December 6, 2018

Market Update: The Roller-Coaster Ride

The market has seen quite a bit of volatility this year and it has been increasing recently.

Downside volatility for the S&P 500 continued at the open today (Thursday), correcting over 2% before recovering and being down only 15 basis points on the day. Currently, the 50-day moving average is close to being below the 200-day moving average for the first time since April 2016. Wall Street frequently sees this as a bearish sign, although it didn’t signal an extended correction in 2016.

It is worth noting that, to a large extent, the recent volatility seems tied to behavioral reactions to events or remarks in the news (rather than technicals in the market or economic fundamentals).

The major themes causing the volatility is uncertainty over both trade and interest rates.

Trade

• Over this past weekend, President Trump and Chinese President XI agreed to a 90-day truce on tariffs, and on Monday the S&P was up 0.9%.
  • The following day, a tweet by the president saying he is a “Tariff Man” spooked markets. This confused investors regarding trade yet again, and the S&P was down 1.1% at the close of trading.
  • It was made public yesterday that Huawei Technologies Co.’s Chief Financial Officer Wanzhou Meng was arrested in Canada (over violations of Iranian trade sanctions) and extradited to the U.S. This is another sign of the uneasy relations between the U.S. and China and one of the causes of today’s volatility.
• Interest Rates
  • In October, Jerome Powell said that rates were “a long way” from neutral. The market interpreted this as the Fed would be more aggressive in raising rates. All major U.S. indices dipped into correction territory briefly and were down 10% from highs.
  • Last Wednesday (November 28th), Chairman Powell said interest rates were “just below” the range of estimates for neutral. It was interpreted that the current cycle of rate hikes would be ending sooner than expected.  The S&P 500 was up 2.3% that day.
  • Stocks recovered from today’s lows after The Wall Street Journal reported that the Federal Reserve might be prepared to signal a change of pace in rate hikes in its December meeting.

There is some more tangible economic data being considered, as well.

• Growth Concerns – After strong economic growth, aided by beneficial tax legislation, markets are concerned with future growth rates. Some market participants may be confusing a slowing of growth rates (to 2 – 2.5% GDP) with a recession (negative growth).  Beacon Pointe’s outlook is for a slower growth rate, not a recession in 2019.
• Yield Curve – There is slight inversion between the 3-yr & 5-yr Treasuries. (3-yr 2.81%, 5-yr 2.79% on 12/04).  This resulted in the news cycle focusing on curve inversion and impending recession.  While there is an observed correlation between an inverted yield curve and future recession, it does not imply causation – a recession is not inevitable. Crucially, it matters what part of the curve is being examined.  The market focused on the only part of the curve that has inverted recently – in this case, the 3-yr x 5-yr. Most academic studies focus on the 3-month x 10-yr curve, which has proven to be a relatively robust predictor of recession, but with a long lead time. Currently the 3-mo. x 10-yr curve is a long way from inversion.

All of this is despite some evidence of good economic news. The price of oil continues to remain low and is down today. While this may not be a positive sign for oil producers, it is good news for consumers. Consumer spending is the primary driver of the U.S. economy.

Market volatility is to be expected after such an extended bull market. Since the presidential election, the S&P is up 32.1% (cumulative) and is still positive on the year.

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