By Justin Pawl, CFA, CAIA
In this week’s edition:
- Q4 Earnings Update. A summary of corporate earnings announcements through last Friday.
- Election Volatility. Democratic caucuses increase the likelihood of additional market volatility.
- Good, But Not Great. The U.S. economy is plodding along, but the all mighty consumer is showing signs of fatigue.
- Fed Speak. The market ain’t buying what the Fed’s selling.
Last Week Today. The U.K. officially cut the cord with the European Union on Friday and is once again an independent country. The U.S. did that nearly 250 years ago, ironically from the U.K., and we wish our mates the same type of success the U.S. has enjoyed in its independence. | President Trump signed the USMCA trade deal, officially relieving one source of potential trade conflict. | The World Health Organization declared the coronavirus a global health emergency. In related news, China announced it will inject $174 billion into money markets today (Monday), but thus far the impact is difficult to detect as Chinese equities opened this morning down nearly -8%.
The continued spread of the coronavirus ignited investor anxiety. Once again, emerging market stocks bore the brunt of the selloff, falling nearly 5% as traders wrestled with how China’s efforts to contain the virus (quarantining entire cities) will impact the country’s economic growth. In the U.S., the major indices fell for the second week in a row. Down about 2%, the S&P 500 is now flat for the year, while the high-growth, technology concentrated Nasdaq Index is up 2% YTD. The last two weeks broke the eerie calm accompanying the markets’ races to new highs, but the S&P 500 is only 3% below its recent record level. Symptomatic of the risk-off sentiment and aided by the Fed’s current messaging (see Fed Speak below), bond yields plummeted, and the yield curve inversion became more pronounced. The 10-year bond yield fell to 1.5% – a quick descent considering it was yielding nearly 2% at the beginning of the year. In the “flight to safety” gold rallied 1.1%, while oil declined 4.9%. Oil is now down 15.6% for the year, which should manifest itself in lower gasoline prices, leading to consumption increases in other parts of the economy.
For detailed weekly, MTD, and YTD financial market performance, click on the table below:
Q4 Earnings Update. Thus far, nearly half of S&P 500 companies have reported earnings for Q4, and the results are not bad against lowered expectations. Approximately 45% of reporting companies announced earnings “beats” and nearly 40% have been ahead of top-line revenue forecasts – results that are in line with historical scores (Goldman Sachs). Nearly 100 more companies will bare their Q4 financial souls to investors this week. Coming into the quarter, analysts forecast a 1% decline in year-over-year earnings, but with results thus far, actual earnings are tracking toward even. Better-than-expected earnings are stemming a portion of the negative impetus from the coronavirus, keeping U.S. indexes near flat for the year while international (-2.1%) and emerging market (-4.7%) indices have not been as fortunate.
Election Volatility. Investors, already skittish due to concerns about the coronavirus, will be faced with a new worry when the Democratic presidential selection process begins with the Iowa caucuses on Monday. The WSJ/NBC News poll shows the self-proclaimed democratic socialist Senator Bernie Sanders holds a slim lead over former VP Joe Biden. Voting results over the next month, which include caucuses in New Hampshire, Nevada, South Carolina, and Super Tuesday (March 3), are likely to affect financial markets if candidates with less friendly business policies emerge victoriously.
Good, But Not Great. The first estimate for Q4 GDP growth came in at 2.1%, and 2.3% for all of 2019, in line with the average “Good, But Not Great” growth rate characterizing the post-Crisis recovery. Consumption, the workhorse of the economy, rose at a mediocre 1.8% pace, and housing continued to recover, improving by 5.8%. Business investment (-1.5%) and shrinking inventory levels (-1.1%) detracted from growth. Foreign trade added 1.5% (see the gray portion of the Q4 column on the far right in the chart below), but that “growth” was flattered by an 8.7% decline in imports, underscoring weak consumer spending in the quarter. On balance, economic growth was relatively stable in 2019. Still, consumer demand is showing signs of weakness, and continued deterioration in spending would put the longest expansion in U.S. history in jeopardy. We are putting the finishing touches on our Q1 2020 “Economic Review and Outlook” letter, where we detail our perspective on current economic trends. Look for the letter in your Inbox and on social media in the next few days.
Fed Speak. The Federal Reserve Open Market Committee (FOMC) held its first meeting of the year last week and, as expected, made no change to interest rates. The Fed messaged that the economy is in a good place, and monetary policy (i.e., interest rates) is at an appropriate level. The Fed did modify their language around the outlook for inflation, emphasizing they would like to see inflation average 2%. This nuanced change implies that the Fed is willing to let the economy run “hot” with inflation exceeding 2% for a while. This messaging comes amidst the Fed’s comprehensive review of its monetary policy approach, the results of which are expected to be released this summer. Our assessment is that Chairman Powell’s message was too sanguine about the economy and the Fed’s ability to hit the 2% inflation target. The market agreed as bonds rallied, and the yield curve inverted more deeply.
Against this backdrop, 2020 may be the Fed’s most critical test since the Financial Crisis. The Fed charged with both sustaining the expansion and preparing for how they will approach the next recession with little room to lower interest rates before encountering the zero-boundary line. Hence, findings from the Fed’s comprehensive monetary policy review, due later this year, will be watched closely. The hope is that the world’s brightest economists and Chairman Powell can translate the findings from the review into a modified approach for monetary policy that syncs with the post-Crisis economic environment to generate higher inflation. Higher inflation would allow for higher interest rates, giving the Fed more ammunition to combat future downturns with the most potent weapon in any central banker’s toolbox – cutting interest rates. The key is to get interest rates higher from where they are now without pushing the economy into a recession. And for that reason, paradoxically, the Fed is more likely to cut rates than raise them this year. Lower rates sooner could keep the expansion going and create the higher inflation the Fed needs to raise rates later without killing the expansion.