Turmoil reigned over the markets last week despite generally positive economic news. The last two weeks (months) have been wild, to say the least. For the week, a “risk off” sentiment prevailed; the Russell 2000® Index fell 5.56%; the Nasdaq lost 4.93%, S&P 500® Index fell 4.60% and the Dow Jones Industrial Average fell 4.50%. The week began positively, with the announcement that the U.S. would delay tariffs as it negotiated terms of a new trade pact with China. The euphoria quickly dissipated, however, following President Trump’s hardline comments and his selection of Robert Lighthizer to lead U.S. negotiations; also, China’s comments on the G-20 meeting take-away varied considerably from President Trump’s. The appointment of Lighthizer as lead U.S. negotiator is not surprising; he led negotiations with both Mexico and Canada in the revised NAFTA treaty.
On Tuesday, the market sold off as hopes for a trade agreement sank. China has subsequently confirmed its belief that an agreement can be reached within the stated 90-days period, and its plans to resume importing oil and agricultural products from the U.S. Relations were tested mid-week with news of the arrest, in Canada, of the CFO of Huawei on charges of violating the trade embargo with Iran. The impact of the arrest on negotiations is unknown, although Chinese officials initially commented that Beijing considers the arrest a separate issue.
On Friday, OPEC and Russia agreed to cut oil production by 1.2 million barrels per day, for six months beginning in January. This week the U.S. EIA reported a significant reduction (7.3 million barrels) in U.S. oil inventories; also, for the first time, the U.S. became a net exporter of petroleum products. The markets reacted positively; on Friday, West Texas Intermediate rose 2.2%; even so, WTI closed more than 30% below its YTD high in early October. In November, the U.S. added 150,000 jobs, below estimates, but sufficient to maintain the 3.7% unemployment rate. This report should provide support to recent Federal Reserve commentary that, in relying on market data, it may signal a slowing of interest rates increases in 2019. Still, the Fed is widely expected to raise interest rates at next Wednesday’s meeting.
Job growth should keep the Fed on its tightening path in December. Forward guidance is losing its usefulness and data-dependency is gaining relevance, given that the U.S. labor market is near full employment and inflation is around the 2% target. The Fed has been stressing its data dependency and striking a less hawkish tone recently, opening the door to a slower pace of tightening in 2019.
The biggest concern we see right now is the flattening and potential inversion of the yield curve. Throughout this correction, the big up days have not demonstrated enough participation/ breadth/ confirmation from risk-on factors- and the big down days have not shown enough of a wash-out. Frankly, the market's weakness was surprising given that you can argue the market got exactly what it was looking for, if not more, in the preceding week's: 1) dovish comments from the Fed, especially at Powell's ECNY luncheon, and 2) a much more optimistic US-China trade deal out of the G-20.
The yield curve reached its flattest level since prior to the great recession but it is important to note that it has not yet inverted. While many are watching the curve as an indicator a recession is lurking, a look back at the last three times the 2/10 curve first inverted suggests equities can rally further before a recession occurs. The big takeaways from the U.S.-CN trade deal are 1) a temporary Shanghai Accord/inflection point is being set up, 2) President Trump is becoming more pro-growth post-midterms/pre-presidential elections, and 3) it will be hard for China to reform in 90 days so incremental changes will take place over the next several months.
The markets are well oversold due to concerns about the impact of trade issues in slowing the global economy. During volatile periods, computer trading programs often lead market activity; extreme stock price declines can result when passive investors follow suit. Recent commentary suggests that an extended trade war may lead to a possible recession; here, though, the underlying assumptions are unlikely. China and the U.S. are very much aware of the potential damage if they fail to resolve trade issues. Politics certainly plays a role as the 2020 election comes into focus. The selloff last week, however painful, may nevertheless have a positive impact on negotiations to the extent that it provides motivation to resolve the outstanding issues. Market sentiment, both positive and negative, is not always rational. Today’s underlying fundamentals remain strong; investors will refocus once the clouds of uncertainty lift.
Source: Pacific Global Investment Management Company
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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