On the Horizon: Will We or Won’t We? | Fourth Quarter 2018
In a nutshell: While investors always have a laundry list of market related concerns, there are a few dominant issues today that are likely to drive investment activity over the coming months. Specific concerns about trade with China, the Fed, and what may or may not transpire in Washington D.C. all relate to or are secondary to a larger question – will the U.S. or global economy slow or even experience a recession? Markets clearly began to price in the risk of a recession this past quarter. Whether or not we experience one will help determine which direction markets go from here.
For insights on each of these focus areas, read below.
In the last few On the Horizon sections of our CFO Report we’ve listed several themes, data points, or anticipated events that might be reasonably expected to move markets in the coming quarter or year. This quarter we’re narrowing that list to focus on what we believe may be the most meaningful. Several of the potentially significant market moving topics have almost a “binary” feel to them – meaning that one of two things are likely to happen. Even though markets are moving rapidly from one extreme to the other, we’ll also attempt to gauge what the market is expecting or may have priced in.
- Will 2019 bring an economic recession? This is really the overriding concern that weighed heavily on markets during the 4th quarter. While we address topics such as trade with China and the Fed separately, the concerns around each (and many other areas) ultimately center on their impact on economic growth for the U.S. and abroad. Will a trade war with China result in causing a recession? Will the Fed raise interest rates too far and push the economy into a recession? There is, of course, no way to know the answer to those questions, but having enjoyed a prolonged period of economic growth has put many economists on high alert. We address this topic a bit more in our Deeper Dive section of this CFO Report. While the weakness this past quarter has clearly priced in some expected economic softening, data showing evidence of an actual recession would likely lead to further equity market weakness. (Read more about our perspective on this in the Deeper Dive section).
- Are we headed for a trade war with China? One of the larger swing factors that economists point to regarding future economic growth is our relationships with global trading partners, specifically China. The U.S. and China have been engaged in an escalating game of chicken over the past year that threatens economic growth in both countries. While each have already levied tariffs against the other, another round of tariffs was set to be enforced on January 1st. At the most recent G-20 meeting in Buenos Aires, however, President Trump and Chinese President Xi Jinping agreed to a 90-day “ceasefire” agreement in hopes that a trade deal could be agreed upon. That development was announced on December 1st, so while both countries bought time, a hard deadline still exists, and markets will be eagerly watching for any signals as to how those talks are progressing. While markets should not be blindsided if talks deteriorate there is still a belief (or perhaps hope) that the two sides will ultimately come to an agreement given what is at stake for both parties.
- Will the Fed raise rates in 2019? If so, how often or how much? The Federal Reserve hiked short-term interest rates yet again in December. The hike was their 4th in 2018 and 9th since they started raising rates in late 2015. The hike in December was largely expected, but markets were clearly disappointed in the Fed’s communication about the path of rates in 2019 as they stated their expectations for two additional rate hikes in 2019. That was down from a prior expectation of three, but markets were still disappointed and reacted swiftly. While most economists and industry professionals have understood the need to raise rates from the financial crisis levels, there is mounting concern that the Fed is raising rates too quickly and may misjudge the strength of the economy. Should the Fed show or communicate greater willingness to be “data dependent” and err on the side of too slow with their next rate hike equity markets would likely react positively.
- Will Washington provide relief or continued drama? At this time last year, on the heels of a significant tax reform deal, investors expected Washington’s impact on the economy and markets to largely be positive. While the tax reforms certainly provided boosts to the economy and earnings, other issues and concerns emanating from the nation’s capital played a major role in driving markets. As of the time of this writing the government is in the midst of one such issue as they are navigating their 3rd partial shutdown of 2018. That is, of course, not the only issue transpiring in Washington D.C. and others will inevitably arise during 2019. Political issues, however, are often shorter term in nature and not overly impactful to the overall economy. With limited impact to the long-term economy and corporate earnings, politically related market weakness typically improves valuations and we’d view as a potential rebalancing or buying opportunity.
- Is Brexit happening? With slightly less than three months left until the United Kingdom is due to leave the EU it is still unclear what that exit will look like. Prime Minister Theresa May did reach a Brexit deal with the EU, but pulled a planned parliamentary vote at home after admitting it would likely be rejected. Lawmakers are currently set to vote on the deal in mid-January and if it is rejected it opens a range of possibilities from a Brexit without a trade deal, a Brexit delay, or even calling Brexit off entirely. While any resulting crisis should be contained mostly to the U.K. and Europe, it would almost certainly have an impact on global investor confidence.
In past quarters this list was full of more potential market negatives than positives. That was likely an outgrowth of the lengthy bull market we’ve enjoyed and the higher than average valuations that resulted. Those elevated valuations could be interpreted as having priced in a lot of good outcomes, both politically and economically, so our concern was about what could go wrong or disrupt the status quo. With markets selling off so significantly during the 4th quarter, that outlook is now much more balanced. It is now quite possible that some markets have flipped from only seeing the positives to fully expecting the worst. We have no way of knowing how any of these issues will work out, but when expectations are low or bad news is already priced in, that is often a positive for future investment returns.
Contact Brad Swinsburg 404-874-6244 to discuss the dominant issues likely to drive investment activity over the coming months.
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Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.