Fed Changes Tune – Market Changes Tone

The Federal Reserve has been in the spotlight since the start of the fourth quarter.  On October 3rd, with the U.S. equity markets flying high, Fed Chairman Powell commented on the Fed’s current monetary policy.  He opined that the Federal Reserve was “a long way” from neutral, implying a steady diet of future rate hikes.  While the markets continuously evaluate multiple inputs, this hawkish statement began a legitimate 10% stock price correction that continued into November.  In a speech on November 28th , Chairman Powell threw the stock market a life preserver when he stated the current fed funds rate was “just below” neutral. Bulls interpreted this as a green light to buy again and may mark a possible end to the current correction.

The Federal Reserve is just one piece of a complicated puzzle.  Market volatility remains high in the fourth quarter as anticipation for slower growth in 2019 gets reflected in current asset prices.  Markets are expecting economic growth rates to decelerate around the world next year.  U.S. GDP growth is forecasted to drop from 2.9% in 2018 to 2.5% in 2019.  Similar downsizing is expected in both Europe and the emerging markets as central banks generally become less accommodative.  In addition to a modest economic slowdown, U.S. corporate earnings growth is likely to shrink into single digits after posting 25% earnings growth this year.

While the Federal Reserve and lower growth forecasts are main events, they are not the only game in town.  Trade and tariff issues are being scrutinized daily, and talks during the G-20 meeting in Argentina will be under a magnifying glass. Any signs regarding a deal or no deal with China will have serious market implications. Plummeting oil prices and a slowdown in housing are also on investors’ minds.

The stock market reversed course in late November to end the recent correction.  Emerging markets, which is still the laggard over the past year, had the highest monthly return of 4.12%.  The Dow Jones Industrial Average, the S&P 500 and the NASDAQ composite had positive gains of 2.11%, 2.04%, and 0.49%, respectively, after a challenging October.  The only major international index in the red was the international developed MSCI EAFE, dropping a negligible 0.13%.  The change in sector leadership was evident as the high flying technology sector took a back seat to healthcare and other value-oriented stocks like Coca-Cola and Proctor & Gamble.

The worries in the stock market gave life to bonds as interest rates declined from recent highs.  Returns for November were positive in the investment grade quality arena, but high yield bonds gave up some ground as credit spreads widened. The benchmark 10-Year U.S. Treasury note entered November yielding 3.15% and finished the month 14 basis points lower at 3.01%.  The yield curve returned to its long-term flattening trend, but still maintained its positive slope.  The 2-Year Treasury note fell by 7 basis points to end the month yielding 2.80%, while the 30-Year Treasury bond fell 9 basis points to yield 3.30%.

Your perception matters as it relates to your ability to be a true long-term investor.  Viewing the world from a glass-half-full perspective can lead to more consistent investment results without the emotional baggage.  For example, the U.S. is eight years into an economic recovery. Many of those years saw economic growth in the 1-2% range.  If next year produces 2.5% growth, this is good news.  If corporate earnings can growth 5-10% next year on the heels of 25% earnings growth year, this is still good news.  If stock valuations were stretched at price-earnings ratios of 19 times, we now have lower stock prices and slightly higher earnings with PE ratios of 16 times; this is good news.  Unemployment is at 3.7%, wages are growing, consumers are very confident and spending; this is also great news.  The backdrop of generally low-interest rates, less government regulation, and lower taxes should help sustain the U.S. markets into 2019.