Marketline Monthly – November 2018
While November offered a bit of recovery after October’s downside, the gains did not come without significant volatility. US stocks surged in the first week of the month, then sank to a lower low than we saw in October, only to rebound to end the month up about 1.7%. The Nasdaq rose only about 0.3% as investors questioned the valuations of many tech stocks. From peak to the currently established trough, the correction on the S&P 500 has been about -10.2%, but many stocks are off twice that or more. If a company was unfortunate enough to be reporting earnings during this time – as many were – the slightest miss could cost the stock 30% in a couple of days. Meanwhile the bounce at the end of the month wasn’t broad enough to declare the market ‘recovered’ – witness the December 4 near-800 point decline in the Dow.
Looking at the forest instead of the trees, today’s environment is very similar to the late 2014/early 2016 period which saw oil prices crash from $110 to $30, coinciding with a slowdown in the Chinese economy and an eventual devaluation of the yuan against the dollar. The US economy did not enter a recession, but US stocks – increasingly sensitive to global temperatures – flattened and entered a period of volatility. The similarities to today are remarkable. Oil has plunged again, from close to $80 to about $50, the Chinese economy is struggling, and the yuan has been depreciating all year with few interruptions. The only difference – one that makes navigating today’s markets trickier – is that the Fed has been hiking rates fairly aggressively (see below). At times like these it is worth remembering the old saw, “the market has forecasted 10 of the last five recessions” – meaning that stocks often overreact to news that turns out to be less onerous than first believed.
I am going to review what we wrote last month, because the bond market has become extremely important to the direction of both stocks and the economy in the last few days. Last month, we wrote: “Much complaining has ensued among stakeholders…about Fed Chairman Powell’s decision to press on with interest rate hikes. Lots of folks think this is a mistake – that the Fed stands to overdo it and cause another recession. Until recently, abundant evidence supported at least a couple more hikes … But now housing has slowed, and oil prices have crashed…The Fed might ruminate on these swiftly developing reversals and stand pat in December. However, the fact that the long bond remains above 3.3% tells me that for now the Fed will stay the course. If the long bond inches up again in yield after another hike, we are going to be pretty convinced that rates are on a sustained path upward. If not – well, we will have to cross that bridge when we see it.”
We are on that “bridge” in the last sentence, right now. The long bond has not held the 3.3% level. Instead, it has dropped to 3.17%, and the mid-section of the yield curve has inverted, causing mayhem in the stock market. Investors are trained to believe that an inversion – where short rates are higher than long rates – is followed by a recession – and it is. A recession could see the long bond back in the 2’s. At this point another Fed hike will be problematic. We have heard Chairman Powell say that he is not concerned with other countries’ monetary and budget situations; his job is to manage ours. That sentiment is part of the problem with the Fed: in a global economy dependent on the US dollar, increases in US interest rates have an almost exponential effect. A light touch and a gradual approach are critical. We’ll see what the Fed does in a couple of weeks. In the meantime, the occasional municipal bond is still yielding 4% – that level is worth pursuing.
Thanks to upheaval in stocks in the last week, our November numbers are already stale. But we want to highlight Mexico, as a standout negative during a generally positive month. Mexico’s Bolsa fell a hefty 5% in November, as the incoming president decided to scrap an ongoing airport expansion, for which bonds had been sold and work had been done. This multi-billion dollar project was shut down on a referendum with less than 1% of Mexico’s population casting votes. Uncertainty about repayment of the bonds gripped the markets and caused investors to question the safety of any investment in Mexico. If this is the way Obrador is going to behave, Mexico’s economy will take a turn for the worse in a hurry – not a happy outcome for its citizens who are already suffering a very high murder rate. The next few months will be informative as far as prospects for this new administration.
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