Higher from here?
December was a brutal month for risk assets, sinking over 9% in the worst December since 1931. With the prior lows of November severely breached, a 7% slide the week before Christmas, a 3% + drop on Christmas day, then a 5% super rally the following trading day (December 26th), one must objectively look at the swiftness and severity of the month’s carnage, the fact that the S&P had touched a 20% decline intraday December 24th from the September peak, and the ensuing rally that immediately followed this dismal decline and question whether a near term bottom can be justified based on extreme oversold conditions.
It is our belief that the market had been pricing in fears that could very well be overblown. The market has been repricing risk assets based on the continuation of US-China Trade tensions without any resolution in sight, a Fed that will stay on pace to raise rates 4 times in 2019 and may go farther than the economy can support, and Peak earnings that suggest last quarter was “as good as it will get”. All have been extremely pessimistic scenarios that have been driving the market re-pricing and overall bearish sentiment.
A positive change of prognosis of any one of those three themes could turn the market on a dime.
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Case in point. On January 4th Fed Chairman Powell spoke at an Association annual meeting and stated that the Fed would be more patient with setting monetary policy, and that they would not hesitate to change the rate of shrinking their balance sheet (by letting maturing bonds run off, and not use the proceeds to buy more bonds). These words calmed the market and sparked a rally of over 3% on the major indices. The market no longer sees the Fed raising rates 4 times in 2019, taking a lot of pressure off one of the key concerns the market has been dealing with over the past three months.
Secondly, during early January negotiations between US and China leaders, the tone of the meeting has been more accommodating and less hostile. Reducing the tension of trade wars has been viewed as positive by the market, and has supported rising asset prices for a net positive return for the first 5 trading days of the New Year.
And, as we enter earnings season, the market will be paying close attention to the guidance that corporate America will be providing on top of their earnings announcements. Since the sentiment is quite negative following last quarter’s earnings announcements, even the slightest hint that the guidance can be revised upward from such a low base case can further calm the market and support higher asset prices in the near term.
No one can say with certainty whether December 24th was the low for the current correction cycle, but we have to observe that the conditions for an imminent recession are still quite low. We don’t have a hostile Federal Reserve, valuations are back to a more average level after the past 3 months of stock price adjustment, inflation is not running hot, and interest rates are still historically low and are not at such elevated levels to be competitive with dividend yields of the overall market, which would imply that there is sufficient reward potential to stay in stocks versus seeking out the safety of bonds at current yields.
We remain hopeful that 2019 will be a positive year, with a stock market that will end the year higher than where it began. However, we do expect heightened volatility, and will continue to be more cautions in managing risk and equity exposure. We believe this formula will allow us to participate in a rising market environment, while reducing the overall volatility in your accounts.
We look forward to what the New Year may bring. If you have questions, please call 330.467.3111 or email dmillet@thewestermangroup.com.
Because the information on this blog are based on my personal opinions and experience, it should not be considered professional financial investment advice. No financial decisions should be made based off this article without consulting with your financial advisor first.
