Market Update - the Dow has its biggest daily point gain ever

Today is a great example of the danger of trying to time the market.  In October, November, and December, investor sentiment began to sour, and the markets trended lower.  The S&P 500 sold off 19.8% from September 21, 2018 through December 24, 2018.  The Dow sold off 18.5% and the Nasdaq sold off 22.5% during the same period.  With market losses mounting, 2018 was beginning to feel a lot like 2008.  However, there are sharp contrasts between 2008 and 2018.  

In 2008, the US (and global) economy was saddled with unprecedented levels of consumer debt, housing was unaffordable, consumer spending was dropping, unemployment was climbing, and the global banking system was on the verge of collapse because of the then current consumer debt levels.  Additionally, the earnings per share of the S&P 500 began to fall.  To make matters worse, the US was still operating under "Mark-to-Market" accounting rules that gave businesses few options other than massive write downs on collateralized debt instruments, which in most cases were still paying more than 96% of their expected cash flows.  

In contrast to 2008consumers in 2018 have the lowest debt to disposable income ratio they've had since the early 1980s.  Housing affordability is closer to where it was through most of the 1990s than what it was in 2008.  Consumer spending has been increasing, and it looks like this will be the best holiday shopping season in at least the last 6 years.  We are also currently enjoying the lowest levels of unemployment that we've had in 50 years.  Further, we don't see any "BUBBLES" like we saw in the housing market in 2008 or in Tech stocks in 2000.  Additionally, since 2008 banks significantly increased the quality of their balance sheets, and US businesses are as healthy as they've been in a very long time.  In short, 2018 looks nothing like 2008, other than that the last few months have been challenging for equities.

We continue to believe the US economy will expand in 2019, and current expectations indicate we may expect to see a 12% earnings growth for the fourth quarter of 2018, with earnings growth continuing all the way through the end of 2019.  We have shared some of our concerns with respect to an inversion of the yield curve, but the Federal Reserve has shown it is aware of the current interest rate environment, and the Fed has signaled that should the data support pausing, it would be willing to pause.  Powell's statement in November, that he believed we were very "near" neutral rates, indicates he may think we won't need any more rate hikes in 2019.  To reiterate our thoughts after the Fed's decision to raise rates, we believe Powell was leaving the door open for future rate increases in the event that the trade dispute is settled with China and global growth begins to accelerate again.  However, he also left the door open to pause raising rates in 2019 should the trade war extend for longer than anticipated. 

Lastly, the US and China continue to make progress on trade; resolving the trade dispute is in both their interest and ours.  It's too early to determine if we will meet the 90 day deadline agreed upon by Trump and China, but if we look at what transpired between the US and Mexico and the US and Canada, we have reason to believe we may very likely have a deal near the currently set deadline.  

What does a government shutdown mean to you?

The federal government is headed for a partial government shutdown that will likely last until January 3rd when the new Congress is sworn in. This is not the first time we have had a government shutdown through the holiday season, as we had one in 1995 when Bill Clinton was president. The major difference between today and 1995 is that this will be a “partial” shutdown with nearly 75 percent of the government already funded and completely unaffected by the shutdown. That leaves just 25 percent of the government impacted by the shutdown. We anticipate a significant portion of personnel will be considered essential and receive exemptions. As such, it could be that less than 10 percent of the government will be impacted. Historically, shutdowns have not had a major impact on the US economy or financial markets. If the partial shutdown occurs, the impact will be even less. However, we are keeping an eye on the secondary effects:

1.  Shutdown headlines will run throughout the holiday season, at a time when media reports are also leading off with falling stock values.

2. The unpredictability of Trump. He agreed to no shutdown on Wednesday, but was spooked by conservative media over the border wall and reversed his position Wednesday night. This is going to make the more important policy issues for financial markets, the debt ceiling and sequestration, tough to solve in 2019.

3.  Because Trump is not getting the wall, he pulled out of Syria by Twitter. This triggered a set of effects including General Mattis resigning. Mattis leaving seems to be a far bigger event. With Mattis gone, does this make it easier to put EU auto tariffs in place which required DoD sign-off? How about Jay Powell being removed as Fed Chair?

4. Republicans are starting to turn on Trump. There are cracks developing in the structure. The economy was holding Trump up and that is fading.

The 1995 shutdown over the holidays was the longest on record. Our belief is that if we shut down tonight, the partial shutdown will be at least 12 days.

We wanted to point out a few facts the media is always inclined to leave out when it comes to government shutdowns.  (1) Most government employees are paid every two weeks, and as stated above, the expectation is that this shutdown will likely be less than two weeks. (2) Further, in past shutdowns the government has generally paid in arrears the wages that would have been earned had their been no shutdown.  (3) Essentially, as long as the shutdown does not last too long , it really should have virtually no affect on the economy.  It is true, the impacted government employees may very likely have to wait an extra week for their paycheck to arrive, but they can reasonably expect to receive their paycheck.  (4) It's also convenient that this shutdown did not start at the beginning of the holiday shopping season.  Perhaps a government shutdown in the third week of November that lasted through the first week of December would have dampened the confidence of some, and led to a reduction in their holiday spending, but that was not the case.

WHAT IS FUNDED AND WHAT IS NOT FUNDED

Departments and agencies already funded for fiscal year (FY) 2019 include

  • Army Corps of Engineers
  • Department of Defense
  • Education Department
  • Department of Energy
  • Health and Human Services
  • Bureau of Reclamation
  • Department of Labor
  • Federal Energy Regulatory Comm
  • Nuclear Regulatory Comm 
  • Social Security Administration

The following departments and agencies have not been funded and would be affected if the Federal government shuts down

  • Agriculture Department
  • Commerce
  • Homeland Security  
  • Housing and Urban Development
  • Interior  
  • Department of Justice
  • Department of State  
  • Department of Transportation
  • Treasury  
  • District of Columbia
  • Environmental Protection 
  • Executive Office of the President
  • Federal Communications  
  • Food and Drug Administration
  • General Services Admin  
  • NASA
  • SEC 
  • U.S. Postal Service

There is still time for a deal to be made but we wanted to give you our thoughts at this time.  We will know more by the end of the day. Please call or email us with any questions you may have.

Source:  Strategas

Market Update 12/21

With attention on the Federal Reserve's decision to increase rates and their updated outlook for 2019, we wanted to share an article today that CNBC published (included below).  As we wrote in our commentary after the Fed's press release on Wednesday, we believe the Fed and Powell were (1) buying themselves time - and the ability to review the data that will come in that time, and (2) leaving the door wide open to reduce the number of rate hikes they may do in 2019 without closing the door on future rate hikes should the economy's growth rate increase.  New York Fed President William's comments in the article below support our interpretation of Powell's press release. 

The reaction to the news today is irrational. The S&P 500's earnings growth for the third quarter of 2018 came in above 28%, and the most recent expectation of fourth quarter 2018 growth is +16%.  Further, ALL ELEVEN SECTORS OF THE S&P 500 EXPECT TO SEE GROWTH.  The behavior of the stock market is not commensurate with the growth that is happening.  For all the talk of recessions and bear markets, earnings data has not provided a case for bear markets or the talk of recessions. 

As we've shared previously, earnings are still growing, and the most current outlook is that they will continue to grow.  Further, valuations look very attractive.  Forward earnings estimates show the S&P 500 now trading below 16 times earnings. If the market were to trade back to its average price to earnings ratio from 1971 until today, the S&P 500 would have to increase over 20%.  

 

 NY Fed President John Williams says the Fed could re-evaluate view in 2019

 

New York Fed President John Williams says the central bank is open to rethinking rate hikes next year, depending on how the economy looks in 2019.

 

"What we're going to be doing going into next year is reassessing our views on the economy, listening to not only markets but everybody that we talk to," Williams tells CNBC.

 

He also says things could "change between now and next year," depending on economic data.

 

Earlier this week, the Federal Reserve hiked its target range for benchmark interest rates to 2.25 percent to 2.5 percent. Central bank officials also forecast two hikes next year, down from three rate raises previously projected.

 

NY Fed President: 2019 outlook may change, rate hikes not guaranteed

 

Federal Reserve Bank of New York President John Williams told CNBC on Friday the Fed is open to reconsidering its views on rate hikes next year.

 

"We are listening, there are risks to that outlook that maybe the economy will slow further," Williams told Steve Liesman during an interview on "Squawk on the Street."

 

Williams said despite this week's forecasts, the central bank is not "sitting there saying we know for sure what's going to happen" in 2019.

 

"What we're going to be doing going into next year is reassessing our views on the economy, listening to not only markets but everybody that we talk to, looking at all the data and being ready to reassess and re-evaluate our views," he said.

 

The market jumped after Williams signaled more willingness for the Fed to rethink rate hikes and its balance sheet policy. Stocks jumped 350 points after the interview.

 

Investors were focused on Fed Chairman Jerome Powell's comments on Wednesday that the balance sheet reduction program is going well and will proceed as planned. Right now, the Fed is allowing $50 billion a month to run off the balance sheet, which is mostly a portfolio of bonds the central bank purchased to stimulate the economy during and after the financial crisis.

 

"We did not make a decision to change the balance sheet normalization right now, but as I said, we're going to go into the new year with eyes wide open, willing to read the data, and reassess the economic outlook and take the right policy decisions," Williams told CNBC.

 

The Federal Reserve on Wednesday hiked its target range for benchmark interest rates to 2.25 percent to 2.5 percent. Central bank officials also forecast two hikes next year, down from three previously projected.

 

Williams said the Fed could could rethink those the two hikes.

 

"Things can change between now and next year," he said. "Something like two rate increases would make sense in a really strong economy going forward. But we're data dependent, we're going to adjust our views dependent on how the outlook changes."

 

Powell also left the door open to other options next year. He emphasized "data dependency" on Wednesday and said if data do not hold up in 2019, the Fed may change course.

 

Markets stumbled up and down after the decision Wednesday, then ultimately turned negative during Powell's news conference. Major equity indexes have moved into correction territory and are mostly negative for the year.

 

"The Fed wants to shrink that balance sheet, they know it's big, it hamstrings them in the next downturn," Peter Boockvar, chief investment officer at Bleakley Advisory Group, told CNBC. "The market knows it's a steady drip liquidity drain every month."

 

The Fed is also dealing with repeatedly criticism from President Donald Trump. On Monday, Trump said "it is incredible" that "the Fed is even considering yet another interest rate hike."

 

— CNBC's Jeff Cox and Patti Domm contributed to this report.

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