in place now that we did then. The U.S. banking system is much better capitalized; the housing industry, although slowing, remains robust. We don’t see either the economic or financial imbalances now that we did then. We can certainly expect more challenges, but a 2008-style crisis remains a remote risk.

Collapse of investor confidence
With the fundamentals solid, what is driving the current pullback is a collapse in investor confidence, which determines where prices go in the short run. It can bounce around quickly and substantially. Looking back at earlier this year and in 2015–2016, those downturns—much like the present one—were driven by bad economic or political news. With rising trade war concerns, political disruption in Washington, and fears of an economic slowdown, we can easily see how confidence has taken a hit recently, as well as the effects on the markets.

We can also see that confidence tends to bounce back, and stock prices with it, when the fundamentals remain sound as they are now. It takes an economic decline, a recession, to create a sustained downturn in stock prices. Absent that recession, pullbacks tend to be short, although they can certainly be sharp. Right now, there are few signs of an imminent recession. In fact, the most reliable indicators say growth will continue for at least the next couple of quarters.

Yes, this is normal
As investors, we should be—and are—paying attention. But it is important to realize that, although the current drawdown is something we have not seen in years, it really is historically normal—and not a sign of another global crisis. As such, we should keep an eye on our longer-term goals and ensure that our portfolios reflect that rather than short-term volatility.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.

Mark Gallagher is a financial consultant located at Gallagher Financial Services. He offers securities as a Registered Representative of Commonwealth Financial Network®, Member FINRA/SIPC. He can be reached at 651-774-8759 or at Mark@markgallagher.com.

© 2018 Commonwealth Financial Network®

Weekly Market Update, December 17, 2018

Presented by Mark Gallagher

General market news
• The 10-year U.S. Treasury opened at 2.87 percent early Monday, while the 30-year opened at 3.13 percent. The 2- to 5-year part of the curve remains slightly inverted, with the 2-year yielding about 0.08 percent more than the 5-year. The 3-year currently has the lowest yield of all three Treasuries, at 2.715 percent, and has the deepest inversion with a yield of 0.1 percent below the 2-year. The market will be paying close attention to the Federal Reserve (Fed) on Wednesday, which seems to be set on raising rates.
• Domestic and global markets continued their pullback last week, as Chinese-led global growth concerns and risk-off sentiment remained. Softer November activity data in China also continued concerns surrounding global growth. November industrial output reached a level of just 5.4 percent, below that of the 5.9 percent expected. Among the top underperformers were financials and energy, as oil weakness and the inverted yield curve between the 2- and 5-year Treasuries continue to weigh on the sectors.
• Other political concerns did not help the cause, as the Brexit picture remains murky and President Trump feuded with Nancy Pelosi and Chuck Schumer on immigration policy. This conflict could lead to yet another government shutdown. The U.S.-China trade truce story continues to be positive, but there are more details to be hashed out.
• There were several data points released last week. On Tuesday, the Producer Price Index showed year-over-year inflation of 2.5 percent for producers, which was in line with expectations and below October’s figure of 2.9 percent. On Wednesday, the Consumer Price Index also showed slowing inflation, with 2.2-percent annual growth in November, compared with 2.5-percent growth in October. The current downward trend in these two popular measures of inflation is an encouraging sign for the economy.
• On Friday, retail sales came in slightly better than expected with 0.2-percent monthly growth, against expectations for a modest 0.1-percent bump. This result follows strong 1.1-percent growth in October.

 

Equity Index Week-to-Date Month-to-Date Year-to-Date 12-Month
S&P 500 –1.22% –5.72% –0.90% –0.04%
Nasdaq Composite –0.82% –5.67% 1.15% 1.87%
DJIA –1.17% –5.56% –0.28% 0.58%
MSCI EAFE –0.89% –3.12% –11.80% –10.23%
MSCI Emerging Markets –0.95% –2.26% –13.95% –10.87%
Russell 2000 –2.52% –7.92% –7.01% –5.16%

Source: Bloomberg

 

Fixed Income Index Month-to-Date Year-to-Date 12-Month
U.S. Broad Market 0.91% –0.90% –1.01%
U.S. Treasury 0.94% –0.34% –0.55%
U.S. Mortgages 0.75% –0.06% –0.15%
Municipal Bond 0.48% 0.57% 0.64%

Source: Morningstar Direct

What to look forward to
This week is a busy one on the economic front, with several reports on housing, a look at durable goods demand, and the consumer income and spending report.

On Monday, the National Association of Home Builders survey showed another unexpected drop, going to 56 for December. This result was worse than a small expected increase to 61 and down from 60 in November, which itself was a surprise drop from 68 in October. This suggests that the housing market may well continue to weaken.

The housing starts report will be released on Tuesday. It is expected to stay steady at 1.23 million annualized, after a small increase last month. A decline in building permit data, however, suggests the final result might be somewhat worse than expected.

On Wednesday, the existing home sales report is also expected to show sales decreasing slightly. They should go from 5.22 million in October to 5.20 million in November. Housing in general appears to be in a slowing trend, but this data would suggest that slowing is steady rather than accelerating.

Also on Wednesday, the Federal Reserve Open Market Committee will conclude its regular meeting with a press conference. Markets expect the Fed to raise its baseline rate by 25 basis points once more. But the real focus will be on what Chair Powell indicates about the pace of rate increases in 2019. With recent assumptions that the Fed is becoming more dovish, markets will be watching closely.

On Friday, we’ll see the durable goods orders report. The headline index is expected to rebound substantially from last month, from a 4.3-percent decline in October to a gain of 2 percent in November, on an increase in aircraft orders. This headline index is notoriously volatile, as we can see. The core index, which excludes transportation and is a much better economic indicator, is expected to improve from 0.2-percent growth in October to 0.3-percent growth in November, on steady growth in business investment. This would be a healthy level of growth, although there may be some upside risk here as industry surveys improved in November.

Finally, also on Friday, the personal income and spending report will be released. It is expected to show that personal income rose by 0.3 percent in November, down from 0.5-percent growth in October, on slower job and labor demand growth. Personal spending growth is expected to decline from 0.6 percent in October to 0.3 percent in November, on a decline in gasoline prices that will offset rising retail sales. This would remain a healthy level of spending growth and would be well supported by the income growth.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg Barclays U.S. Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million.

 

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2018 Commonwealth Financial Network ®