Stocks finished lower for the week, with all major indices (S&P 500, Dow and Nasdaq) in correction territory for the first time since February of 2016. Trade headlines remain front and center. While there were some positive signs of de-escalation in the trade rhetoric, this was offset by continued global growth concerns. Chinese officials signaled changes to economic policies that could increase access for foreign companies and announced China's intent to buy U.S. agricultural products along with cutting the tariff rate on imported U.S. cars. In our view U.S.-China trade tensions are unlikely to be resolved immediately. Although we don’t expect a full-blown trade war, lengthy negotiations mean additional volatility is likely. In the U.S., economic data was encouraging as retail sales grew faster than expected, supported by strong consumer confidence, rising wages and low unemployment. Overall, uncertainty remains and risk appetite appears low at the moment, but strong economic fundamentals and lower valuations support a positive outlook for stocks.
Daily Worries Keep Markets Volatile
At this time of year we frequently are reminded about the "deal of the day." In contrast, markets continue to be jolted by the "worry of the day." Both may capture your short-term attention, but most of the time we think it's best to resist reacting to either one. And while deals are usually gone in a flash, many of the worries are part of bigger themes that could continue to keep markets volatile. Investors have been focused on signs of slower global economic growth, trade tensions and concerns about the pace of Federal Reserve interest rate increases.
Shifting trade tensions – Prospects for progress between the U.S. and China were offset by additional worries about the ratification of the trade agreement between the U.S., Mexico and Canada, keeping trade tensions in the headlines. U.S.-China trade tensions seemed to calm a bit as meetings between the two sides began. China resumed U.S. soybean purchases and announced a 90-day reduction in auto tariffs. Both the U.S. and China appear to want to reach an agreement to prevent escalating tariffs, which is positive. But the issues may be difficult to resolve; we think the progress could be slow and the tensions are likely to provoke more volatility ahead.
Global economy still growing – Global growth worries have been taking more than their share of daily investor concerns. The recent focus has been mainly overseas, since the U.S. economy appears solid. Retail sales were stronger than expected in November, industrial production rose more than predicted and other indicators point to continuing modest growth. Although prospects for global economic growth rates continued to edge lower, they remain positive, while investors have become overly pessimistic in our view. China's economy slowed more than expected in November, with slower growth in retail sales and industrial production. Eurozone indicators also disappointed recently. We think signs of improving growth or lessening trade tensions could be positive catalysts internationally.
Fed rate worries – Uncertainty about the prospects for the path of short-term rate increases is another daily worry for investors. The Fed is generally expected to increase short-term interest rates on December 19, based on its assessment of near-full employment, modest economic growth and the need to continue to remove the very accommodative policies it put in place during the great recession. But fears that the Fed will over-shoot and raise rates too high have been a recent concern, and we expect the Fed will continue to work to calm investor fears about rapidly-rising interest rates.
Better valuations --One silver lining hidden in the cloud of weaker global data and lower stock prices is the improvement in equity valuations. We think investors have become too pessimistic. The S&P 500 is down nearly 10% while earnings have increased, reducing its price-earnings ratio to 16.3, below its average over the past five years. Relative valuations for international developed markets have fallen to less than they were in 2012, when investors feared the Eurozone would break apart. And the emerging market benchmark is down 22.5% from its 2018 high and is at its lowest relative valuation level since December of 20131. Lower valuations mean stocks appear more attractive, and while they don't predict short-term returns, historically they've meant higher long-term returns2.
Deal of the day or worry of the day? Just as the deal of the day doesn't last long, we don't think the worry of the day is a good guide to the long-term prospects for the markets or the economy. With short-term concerns dominating the headlines and prompting sharp daily moves, it's important to have an investment portfolio designed to keep you comfortable when markets are volatile, and that means it needs to have the right mix of stocks and bonds based on your comfort with risk, time horizon and goals. Over time, stocks have risen along with the underlying fundamentals of economic and earnings growth, which we think remain positive. And better valuations may mean better returns over time – making long-term stock investments a good "deal of the day", in our view.
Sources: 1. Factset, 2. Bloomberg and MorningStar Direct. Past performance of the market is not a guarantee of what will happen in the future.
|Dow Jones Industrial Average||24,101||-1.2%||-2.5%|
|S&P 500 Index||2,600||-1.3%||-2.8%|
|10-yr Treasury Yield||2.89%||0.04%||0.48%|
Source: Bloomberg, 12/14/18. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
The Week Ahead
The main focus will be on the Federal Open Market Committee (FOMC) decision on Wednesday, where the Fed is widely expected to raise rates by 0.25%. Investors will be looking for changes in the forward guidance and potential signals that the U.S. central bank could be slowing down the pace of rate hikes in 2019. Other important economic releases include housing starts and building permits on Tuesday, existing home sales on Wednesday and personal income and spending along with consumer confidence on Friday.
The Weekly Market Update is published every Friday, after U.S. markets close.
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