Covenant Weekly Market Synopsis for November 30, 2018

December 3, 2018

Last Week Today. The first of two revisions for Q3 GDP matched expectations of 3.5% and was unchanged from the original estimate. The trailing four-quarter GDP growth average is 3% – well above the 2.1% trend since the Financial Crisis, but likely heading back to trend once the effects of fiscal stimulus fade in 2019. | President Trump threatened to cut subsidies to General Motors (following GM’s decision to close some US plants) and announced he is again considering auto import tariffs on Europe. | At the G-20 meeting over the weekend, China and the U.S. agreed to a cease-fire in the trade war, with the U.S. postponing plans to increase tariffs from 10% to 25% on $200 billion come January 1st. Reportedly, the truce includes an agreement by the leaders to enter negotiations on China’s forced technology transfer, intellectual property protection, non-tariff barriers, and cybertheft. Should the talks fail, the White House said the 25% tariffs would be implemented after 90 days. Look for lots of twists, turns, and associated market volatility as this situation evolves, as the two sides are far from a permanent trade agreement. | On the sidelines of the G-20 meeting, Russia and Saudi Arabia decided to extend their agreement to manage the oil market, setting the stage for a production cut at this week’s OPEC meeting in Vienna.

After serving up a turkey of performance during the Thanksgiving holiday week (S&P 500 -3.8%), risk assets rallied last week with the S&P 500 jumping +4.8% for its best weekly gain since December 2011. Global equities lagged the U.S., though they were positive on the week as developed international markets rose +1.0% (as measured by the EAFE Index) and emerging markets gained +2.7%. It was also a good week for traditional fixed-income investors as yields fell across the curve, with the 10-year bond finishing the week below 3% for the first time since mid-September. Crude oil ended a nightmare of a month with a +1.0% gain but declined -22% in November (a tough month for many energy traders, but a positive one for the U.S. consumer as lower oil prices will translate into reduced gasoline prices).

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Federal Reserve Update. Since the Fed Chair Powell’s comments on Wednesday had an undeniable impact on the markets (S&P 500 +2.3%), let’s take a moment to review the change in the messaging. Unsurprisingly, Fed Chair Powell’s comments on Wednesday were a preview of the minutes from the Fed’s November meeting released the following day – the market interpreted both Powell’s comments and the minutes as dovish. Back in October, Powell communicated that the Fed Funds Rate was “a long way from neutral” (the Fed Funds rate which is neither restrictive nor stimulative to the economy), but on Wednesday he changed his language to interest rates are “just below the broad range of estimates” of the neutral rate. The market took the updated language as a suggestion the Fed may deliver fewer than the three additional interest rate hikes included in their current 2019 forecast. The Fed will move rates higher by 0.25% (to 2.5%) in December of this year, but the change in the Fed’s tone provides greater policy flexibility next year.  Speaking of flexibility, beginning in 2019 the Fed will host a press conference following each meeting (rather than every other meeting as has been the case), meaning that all eight Fed confabs in 2019 will be “live” meetings in which the Fed can adjust their target interest rate in an effort to engineer a soft landing for the economy.

Powell & Trump. In last Friday’s edition of the Wall Street Journal, Nick Timiraos published an interesting article describing how Fed Chair Jerome Powell handles President Trump’s repeated (and pointed) criticism. In compiling his research for the article, Mr. Timiraos interviewed dozens of lawmakers, current and former officials from the Trump administration and the Fed, as well as business leaders. The article offers a behind the scenes look at Fed Chair Powell’s conundrum with Trump, as well as the relationships of other Fed Chairs and Presidents. Following the first rule of his playbook, Powell declined an interview request for the article.

The article can be found here, but it requires a subscription. If you don’t have a subscription to the WSJ or lack time to read the article, a summary is included below:

As has been widely covered, Fed Powell is not a trained economist, and he brings a certain skepticism of traditional economic models that have guided previous Fed Chairs’ monetary policy decisions. For example, with the unemployment rate at 3.7%, several monetary policy models point the Fed to raise interest rates aggressively. Powell, on the other hand, has guided the Fed to increase rates only gradually relying instead on financial market feedback to determine if rates are moving into restrictive territory.

The article also describes the relationships between several Fed Chairs and their respective Presidents. While not common historically, as the Fed was designed to be an apolitical agency, Powell is not the first chairman to face criticism from a President and his top officials. However, at least two Presidents went beyond publicly criticizing the Fed Chair. President Lyndon Johnson summoned then-Fed Chair William McChesney Martin to his Texas ranch to reprimand him for hiking rates beyond what President Johnson thought was reasonable. In that case, Martin held his ground, which led to his ouster by incoming President Nixon. Nixon replaced Martin with Arthur Burns in 1971. President Nixon pressured Burns to maintain low rates before the 1972 election. In that situation, Burns caved by holding rates low which fueled the great inflation of the 1970s (inflation doubled to 8.8% in 1973 and continued to gain steam peaking at 14% in the early 1980s).

In contrast to former Fed Chair Burns, Powell has developed an effective playbook for dealing with President Trump.  Based on Powell’s actions, his playbook can be summarized in four rules: 

  • Rule 1: Speak not of President Trump.
  • Rule 2: When provoked by President Trump, don’t engage.
  • Rule 3: Make allies outside the Oval Office.
  • Rule 4: Talk about the economy, not politics.

Thus far, President Trump’s actions fall well short of the egregious interference or Presidents Johnson and Nixon. Nevertheless, Powell is facing President Trump’s ire and will likely continue to be so long as he is raising interest rates. However, the Chairman has not cowed to the criticism and, given his extended experience in Washington, is unlikely to do so.  This is critical, as maintaining the Fed’s independence will be a positive for the economy and investors in the long-term.

Eco Data Quick Hits.

  • Consumer – The consumer began the fourth quarter with a bang, as spending increased in October by 0.6% vs. the 0.4% consensus estimate. October’s result brings the 12-month moving average up to a solid 4.8%. With consumer confidence measures at elevated levels, unemployment at 3.7% (the lowest in roughly 50 years), personal income growth rising, and the holiday season in full swing, consumption should remain strong through the end of the year.
  • Inflation – Although many publicly traded companies cited rising input costs during their Q3 earnings calls, inflation has yet to make its way into the broader economy. Core Personal Consumption Expenditures (Core PCE) rose at 1.8% YOY in October and has been trending downward since peaking at 2.0% in July. Core PCE is the Fed’s favored inflation measurement, and since it remains below the Fed’s 2.0% target, the Fed should not be in a rush to raise rates beyond the forthcoming hike in December.

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‘Tis the Season: Since 1950, December has never been the worst performing month in the year. Although the bar is pretty low in 2018 (owing to October’s nearly -7% slide), December is positive 75% of the time with gains averaging +1.6%. We’ll see if Santa Claus can deliver yet another rally in 2018. (Source: LPL Financial Research).

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Be well,

Jp.