Market Wrap-up | February 3, 2019

Written by: Robert P. Seawright, Chief Investment & Information Officer, Madison Avenue Securities, LLC

Domestic stocks moved higher last week, powered by good gains on Wednesday and Thursday. Communication services shares fared best within the S&P 500, helped by a sharp rise in Facebook after the company reported solid fourth-quarter earnings. Energy and industrials shares also performed well, with the latter helped by better-than-expected revenues from GE. A drop in longer-term bond yields weighed on the financial services sector by threatening bank lending margins.

Fourth-quarter earnings releases drove much of the market’s trading, with 117 companies within the S&P 500 reporting results. Stocks fell Monday after disappointing results from NVIDIA and Caterpillar. Stocks regained momentum at midweek, however, after Apple reported a slight gain in earnings and a smaller drop in revenue than many had feared given recent press over falling iPhone sales. The benchmark 10-year U.S. Treasury note closed the week yielding 2.70 percent.

The pan-European STOXX Europe 600 gained slightly, but its advance was tempered by ongoing Brexit and U.S.-China trade uncertainty, weak regional data, and news that Italy’s economy fell into recession. Chinese stocks gained as hopes for a possible trade deal with the U.S. offset concerns over an influential private manufacturing gauge that fell to its worst reading since 2016, the latest evidence of the country’s deepening growth slowdown. For the week, the Shanghai Composite edged up 0.6 percent and the large-cap CSI 300, China’s blue-chip benchmark, climbed almost 2.0 percent. Japanese stocks were flat to a touch higher last week.

Last week’s biggest news, while obviously impacting the markets, was not directly market-related.

According to the consensus view, two different trends have been moving markets of late. One is the China factor, which is manifested in two separate ways. The first of these is the health of the Chinese economy generally, a huge market for businesses around the world. China’s economic difficulties are sending shock waves worldwide as its growth is down to its slowest rate in three decades. At least 440 Chinese firms said their 2018 financial results deteriorated, with 373 saying they’ll post a loss. Roughly 86 percent of those incurring losses were profitable in 2017. The other part of this trend is the trade war between China and the U.S. Any sign of peace is deemed good for riskier assets (mostly stocks), and vice versa

The second trend is central bank action or the lack thereof. At the beginning of December, it seemed as if all the major central banks were set to tighten what had been remarkably easy monetary conditions, perhaps precipitously. Cheap money generally boosts riskier assets (mostly stocks) by providing greater access to capital and by pushing investors there in search of yield. 

After listening to Federal Reserve Chairman Jerome Powell’s press conference Wednesday, after the Fed raised short-term interest rates by a quarter point in December and signaled two rate increases were likely in 2019, and after nine well-telegraphed interest rate hikes since 2015, it now appears that higher rates are off the table, at least for now. The Fed might even dial back its plan to work down its bloated balance sheet. At his previous press conference six weeks ago, after boosting interest rates for the fourth time in 2019, Powell ushered in the final and most dramatic stage of the pre-Christmas sell-off in the stock market by sounding far more hawkish than anyone in the market thought possible. Now, he’s doing the opposite. 

The following sentence appeared in the Federal Open Market Committee’s December statement.

“Some further gradual increases in the target range for the fed funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective.”

That sentence was nowhere to be found in Wednesday’s statement, but the following sentence was added.

“In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.

After just six weeks (and a significant market drop), the Fed went from a clear signal that more rate increases are likely to expressing the need for “patience” with no prediction about the future of rates. That’s about as dramatic a shift as you are likely to see from a central bank.

That said, the market’s reaction to this news was far more muted might be expected. The benchmark 10-year U.S. Treasury note yields fell three basis points to 2.68 percent, having been as low as 2.54 percent at the start of the year, and at 2.89 percent on the eve of the previous Powell press conference, while the yield curve steepened. The S&P 500 had a good day, jumping 1.55 percent to bring its gain since the day before Powell’s previous press appearance on December 19 to 5.30 percent. The damage of the previous appearance, in other words, had already been undone in the stock and bond markets. In barely six weeks, we have gone from the Fed leading the markets to the other way around.

A hawkish Fed generally leads to a stronger dollar, which makes life harder for emerging markets, undermines the U.S. trade agenda by weakening the competitiveness of American exporters, and impedes the dollar-denominated profits of U.S. multinationals. Now: the opposite. And it’s not just the Fed. A slowing global economy and low inflation has central banks around the world rethinking plans to pull back on financial stimulus. However, bear in mind that the last three times the Fed was forced to stop its rate hike cycle, a recession soon followed. 

Friday’s jobs report was outstanding. The economy added 304,000 jobs in January — significantly more than the 170,000 economists were expecting — while the unemployment rate ticked higher to 4.0 percent, reflecting the impact of the government shutdown. Average hourly wages for private-sector workers grew 3.2 percent from a year earlier. Neither the federal government shutdown nor market turmoil had any apparent impact on private hiring. The job market is also getting stronger. In the last three months job creation was its fastest in three years. Most notably, the U.S. is defying its demographic headwinds. The participation rate (the share of the population working or looking for work) is supposed to be falling as the baby boomers retire. Instead, it has climbed to 63.2 percent, a five-year high. That’s largely thanks to surging participation among prime-age workers, especially women, whose participation, at 76 percent, matched its highest rate since 2003.

Other news and notes follow.

Banks and smaller companies propelled stocks to their best January in 30 years, a sign that investors are favoring sectors tied to the U.S. economy. The Dow and the S&P 500 both closed with their biggest monthly gains since October 2015. The blue-chip index’s 7.2 percent rise was its best January performance since 1989, while the S&P’s 7.9 percent advance marked its best start to the year since 1987. The Dow and the S&P have each climbed 15 percent since Christmas Eve, their largest such percentage gain between the trading day before Christmas and the end of January since 1975, according to Dow Jones Market Data.

From 1926 to 2016, just 90 stocks of 26,000 account for half of all gains.

Europe’s economy is giving people the jitters. Investors are backing away from European assets, as worries over slowing growth and political uncertainty push the European Central Bank to rethink plans to tighten monetary policy this year. EU GDP grew at a tiny 0.3 percent in the fourth quarter of 2018, capping a year of low showings and as Italy slipped back into recession. Slow European growth is a concern for the global economy, too, particularly as China’s growth lagged last year, too.

Greg Mankiw, Harvard professor and Chair of the Council of Economic Advisers under President George W. Bush, took a look at President Trump’s economic plan and found it wanting.

The Department of Justice is seeking to shut down EcoVest, a sponsor of real estate investment programs, all focused on conservation easements, that it deems fraudulent. 

Overall, only 39 percent of Americans are well-disposed toward socialism, with older people and men particularly negative. However, 61 percent of Americans aged 18-24 have a positive reaction to socialism while the positives for capitalism are at only 58 percent.

President Trump announced new sanctions against Venezuela, targeting the wealth of Nicolás Maduro. “The world’s democracies are right to seek change in Latin America’s worst-governed country,” The Economist writes in a lead editorial.

The Treasury Department will have to borrow $1 trillion to pay for the government’s growing budget deficit, a consequence of increasing government spending and smaller revenues due to President Trump’s 2017 tax cuts. Meanwhile, the 35-day government shutdown eroded the economic benefits of tax reform and spending increases, according to the White House’s projections. $3 billion in economic activity was permanently lost to the shutdown, the Congressional Budget Office estimates. Even worse, the tax cut has had no major impact on business capital expenditures.

New York’s top financial regulator will allow life insurers to use data from social media and other nontraditional sources when setting premium rates, although they will have to prove the information doesn’t unfairly discriminate. 

PG&E, which is California’s largest utility, filed for bankruptcy protection as it struggles with billions of dollars in potential liabilities from its role in sparking California wildfires, triggering one of the most complex corporate reorganization cases in years.

As the two sides resumed talks last week, the U.S. and China were sharply divided on trade issues, suggesting a hard slog ahead of a March 1 deadline. However, progress was said to have been made and President Trump expects to meet with Chinese President Xi Jinping later this month to resolve the conflict that has rattled the global economy. 

Brexit keeps going nowhere fast.

Pending home sales fell 2.2 percent in December, meaning almost 400,000 fewer contracts were signed to buy existing homes. It’s part of an ongoing slump that’s seen 12 straight months of year-over-year declines. It’s also the lowest December sales reading since 2013. Existing home sales had been trending higher but also reversed course last month, falling 6.4 percent from November to a seasonally adjusted 4.99 million sales in December. That’s down 10.3 percent from December 2017’s 5.56 million sales when the metric was moving in the opposite direction.

More than 50 investment advisers are under pressure to settle federal claims they steered customers to mutual funds that charged excessive fees, even though asset manager fees are being squeezed generally. Meanwhile, the outsourced-CIO market is booming – and its influence is reverberating across the asset management industry.

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