Following a strong earnings season, several factors, including falling oil prices, Brexit, Italy’s controversial budget, tariffs and the Federal Reserve’s likely rate increase, continued to dampen investor sentiment. All of the major indices fell for the week, the Russell 2000® declined 1.42%, followed by the S&P 500® Index (-1.61%), the Nasdaq (-2.15%), and the Dow Jones Industrial Average (-2.22%). The decline in oil prices into bear market territory created additional concerns that the commodity might repeat its extended bear market which began in 2014 when the Iranian sanctions were lifted. The factors behind this current bear market though, are considerably different. Saudi Arabia and Russia temporarily increased production to offset the early November restart of the embargo on Iranian oil; however, oversupply resulted when the U.S. extended the cutoff date for several major countries by six months. Futures, options and seasonal refinery maintenance shutdowns each contributed to volatility in oil prices and the Energy sector. In addition, some, but not all, analysts suggest that demand for oil may decline next year. A steadying factor is the on-going, and diverse, demand for oil-based products in manufacturing, chemicals and automotive industries.
The Energy sector is only now in the early stages of recovery; investors are unnerved by the threat of another bear market. Most production remains comfortably profitable at current oil prices; yet, the diminished prices may stress the governments which depend on oil production as a major revenue source. Looking ahead, OPEC countries must factor the emergence of the U.S. as the world’s largest oil producer; at the December meeting, OPEC will likely decide to curb production to restore a supply/demand balance. Stabilization in oil prices, as well a possible easing of trade tariffs and progress on Brexit, will be important influences on market sentiment heading into the final month of 2018.
The National association of home builders (NAHB) housing market index showed a sharp decline in Nov, dropping -8 points m/m to 60. The decline was broad-based across regions. This matters because a broad-based housing decline is likely not weather-related, and more closely tied to rising interest rates & affordability. Even though rates are still historically low, there’s evidence increased U.S. borrowing costs are starting to bite. Bottom line, we continue to look for a Fed pause in the U.S. rate-hike cycle in 2019.
A long-awaited, but still preliminary, Brexit deal was unveiled this week; its future in the British parliament is uncertain, but the deal’s failure increases the likelihood of a hard Brexit. Meanwhile, the U.S. and China are quietly negotiating tariffs; commentary from President Trump and other U.S. officials hint that the parties may agree at the G20 meeting later this month to a tariff cease fire. Italy’s unwillingness to yield to European Union’s budget rules continues. Here at home, the market expects the Federal Reserve to raise rates again in December, yet Fed Vice Chairman Clarida commented today that the timeline may be flexible as they assess economic data and analyze the impact of tariffs on global growth and the U.S. economy.
Very gradual monetary policy tightening (Interest rate tightening) against a backdrop of easier fiscal & regulatory policy has a chance of achieving the seldom-seen “soft landing” for the economy. True, mixed government in the U.S. could continue to contribute to market volatility (political investigations set to go, a debt-ceiling fight, angst over eventual USMCA approval). Despite the 2018 blue wave, there is must-pass legislation that has to get done.
Any “soft landing” should be accompanied by the US$ peaking, in our opinion. That’s not happening yet, and may not happen until after the Dec Fed rate hike (depending on the language used around such a move). But if there’s a 2019 Fed pause accompanied by stimulus abroad (including fiscal policy in China) & some removal of trade uncertainty, the ingredients are in place.
A U.S./China trade deal could be another factor. To be fair, there are long-standing issues between the U.S. and China (intellectual property, etc). But we believe President Trump wants a deal in the near-term (even if it is temporary).
A soft landing in the economy is not always accompanied by a soft landing in the stock market. Equities and corporate earnings are frequently more volatile. But we do have a list of items to watch: oil, China and the Fed remain the key global macro factors driving markets currently. We continue to believe that the path forward for global risk assets likely is dependent on: 1) a Fed pause in 2019, 2) a U.S./China trade deal (even if short-term) & China stimulus, and 3) oil prices remaining stable.
Source: Pacific Global Investment Management Company
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