At first glance, investors got what they wanted: a less aggressive Federal Reserve and calming words on trade. That they still aren’t pleased suggests a bigger issue is underscoring their anxiety.
That issue is the possibility economic and earnings growth will slow down or stop next year, a scenario that unlike the trade war and interest-rate policy defies any obvious human solution. The S&P 500 plunged 3.2 percent, the Dow Jones Industrial Average sank almost 800 points and bond yields tumbled.
Reading too much into day-to-day moves is usually a mistake and a half dozen explanations exist for Tuesday’s walloping in equities. At the bottom of virtually all of them, however, lurk concerns that the market sees something to suggest the decade-long expansion that has fueled the bull market is in greater jeopardy than economists realize.
“The fundamental data is just not pricing in a robust, exciting, and upwardly sloping market,” Alicia Levine, BNY Mellon Investment Management chief strategist, said on Bloomberg TV. “The bond market is clearly giving a different signal than the equity market has in the last week. And the bond market is concerned about slowing global growth.”
Of course, a strong jobs report Friday could go a long way to alleviating concern that a significant slowdown is imminent. Recent readings on U.S. manufacturing and personal spending also showed that any impact from the trade tensions has not fed through to the world’s largest economy, at least not yet. And while one part of the Treasury yield curve inverted for the first time since 2007, the relationship most closely watched by the Fed is emitting a more muted warning.
For now, though, equity bears have wrested the upper hand in markets and focus is squarely on the risks they’re flagging:
Yield Curve Signal
Noise abounds in stock gyrations but coincidences bother traders. One fact that stands out right now is that the market abandoned its single-session celebration of Donald Trump’s trade truce on the same day the yield on three-year Treasuries fell below the 5-year rate for the first time in a decade. A more closely watched relationship, the spread between 2- and 10-year yields, remains positive, though the gap keeps getting slimmer.
“As parts of the yield curve invert, investors are getting spooked about potentially receiving a recession signal,” said Michael O’Rourke, JonesTrading’s chief market strategist.
Could the focus on trade and central-bank policy have been a red herring? Those who say so got a boost Tuesday. Progress on both fronts failed to sound the all clear in markets, putting the focus back on a fundamental backdrop that while robust now, is virtually certain to slow in 2019.
Decelerating global growth and concerns about margin pressure from higher labor costs as well as tariffs on imported goods have seen analysts trim their estimates for earnings growth in 2019. And there might be further downside yet. Despite the plunge in crude oil prices, expectations for profit growth among energy companies next year are in excess of 20 percent.
Since the S&P 500 peaked in late September, defensive areas of the market have continued to gain traction -- another fact that is cited by doomsayers as portending a slowdown. Utilities, real estate and consumer staples are the only sectors that have provided a positive return, while groups more closely associated with the economic cycle have yet to emerge from a correction. That has some weighing recession odds, wondering if the market has sussed out a slowdown.
“The only stocks up today are those that go up when people think the economy is slowing down,” Donald Selkin of Newbridge Securities said by phone. “That’s another sign -- those defensive stocks are the ones people run into when we have perceptions of economic slowdowns.'
Trade, Fed Walk Backs
Even the news that pushed the S&P 500 to a 6 percent rally in the prior six sessions may not be great news. While the meeting between Presidents Donald Trump and Xi Jinping in Argentina produced positive headlines and a trade truce for now, its positive extent is already being questioned as few details emerge.
And after Fed Chairman Jerome Powell’s dovishly-interpreted turn sparked the best week for stocks in seven years, strategists have already thrown cold water on the rally. Then there’s Federal Reserve Bank of New York President John Williams who reiterated his support for further rate hikes Tuesday, and an upcoming testimony from Powell to Congress waiting in the wings.
“We haven’t really had resolutions,” Randy Frederick, vice president of trading and derivatives at Charles Schwab, said in a phone interview. “What happens when you get a news story that sounds optimistic is you get an immediate positive response but ultimately none of those issues have been resolved. It’s uncertainty.”
Waning Global Growth
Remember synchronized global growth? Stocks sure miss that.
Concerns about Chinese activity have mounted as the nation’s November manufacturing purchasing managers’ index slipped to 50 in November, a level that separates expansion from contraction. That’s the worst reading since July 2016. Meanwhile, estimates for eurozone economic growth in 2019 have been slashed from 2 percent to 1.6 percent.
“Our now-cast model suggests global growth has slowed from about 4.5 percent quarter-over-quarter seasonally adjusted annualized) at the turn of the year, to about 3 percent in the fourth quarter of 2018,” write UBS economists Arend Kapteyn and Pierre Lafourcade, noting that this marks the sharpest slowdown in six years.
The S&P 500 could form a technical pattern called a death cross as soon as next week, with its shorter-term 50-day moving average crossing below the longer-term 200-day one. Such a move is rare and prior to the market’s recent gyrations, the S&P hadn’t done so since 2016. Typically, it signals that a bull market could be ending and that a downtrend is close in sight, according to Charles Schwab’s Frederick.
“Almost no degree of a market rally would avoid it,” he said. “Even if we got 30 point moves on the S&P for the next five days -- we might avoid it but if you have a move down like today, that’s going to bring it closer. It’s a technical signal that has a pretty good long-term track record.”
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