Weekly Market Update (January 7, 2019 – January 11, 2019)

By Craig Fehr January 14, 2019

Stocks finished higher for the third straight week, with small-cap and international markets outperforming. After the recent gains, the S&P 500 is now up 10.4% from the December low1. The main drivers of the market rebound have been optimism around the U.S.-China trade talks, some backpedaling from the Federal Reserve on its interest rate trajectory, and oversold conditions. Talks between U.S. and Chinese officials took place in Beijing, with some encouraging comments hitting the press about the prospect of reaching a trade deal. Adding fuel to the rally, the FOMC minutes released this week showed a more cautious approach to the extent and timing of future interest rate hikes, noting that the Fed can afford to be patient about further policy firming. Lastly, a couple of company profit warnings failed to bend sentiment, which was interpreted as a sign of reduced expectations heading into the earnings season next week.
Source: Bloomberg

The Upside of a Down Market

New year, new mood.  After a fit that led stocks sharply lower in December, the market has shown a sunnier disposition of late.  We haven't seen the last of the market's mood swings, but we think the recent rally provides the following three takeaways:

  • Panic doesn't pay – Stocks have staged a healthy rally in the past two weeks, rewarding investors that stayed calm in the face of December's panic. This highlights the importance of a longer-term perspective, as some of the market's best days often come on the heels of its worst. For example, the late-December sell-off included the worst two-day decline (-4.8%) since 2015, which was followed the very next day by the best daily gain (+5.0%) since March 20091. We have now experienced four corrections (declines of 10% or more) in the past four years, directly in line with the average since 1900 of one correction per year. It's a reminder that despite the uncomfortable nature of market pullbacks, volatility is in fact a normal part of investing. Being a long-term investor does not require you to ignore shifts in the market, but it does require perspective and discipline. Stocks are now up 10.4% from their December low, having recouped more than 40% of the total decline.  Looking at the 10%-plus pullbacks since 2010, the market regained the entire drop in an average of 90 days1. This is no guarantee that recent losses will be erased in such short order, but the rally over the past few weeks is a reminder that the decline in December was not a one-way path toward a severe bear market.
  • The market has regained some composure –  After falling in 11 of the 14 days leading up to Christmas, the tone in the stock market has pivoted more recently, with stocks rising in six of the eight trading days in January.  This is not by accident. Instead, the prevailing fears of an imminent recession, a trade war and Fed rate hikes have been assuaged by incoming data.
    • The economy - We're in the later innings of the expansion, in our view, but it's not the bottom of the ninth. The December jobs report showed the labor market is still quite healthy, backed by strong hiring and faster wage growth. The decline in initial jobless claims last week supported that view, with new claims remaining near the best levels of this expansion. The Small Business Optimism Index ticked down slightly in last week's reading, but it remains well above the average of the previous two years. This economy is not bulletproof, and we anticipate slower growth this year, but a healthy consumer and business-investment environment suggests a recession is not looming.  
    • Trade – Stocks have responded positively to news last week that progress is being made on trade negotiations between the U.S. and China. It's far too early to declare victory on this front, as we think trade tensions will remain a source of volatility this year. That said, we think a resolution can be reached, as we maintain our view that an outright trade war – as the market has feared – is not the most probable outcome. 
    • The Fed – Recent commentary from the Fed has allayed fears that it would overtighten rates this year. Fed Chair Powell has noted that the central bank will be flexible with future rate hikes, letting incoming economic data guide policy ahead. Inflation data last week showed that consumer prices fell last month, thanks to the sharp decline in fuel prices. Stripping out food and energy, core inflation is up 2.2% in the past year. This is within the Fed's comfort zone and signals that the Fed does not have to be more aggressive in hiking rates.

As we noted during the sell-off, the decline in the stock market was not fully in sync with the economic and corporate earnings fundamentals, which remain more favorable than a 19% market drop would suggest. In the last two weeks, U.S. small-cap stocks have doubled the return of the S&P 500, and the energy and consumer discretionary sectors have led the gains. We believe outperformance of these more cyclical investments signals better optimism on the economic outlook and gives us some comfort that the market won't ignore the fundamental underpinnings indefinitely. Corporate earnings announcements start this week, offering a fresh look at the health of corporate America. Broadly, we think earnings will rise again in 2019, offering support for stock market performance as we advance through the year.

  • Even good markets have bad stretches – This market rebound has been encouraging, but it's too early to sound the all-clear. In the late innings of this expansion, the balance of encouraging and cautious indicators is likely to drive ongoing volatility. More specifically, we don't anticipate the market to return to new highs quickly, as it has done fairly consistently following pullbacks during this expansion. But we don’t think ongoing volatility should be interpreted as the inevitable end to this bull market. As the table shows, most pullbacks are not the start of a bear market. Interestingly, current conditions (an extended economic expansion, falling oil, a slowdown in Asia, anticipation of tighter Fed policy, fluctuating global currencies) resemble those of 1998, a period that saw a steep market pullback, followed by an extended bull market. We think investors should let their long-term strategy be their guide, aligning portfolio decisions with goals and comfort with risk. Doing so can create long-term opportunities out of short-term market reactions.     
Period
Catalyst
Decline
Became a Bear Market?
Total Return over Next 12. Mos.2

Late-2018

Recession + trade fears

-19.8%

??

??

Early-2018

Rising rates

-10.2%

NO

??

Early-2016

Falling oil, rising dollar

-12.0%

NO

27.8%

2015

China slowdown, Fed rate hikes

-12.4%

NO

17.5%

2011

Eurozone debt crisis

-19.4%

NO

30.7%

2010

Recession fears

-16.0%

NO

33.0%

'08-'09

Housing bubble, financial crisis

-56.8%

YES

70.6%

2003

Iraq war

-11.7%

NO

43.2%

2000

Tech bubble

-49.1%

YES

32.5%

1999

Fed tightening

-12.1%

NO

8.3%

1998

Asian/currency crisis, LTCM collapse

-19.3%

NO

25.7%


Source: 1. Bloomberg, S&P 500 index. 2. Total return of the S&P 500 index.

Craig Fehr, CFA
Investment Strategist


Index Close Week YTD
Dow Jones Industrial Average 23,996 2.4% 2.9%
S&P 500 Index 2,596 2.5% 3.6%
NASDAQ 6,971 3.5% 5.1%
MSCI EAFE 1,786.13 0.02% 3.9%
10-yr Treasury Yield 2.70% 0.03% 0.01%
Oil ($/bbl) $51.68 7.8% 13.8%
Bonds $106.55 -0.1% 0.1%

Source: Bloomberg, 01/11/19. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.


The Week Ahead

The week marks the unofficial start to earnings season, with several national and regional banks reporting quarterly earnings. On the economic front, the release of some economic indicators is affected by the government shutdown. Important economic data include the PPI on Tuesday, retail sales on Wednesday, and the University of Michigan's Consumer Sentiment, along with industrial production, on Friday.

Review last week's weekly market update.

Important Information

The Weekly Market Update is published every Friday, after U.S. markets close.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.
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Past performance does not guarantee future results.

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This information is approved for use with the public.
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It is believed to be reliable, but its accuracy and completeness are not guaranteed.

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