By Kenneth J. Entenmann, CFA
\nWhat a difference three months make. At the end of the third quarter of 2018, every equity market index was posting significant positive returns, and the markets were focused on an overheating economy and the fear of rapidly rising interest rates.
\nSuddenly, market psychology turned sharply negative, and the new fear was an imminent global economic recession brought on by trade wars, overaggressive central bank policy and an earnings recession. By year\u2019s end, volatility spiked to levels not seen since 2008, and all the major equity indices were decidedly negative. International markets suffered the most, with the developed markets (MSCI-EAFE Index) falling 13.32 percent and the emerging market (MSCI-EM Index) falling 14.49 percent.
\nThe domestic equity markets fared better, but still posted negative returns for the year\u2014Dow Jones Industrial Average fell 3.38 percent, S&P 500 fell 4.39 percent, Nasdaq composite fell 2.81 percent and Russell 2000 fell 11.03 percent\u2014a very tumultuous end to 2018.
\nAs we enter 2019, market psychology remains negative. Uncertainty around four major themes\u2014global economic growth, trade wars, earnings recession and central bank policy\u2014continues to generate high levels of volatility. While all these concerns are real, the heightened negativity surrounding them seems to be overwrought.
\nAs time goes on, the fog of uncertainty is going to lessen. For long-term investors, the significant market correction in the fourth quarter of 2018 should present a nice long-term opportunity.
\nGlobal economic growth
\nThere is no doubt that economic growth has slowed around the world, particularly in China and Europe. In the U.S., the third quarter gross domestic product was 3.4 percent, strong, but down from the 4.2 percent in the second quarter of 2018.
\nHowever, there is a big difference between slowing growth and a recession. Growth has slowed, but forecasts for 2019 continue to call for positive economic growth around the world. In early January, the U.S. announced that its economy added a remarkably strong 318,000 new jobs in December. It is hard to call for a recession when the labor market is on fire. Perhaps the fear of economic recession is overstated.
\nTrade Wars
\nThe Trade War with China is generating all sorts of apocryphal headlines. The uncertainty surrounding the duration of trade discussion has led to concerns about corporate profits. Apple\u2019s recent pre-announcement that it would miss first quarter revenue numbers spooked the market.
\nHowever, the suggested impact of the tariffs is wildly overstated, at least for now. To date, there have been roughly $130 billion in proposed and implemented U.S. tariffs. That is $130 billion on a worldwide economy of nearly $100 trillion.
\nWhile all tariffs are bad, the impact on the global economy is a rounding error. The U.S.-China negotiations have a March deadline, and more information will become available, hopefully reducing the uncertainty. These negotiations are having an impact on both the U.S. and Chinese economies.
\nBoth countries need to come up with a solution to this problem. As in any negotiation, there is low-hanging fruit that will generate positive headlines. In the end, it is expected that significant progress will be made.
\nEarnings Recession
\nFor the first time in several years, corporate earnings are expected to decline from 2018 levels This is hardly surprising. A significant drop in the corporate tax rate fueled earnings growth in 2018. In 2018, S&P 500 earnings rose 20 percent, but nearly half of that was due to the tax cuts. As we enter 2019, the tax cut benefit goes away. The market is struggling to determine what the right growth rate for 2019 earnings will be. Consensus forecasts call for earning to grow around five percent. Still positive, but with little room for error.
\nFederal Reserve Policy
\nPerhaps the market\u2019s biggest uncertainty revolves around the Fed interest rate policy. One of the catalysts of the fourth quarter market sell-off was the market\u2019s response to Fed Chairman Jay Powell\u2019s speech in early October when he stated the Fed \u201chad a long way to go\u201d on interest rates. The conclusion was that the Fed was failing to see slowing economic signals and would raise interest rates indiscriminately, causing an economic recession.
\nHowever, recently, Chairman Powell has acknowledged that there was evidence of global economic slowdown, the psychological impact of the trade tariffs, and the markets harsh reaction to those conditions. He stated the Fed would be \u201cflexible\u201d with its rate policy. This proved to be a great relief to the markets.
\nFor the moment, the uncertainty surrounding the Fed policy has been reduced. Also, the market has done much of the work on interest rates for the Fed. The yield on the ten-year treasury note reach a recent high of 3.23 percent at the end of the third quarter; today it yields 2.60 percent.
\nAs we look to 2019, the one certainty we see is that volatility will remain high as the market digests new information regarding the Four Horsemen of Uncertainty. The concerns are real and will take time to resolve. Headlines and tweets will continue to generate hype, cheers and jeers and forecasts of doom. The powerful, fourth quarter market correction has largely priced in the worst-case scenario. For the patient, long-term investors, this should prove to be a great investing opportunity.<\/p>\n","protected":false},"excerpt":{"rendered":"
By Kenneth J. Entenmann, CFA What a difference three months make. At the end of the third quarter of 2018, every equity market index was posting significant positive returns, and the markets were focused on an overheating economy and the fear of rapidly rising interest rates. Suddenly, market psychology turned sharply negative, and the new […]<\/p>\n","protected":false},"author":89,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"yoast_head":"\r\n