Market Strategy Radar Screen Weekly November 12, 2018

What a Diff’rence a Day Makes

The contrast between relief and worry was on display as the market reacted to the week’s news

With the bond market closed today for Veterans’ Day equities stateside will hold investors’ attention in terms of what direction stocks will move after last week when equities rallied powerfully the day after mid-term elections only to stumble on Thursday and Friday on the back of the Fed’s FOMC meeting as the Fed’s comments signaled that the economy is doing well enough to make a rate hike in December all the more likely.

Even though market expectations were for the outcome of last week’s FOMC meeting to be no rate hike in November and essentially no change in policy that might preclude a hike in December, the market opted to get rattled last Thursday and Friday.

In our opinion the market’s nervous reaction to the outcome of the Fed’s November meeting signaled less a surprise at the outcome on Thursday than the typical nervousness that goes with a change of leadership at the Fed. We believe the market’s reaction is not so much a negative reflection of opinion about Jerome Powell’s leadership but merely par for the course when a new boss assumes the role at the Fed. We recall that it took years for the market to get used to the style of Ben Bernanke and Janet Yellen. It will likely take some time yet for the markets to get accustomed to Jerome Powell’s leadership.

In the meantime investors and traders will simply have to deal with spells and bouts of market jitters around every announcement that has potential to signal an unexpected change of policy or in the current situation, that might signal higher rates at a faster pace than the highly sensitive and measured methodology that this Fed hike cycle has thus far brought.

Ironically, since the tenure of Ben Bernanke as chairman of the Fed a high level of transparency and clarity in the way the institution is run has made Fed policy considerably clearer for investors to ponder than under his predecessors. Janet Yellen followed Bernanke’s lead in keeping a high level of transparency and frequent communication during her term at the Fed and so far so has Jerome Powell in our view. Ironically the market at least for now appears haunted by the ghosts of earlier Fed officials who in our memory were considerably more opaque by comparison.

The day after the stateside mid-term elections last week stocks world-wide broadly rallied. Stateside stocks jumped higher on Wednesday with the Dow Jones Industrials, the S&P 500, the S&P 400 (midcaps), the Russell 2000 (small caps) and the NASDAQ Composite (weighted some 40% in technology and tech related stocks) respectively gaining 2.1%, 2.1%, 1.5%, 1.7% and 2.6%.

Major international equity benchmarks rallied last Wednesday as well on back of the US election results with MSCI EAFE (developed markets ex-US and Canada), MSCI Emerging Markets and MSCI Frontier Markets respectively adding 0.9%, 0.6% and 0.4%.

The day of the FOMC announcement and on last Friday markets stateside and internationally gave back some of their post-election day gains.

Notwithstanding the give back of some ground after the FOMC meeting stocks stateside managed to keep a good part of their gains with the Dow Jones Industrials, the S&P 500, the S&P 400, the Russell 2000 and the NASDAQ Composite respectively posting gains for the week of 2.8%, 2.1%, 1.1%, 0.10% and 0.68%. (See pages 7 and 8 of this report for more details)

Internationally MSCI EAFE managed to post a modest gain of 0.20% while MSCI Emerging Markets and MSCI Frontier Markets declined respectively 2.1% and 0.5% for the week on concerns that greater expectations for a rate hike in December could strengthen the dollar further along with trade war jitters.

But Wait, There’s Earnings…

With just 50 of the S&P 500’s member companies left to report, Q3 earnings have nicely exceeded expectations: up so far 26.8% on the back of revenue growth of 8.4%.

Concerns about likely “tough comps” for earnings results in quarters ahead (against the stellar growth rates of the most recent three quarters which have reflected the effects of the Tax Reform compared with pre-tax reform results) have kept the market to a large extent from celebrating the Q3 results. We believe the market will likely be able to come to terms with that reality so long as earnings and revenue results in future quarters are supported by economic and corporate fundamentals and remain historically attractive.

Trade Resolution Ahead?

We believe, most importantly for the markets that a resolution of the trade war risk overhang will be needed to rid the equity markets of their recurrent funk. We continue to expect a resolution now that the mid-term elections are over, sometime before the end of this year or at the latest by the end of the first quarter.

Slowing in the Chinese economy tied to their domestic growth is exacerbated by the trade war with the US and will likely worsen if tariffs are ratcheted up further and the trade war becomes protracted. For the US, a prolonged trade war could trim the sparkle off what has become a sustainable economic expansion, increase inflation and reduce earnings at companies with significant global exposure.

The G20 meeting in Buenos Aires, Argentina at the end of this month will offer an opportunity for President Trump to meet in person with President Xi of China. Ahead of that meeting, talks between the leaders have already begun over the phone with reports that both sides might be more amenable to finding a resolution. Progress not perfection is what the markets stateside and globally will be looking for around their talks.

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