Market Strategy Radar Screen Weekly March 26, 2018

From “Great Expectations” to “Curb Your Enthusiasm”

So far 2018 is the shaping up to be the year of “do-overs”

A year that began with what seemed like a consensus of great expectations for the equity markets in the first four weeks of the year has turned into a “do-over-again” type of year for the stock market as inflation fears, concerns about the transition at the Fed, trade war worries and geopolitical risks loom over the landscape.

While the market has found plenty to worry about the good news of improving fundamentals--both economic and corporate--appears not to be showing signs of deterioration but rather of more to come if at a modest rather than robust pace as some had hoped for.

From our perspective, the market looks near-term oversold when the fundamentals are taken into account.

While an all-out trade war with China would likely challenge the current pace of global growth, such trade dislocation would appear not to be a likely outcome from what has come to pass so far. For now there have been “shots across the bow” from both the US and China resulting thus far in tariff regimes of symbolic but not sizeable consequence.

The global equity markets may have well overreacted to trade war risk, in our view, at least based on the tariffs and response outlined by both sides thus far.

In time hindsight may well show not only that the equity markets over-reacted last week but could show that they also created yet another “buy the dip” opportunity along the timeline of what is in our view the “most hated and denied bull market” we’ve seen over the course of the past 35 years.

No Surprises from the Fed

The outcome of the FOMC meeting last week as expected resulted in the Fed raising its benchmark rate by 0.25% or 25 bps (from 1.25-1.50% to 1.5% to 1.75%).

So far this Fed-Funds hike cycle the Fed has raised just six times at 25 bps per hike (or 150 bps in total) since it started raising the rate in December 2015 28 months ago.

The last time the Fed was in a hiking mode (from the end of June 2004 through the end of June 2006) it raised rates 17 times, 25 bps at a time, or by 425 basis points to 5.25%.

Thus far the Fed has been able to hike its benchmark rate at a slower pace than many expected. Inflation has risen some but not enough to equal or surpass the Fed’s target.

Economic growth appears sustainable for now in an annualized range of 2.0% to 2.5% before the effects of any added stimulus from tax reform.

Wage growth and overall inflation remain moderate but not robust, likely held in check by a combination of robotics, algorithms and globalization that create a highly competitive corporate landscape and labor pool.

The Fed Chairman’s tone in his post FOMC press conference last Wednesday signaled a less hawkish tone than he’d used in early February when assuming his roll. The minutes of last week’s FOMC meeting will have no dearth of readers when they are released in a few weeks.

Economic Views Went from Hot to Warm in a Month

Economic data which in January looked hotter than expected now points to modest growth for the near term and less need for the Fed to get aggressive in working its process of interest rate normalization in the months ahead.

As tariff regimes and retaliatory actions captured the attention of many traders and market observers last week, others noted that --though it may be too soon to tell--the Tax Reform package has yet to show much effect in providing additional stimulus to the economy.

The latter notwithstanding the markets indeed took a nearterm drubbing last week with the Dow Jones Industrials, the S&P 500, the S&P 400 (mid-caps), the Russell 2000 (small caps) and the Nasdaq Composite (mostly large cap and some 40% weighted in technology-related stocks) respectively shedding 5.7%, 6%, 5%, 4.8% and 6.5%.

Foreign markets resonated the concerns of the US markets to a lesser degree (perhaps somewhat attributable to dollar weakness versus many foreign currencies) with MSCI EAFE (developed markets ex-US and Canada), MSCI Emerging markets and MSCI Frontier markets respectively shedding 2.64%, 3.4% and 0.84% last week.

Social Media “Unfriended”

Last week the biggest names in the medium were taken to task on privacy and security issues.

Beyond the issues tied to tariffs the markets resonated with concerns tied to the biggest names in social media which came under increased fire as they were taken to task by government officials stateside and in Europe on issues tied to privacy and security risk regarding information belonging to individuals, corporates and governments around the world.

It is our take that what has come forth in the social media space is not unlike what has happened historically with other developers of innovations which have effected profound changes in the way people live and societies function.

Electric utilities, telephone companies, railroads, auto makers, broadcasters and many others have gone through the process of being “the next new thing” to becoming the big brother that needs to be regulated in some manner to protect society.

From faster vehicles to seat belts to shoulder harnesses to airbags, to mileage efficiency standards -- innovation has historically led to necessary levels of oversight or regulation.

While we believe near term social media will be facing speed bumps in and outside of the market place the likely outcome will not so negatively impact profitability (as some observers have projected) but likely change the way their profits are derived.

From our experience with technology we have come to learn that “the technology genie” is more likely to change its form than go back into the bottle.

Right size expectations key for now

The complexities of global trade tell us it will likely take some time to put trade agreements in place but in the meantime progress not perfection is what will give the markets renewed confidence that a trade war is not likely to break out.

Over the weekend news items crossed the transom signaling that talks are under way between US and China officials to overt a trade war. Another news item noted that Korea had come to an agreement related to the importation of steel into the US but that little progress for US agricultural exports to Korea has been made.

For now, investors will need to practice patience and keep an eye out for “babies that get thrown out with the bathwater” on days when volatility rises and reason ebbs.

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