The volatile equity markets continued dramatic price swings while bond yields moved lower in the fourth quarter. The potential for a trade war with China and higher interest rates has investors concerned that economic growth will be constricted. With U.S. annual inflation dormant at 2.2%, reduced home sales for the past nine months, decelerating automobile sales, declining commodity prices and slowing GDP growth, the concern is the Federal Reserve has already raised rates too quickly.
There is a six- to nine-month lag time between the Federal Reserve’s action of raising rates and the effect it has on the economy. This is a period when uncertainty about corporate earnings, consumer and corporate debt levels and U.S. dollar strength causes instability. As investors in leveraged hedge funds, lower credit quality bonds and those trading on margin unwind their positions, the market has tested bear market territory, defined as losing 20% from its previous peak. The Federal Reserve recently calmed the market with some signals that they are going to be patient and gradual in any further rate hikes.
|S&P 500 Index||-6.2%|
|S&P Mid-Cap 400 Index||-12.4%|
|MSCI All World Cap Index||-11.1%|
The China trade and tariff issue remains in the spotlight with many negotiating points taking significant time to resolve. The Trump administration is well-aware of the U.S.-China co-dependency, but is leveraging economic power to resolve the significant trade issues. The President is using his unorthodox style to demolish the old conventional geopolitical structures in defense, immigration and trade to build a shiny new America centric world. The administration will most likely soon declare its trade achievements with China as a victory, which will be positive for the markets.
The S&P 500 declined 20% in the quarter from its record high, which reflects the global pessimistic news about Brexit, U.S. budget issues, a China economic slowdown and European economic stagnation. Bond yields, which were rising in the third quarter, reversed and fell dramatically with 10-year U.S. Treasury bonds trading at 2.68% at year-end. Every sector of the equity market has corrected with energy, materials, industrials and financials oversold and reflecting significant valuation discounts. U.S. economic growth, and even corporate earnings growth, will decelerate, but recession is not imminent. Corporate earnings should grow at 5-8% while the U.S. economy should have steady growth at around 2%. Apple already admitted slower revenue growth – mostly in China – which has provided an exceptional buying opportunity since the stock now trades at a incredibly-low 12x Price to Earnings multiple. The overall equity market is trading at 14x Price to Earnings and looks oversold, so it should rebound in 2019.
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