CFO February 2019 Economic and Financial Market Outlook

After peaking in September, the U.S. stock markets suffered a surprisingly deep correction during the 4th quarter of 2018, driving the global equity markets lower to finish 2018 with some of the worst overall declines since 2009. We believe the dramatic dive in the global stock markets during Q4 was caused by widespread investor capitulation that turned an overdue, orderly correction into a “mini-panic” with increasing investor fear and selling pressure as the stock markets declined. As we briefly summarize below, there were few places to hide [Sources: Morningstar, Ned Davis Research, Thomson Reuters]:

•           The S&P 500 [-6.2%] posted its biggest yearly drop since 2008. Almost all the damage was done in the fourth quarter [-14.0%].

•           Bonds outperformed stocks for the first time in four years. The Barclays Aggregate Bond Index [+0.01%] beat the S&P 500 Index by a whopping 625 basis points (bps) in 2018.

•           International stocks performed even worse than U.S. stocks in 2018. In U.S. dollars, The MSCI EAFE [developed markets] and MSCI Emerging Markets indices declined by over -13% and -14% respectively.

•           Commodities were the worst performing asset class of all the major asset classes. Dragged down by the plunge in crude oil prices, the S&P GSCI index of commodities fell by over -13% in 2018.

•           With the exception of the U.S. Dollar [Index] that rose +4% in 2018, The +1.8% meager, annual return for U.S. 30-day Treasury Bills was still the best return among the major financial market indices that we track.

Since we provided our clients with our last “Economic and Financial Market Outlook” in our December CFO Newsletter, the research data from Ned Davis Research [NDR] has indicated that the global economic slowdown has deepened somewhat, and the U.S. economy has lost some momentum as well. NDR has reduced their 2019 forecast for the global economy from +3.7% to +3.5% annual growth. The current global slowdown is being exacerbated by trade disputes, particularly the tariffs the U.S. has imposed on imports from China. Tariffs have undoubtedly played a role in slowing not only the economic activity in China, but the overall global economy as well. The ongoing Brexit saga and other political turmoil in the large European economies also continue to weigh on European and global economic growth.

As of the end of January, NDR has currently reaffirmed their 2019 call for healthy U.S. economic growth of +2.5% with low inflation, but a protracted global slowdown would likely lead to slower U.S. growth but no recession in 2019. Investor sentiment is currently negative from the endless U.S./China trade and intellectual property negotiations; The financial hangover from the partial, but extended, government shutdown; The U.S. debt ceiling debate and Brexit just to name some of the key risk factors. However, the outlook is not all gloomy. U.S. payrolls and wage income grew at stellar rates in December [and again in January!], and the holiday shopping season was one of the strongest in recent history. Credit conditions still remain broadly favorable for economic growth. Even though the Fed raised rates again in December, real [after inflation] interest rates still remain low, and Fed Chairman Powell has since communicated a more “Dovish” outlook for future interest rate increases by the Fed during 2019. That positive development notwithstanding, the elevated and persistent (geo)political uncertainty is making the prediction of the direction of interest rates, the global economy and financial markets even more challenging.

With 2018 having been the worst year in a decade for U.S. stocks, many investors were probably doubting the existence of any “Santa Claus” but the Santa rally did come, albeit late, with a +7% rebound in the DJIA during the final trading days of 2018 that has, in turn, been followed by a continuation of that rally through the end of January 2019. While the extended rebound rally may be a good harbinger of a bullish recovery from the market lows set by the “mini-panic” of in the fourth quarter of 2018, market volatility will likely persist throughout 2019. For the recovery to be sustainable, we need to see positive resolutions to our key wish-list for 2019: [1] Washington politicians need to focus on the primary job they were elected for by Americans: Create real economic growth [starting with avoiding another government shutdown!]; [2] The Fed must put interest increases on hold and be more “data-dependent” on future rate increases [which will also help keep the U.S. Dollar stable]. Powell’s January 4th comments provided at least a blinking green light for that critical need; [3] The U.S. economy needs to avoid any global recessionary pressures and, while the U.S. December and January Jobs reports were a good start, the light is still blinking a cautionary yellow; [4] China and the U.S. need to resolve their trade war and the resolution light is now blinking yellow which is a positive sign; [5] The European economies and global financial markets need a constructive resolution to Brexit but the light is flashing red because the political situation remains a wild card; [6] The price of oil needs to continue to stabilize and the light is flashing green given the roughly +15% rebound since late December; [7] Analysts must be reasonable about earnings expectations and while the resolution light is flashing yellow, the expected growth rate for 2019 corporate earnings has already been lowered from  over +12% to just under +9% and that is a very good start; [8] We need sustained improvement in the breadth [percentage of participating stocks] in the ongoing recovery of the stock markets. The technical evidence is showing real progress and a flashing green light, but investors need to carefully monitor the technical evidence and ongoing progress for our entire “wish-list” outlined above in managing their appetite for stock and bond market risk taking over the course of the 2019 year.