| Feb. 04, 2019
FAQs on the Markets and Economy
Has the Fed become more dovish on their view of future rate hikes?
Yes. Since Q4’s steep slide in stocks, senior Fed policy makers have been taking back some of their hawkish statements from last year.
In December, they reduced the number of projected rate hikes in 2019 to two, from three. In the press release from the January FOMC meeting, they dropped the language of “further gradual hikes” and replaced it with language stating they will be “patient” with the decision to raise interest rates in the future.
At the press conference following this meeting, Chair Powell argued that the case for rate hikes has “weakened somewhat” in recent months because inflation remains subdued and the risks posed by financial imbalances have receded.
With this dovish pivot over the past few months, equity prices have started to recover from their Q4 drubbing. January’s stock market was the best in about 30 years. Corporate credit spreads have also narrowed.
What is happening with Europe’s economy?
Since the end of the global financial crisis, economic growth in the eurozone has been plagued with problems and has consequentially had a pace of economic growth that has been slower than what has been seen in the United States.
Then, in 2016, with many of their problems behind them (like the Greek sovereign debt crisis) and led by stronger consumption, growth started to pick up. For eight consecutive quarters, the pace of economic growth was faster than the U.S.’s (chart).
But growth has stumbled again, and growth decelerated in 2018. The yearly change in GDP currently stands at 1.6%, about half the 3.0% growth rate in the U.S. Much of the weakness has been attributed to slower manufacturing, due in part to global trade tensions and uncertainty with Brexit.
All of this appears to be a slowdown, not collapse, in economic growth. On the positive side, their unemployment rate is at the lowest level in about a decade and wages are relatively strong at 2.5%, above the inflation rate of 1.6%.
Will the bull market continue in 2019?
Equity markets appear to have found their footing over the first month of the New Year, with the S&P 500 up 15.1% from the December low. Although the damage from the recent correction has not been fully repaired -- the market is still 7.6% below last year’s high – the pendulum of sentiment appears to have swung back to a more balanced position.
A dovish turn by the Fed and a resumption of trade negotiations with China have improved investor sentiment, while earnings and corporate guidance released so far have been better than feared.
Nearly a quarter of S&P 500 companies have now reported results, with profits rising more than 13% in the recent quarter. Consensus earnings estimates for 2019 have come down a bit, but still forecast better than 6% growth this year.
The early-year rebound in the market is encouraging. It indicates a wider investor focus that includes ongoing political risks in addition to the still favorable fundamentals, which is an environment in which the market can perform reasonably well. While this likely won’t prevent ongoing market swings in the months ahead, it should allow for the long-running bull market to continue over the foreseeable future.
What is happening to corporate spreads?
During Q4 of last year, credit spreads were widening, indicating the possibility of slower economic growth on the horizon; this move paralleled the drop in equity prices.
There were multiple concerns that forced the widening: slowing economic growth, future Fed policy that was viewed as too restrictive, softening in the manufacturing sector, trade dispute with China, the upcoming earnings season and a handful of technical factors.
Even with those outstanding issues, it was surprising to see the widening since not much had changed in the underlying economy.However, slightly dovish comments from Fed policy makers at the end of last year followed by even more dovish statements this year have helped change the market’s outlook, and spreads have been narrowing again (chart: the change is subtle; remember these are high -quality bonds, not stocks).
What is the impact of the U.S. government shutdown on the economy?
Congress and the president have reached a deal to temporarily reopen the government until February 15, halting the longest shutdown in U.S. history at 35 days. The three-week extension could provide time for a more permanent deal to be reached, but given the current political divide, that outcome is far from guaranteed.
While the personal impact many suffered from the shutdown should not be overlooked, the impact to the overall economy has likely been minimal. The CBO estimates the shutdown shaved 0.1% off real GDP growth in Q4 and 0.2% in Q1. Most of that growth will be recovered, though some will be lost permanently.
The bigger concern we think is that the recent impasse may serve as a prelude for much bigger fights on more economically important issues down the road. An agreement on the debt ceiling must be reached in March and, even more importantly a decision must be made on whether to lift budget caps in October.
Failure to do so will cause a large step-down in government expenditures, which has been adding roughly half a percentage point to GDP growth over the past year.
What is City National Rochdale’s investment outlook for 2019?
Although it can be difficult to remain calm in the midst of market action like we’ve seen over the past couple of months, our advice is to stay disciplined and invested. Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed-income class.
Still, patience and discipline will be more important than ever. The investment landscape has grown more challenging as investors adjust to more typical late-stage conditions of higher inflation, rising interest rates and less accommodative monetary policy.
Meanwhile, concerns over slowing global growth, trade tensions and other geopolitical risks mean that markets likely will continue to be subject to periodic swings in sentiment and potential pullbacks.
Both our equity and fixed income research teams have made deliberate risk-mitigating portfolio changes over the past year with the recent type of volatility in mind.
These decisions have helped fortify client portfolios to weather the turbulence we are experiencing, while leaving them well-positioned to take advantage of opportunities ahead should they present themselves.
