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Temporary Trade Truce Buoys Markets

Temporary Trade Truce Buoys Markets

  • 12.03.18
  • Markets & Investing
  • Article

Investors continue to monitor tech sector volatility, Brexit negotiations and Italian debt.

The market gyrations that characterized October continued through November, leaving the major domestic stock indices essentially flat for the month. The same issues were on investors’ minds, namely trade issues, tech sector volatility, Brexit negotiations and Italian debt. Although economic data for the United States has been relatively positive, concern seems to be building that the pace of economic and earnings growth will slow in 2019, explains Nick Lacy, chief portfolio strategist for Raymond James Asset Management Services, exacerbated by declining sentiment and global growth measures.

“Slower growth doesn’t mean a contraction,” Lacy clarified. “Things are actually in pretty good shape, which gives me reason to believe the markets will be fine.”

After months of elevated tensions between the U.S. and China, investors welcomed news of a trade ceasefire that emerged from the G20 summit over the first weekend of December. President Trump and China’s President Xi agreed to halt tariff escalation for now and continue dialogue on the more difficult questions of China’s structural reforms with a 90-day timeframe. Given the challenges ahead, negotiations may begin to fray, and the threat of a tariff hike to 25% (with an additional tariff package as further leverage) could re-enter market considerations, explains Washington Policy Analyst Ed Mills.

In the immediate term, China will begin purchasing a yet to be determined quantity of U.S. agricultural, energy and industrial products. China also signaled willingness to institute stricter controls on opioid exports. This arrangement is essentially a “lite” version of the nixed agreement in May. However, an encouraging sign is that the terms have expanded to broader questions in the spirit of negotiating a larger deal, and the worst-case scenario of significant immediate-term escalation has been put on hold, Mills added.

 

12/29/17 Close

11/30/18 Close

Change YTD

% Gain/Loss YTD

DJIA

24,719.22

25,538.46

+819.24

+3.31%

NASDAQ

6,903.39

7,330.54

+427.15

+6.19%

S&P 500

2,673.61

2,760.17

+86.56

+3.24%

MSCI EAFE

2,050.79

1,809.56

-241.23

-11.76%

Russell 2000

1,535.51

1,533.27

-2.24

-0.15%

Bloomberg Barclays U.S. Aggregate Bond Index

2,046.37

2,008.62

-37.75

-1.84%

Performance reflects price returns as of 4:30 EDT on November 30, 2018.

Here is a look at what’s happening in the economy and capital markets, as well as key factors we are watching:

Economy

  • Recent economic data reports have been consistent with moderate growth overall, explains Raymond James Chief Economist Scott Brown.
  • The first half of next year should bring more fiscal stimulus in the form of tax cuts and government spending, which should support growth, but the impact is expected to fade in the second half, Brown notes.
  • The pace of future rate increases is uncertain, but the central bank is expected to raise rates more slowly in 2019. Fed Chairman Powell recently noted that the federal funds rate “remains just below the broad range of estimates of the level that would be neutral for the economy – that is, neither speeding up nor slowing down growth.” However, most Fed officials see the neutral rate as higher than the bottom of the range.
  • Powell’s hint that we are near neutral and that the central bankers are considering a more flexible approach did not escape the attention of market observers, like Chief Investment Strategist Jeff Saut.

Equities

  • Investors welcomed news of the U.S.-China trade détente, and equities are likely to strike a positive tone in the coming weeks, noted Michael Gibbs, managing director of Equity Portfolio & Technical Strategy.
  • However, with both sides far apart on major issues (such as intellectual property rights), investors will likely remain guarded until they see actual progress. “For this reason, we do not budge from our stance that the S&P 500 will remain range-bound, trading (low to mid-2600s to mid-to-upper 2800s) in the coming months.” Gibbs said. “The news only causes us to believe the market remains in the mid-to-high end of the range in the coming weeks.”
  • With substantial manufacturing in China, numerous companies were at risk of margin compression if tariffs moved up to 25%. The consumer discretionary sector is a beneficiary as well with products bound for the U.S. originating in China.
  • With the S&P 500 still down 6% from the September peak and with over 53% of the stocks in the index down at least 15% from their 52-week highs, ample opportunity remains, he notes.

Fixed Income

  • Given that the Fed left the discount rate unchanged in November, there remains a high probability that the central bankers will hike rates in December according to market expectations. Per the most recent Fed dot plot, another three to four rate hikes are anticipated in 2019.
  • It’s likely that the bond market will continue to react to market conditions, and investors can expect some volatility in the near future. For example, the latest 10-year Treasury yield fell from 3.227% on Nov. 6 to 3.02% toward the end of November, points out Doug Drabik, senior fixed income strategist.
  • While there has been ample attention paid to the equity markets over the past month, widening spreads in the high yield and BBB indexes suggest that equity market volatility is impacting “equity-like” fixed income, adds Peter Greenberger, director, Mutual Fund & 529 Plan Product Management.
  • Look for the range to remain tight with a continued bias to a slightly higher range, barring any geopolitical impact, Drabik added.

International

  • The U.S.-China agreement to pause their trade escalation can be viewed as a short-term face-saving measure that allowed both sides to come away with wins for their domestic audiences as the tougher part is left to be resolved over the next three months, according to Mills.
  • President Trump is now directly involved in the process, increasing the sensitivity around the final outcome. If negotiations stall and the president comes under increased domestic scrutiny for a lack of progress, we are likely to see a return to an escalatory strategy, Mills noted.
  • The United Kingdom has forged a tentative Brexit agreement with the European Union, but details on trade relations and other matters are essential to the stability of the UK economy, explains European Strategist Chris Bailey. Expect to see some significant political cajoling before an agreement eventually gets ratified.
  • Meanwhile, the rest of the European Union is debating the proposed higher Italian budget deficit. The fear is that a higher deficit sets new regional precedents which may lead to instability in the region.
  • Pan-European markets remain at a discount to their American peers and offer potential for both growth and income-focused investors, if issues such as Brexit and the Italian budgetary debate can be progressed, adds Bailey.
  • Any signs of compromise will be taken positively. If calmer heads prevail, then 2019 can still offer plenty of opportunity in markets outside of the United States.

Bottom Line

  • We continue to recommend staying in equities and fixed income, with a bias toward higher quality as late-cycle growth can last for some time, according to Lacy.
  • Volatility could be an opportunity to buy if you are looking to put cash to work.
  • Keep in mind that a well-diversified portfolio can help you weather downturns and recover more quickly on the upside.

Also, note that U.S. markets will be closed on Wendesday, December 5. The day has been designated a national day of mourning out of respect for former President George H.W. Bush, who passed away last Friday.

Your advisor will continue to watch for legislative updates as well as economic developments. In the meantime, please reach out to him or her if you have any questions.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc., and are subject to change. Past performance is not an indication of future results and there is no assurance that any of the forecasts mentioned will occur. The process of rebalancing may result in tax consequences. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Small and mid-cap securities generally involve greater risks. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. The performance noted does not include fees or charges, which would reduce an investor's returns. Asset allocation and diversification do not guarantee a profit nor protect against a loss. Debt securities are subject to credit risk. A downgrade in an issuer’s credit rating or other adverse news about an issuer can reduce the market value of that issuer’s securities. When interest rates rise, the market value of these bonds will decline, and vice versa. High yield securities involve additional risks and are not appropriate for all investors. Price/Earnings Ratio is the price of a stock divided by its earnings. It gives investors an idea of how much they are paying for a company’s earning power. While interest on municipal bonds is generally exempt from federal income tax, it may be subject to the federal alternative minimum tax, state or local taxes. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Chris Bailey is with Raymond James Euro Equities, an affiliate of Raymond James & Associates, and Raymond James Financial Services. Material prepared by Raymond James for use by its advisors.

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