10-15 Associates

A New Chapter

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All in one month we rang in the new year, lived through the longest government shutdown in history, got news that the Federal Reserve was ready to pause on raising rates, received fourth quarter earnings data, felt the wrath of mother nature with record setting low temperatures, and had the best start to the year in the markets in more than three decades! The Christmas Eve low feels like it was a long time ago and still begs the question, “what exactly was that all about?” Although there is still no resolve on the China trade deal, we have gotten rumblings that there is possibly a framework to get there. The political arena for the 2020 election has already begun to heat up. Howard Schultz, ex CEO of Starbucks, expressed his intent to run for President on the Independent ticket.  In addition, the new voice in congress, Alexandria Ocasio-Cortez, has elicited a new conversation in this country calling for a 70% tax on the ultra-wealthy, raising questions about the message of the party for 2020. Despite all the confusion, the Dow and S&P 500 added 7.17% and 7.87% respectively for the month.

It is perhaps notable that a lot of credit can be given to the Federal Reserve for sparking off the rally and further fueling it late in the month. This is notable because one could argue it was also the Federal Reserve that tripped the downside lever at the end of the year and fueled the decline with their December 19th policy statement, leading to the Christmas Eve low. From the December 24th low through the end of January, stocks gained 15.9%, which is equivalent to $4 trillion in market capitalization. It all began on January 4th, just weeks after the Federal Reserve had raised rates and indicated that further increases were likely. Federal Reserve chairman, Jerome Powell, said that the central bank would be patient before raising rates again. The bond market quickly “re-priced” rates, reflecting a very different trajectory for future interest rates. Long term rates as well as short term rates dropped during the month. 10-year treasury rates fell by 2.05%, while two-year rates declined by 1.21%. Falling rates reignited hopes that the economic recovery still had life and would not immediately be cut short by a policy error. The move, some argued, was that Wall St. had once again taken control of the Fed or that they had caved to the demands of the President. Whatever the reason, the reversal by the Fed can be credited, at least in part, for the sharp turnaround we experienced in January.

Should this end of the tightening be viewed as a green light for stock investors? Few changes in financial markets have a binary outcome, meaning all good or all bad. We have removed the risk of rising rates, at least in the near term. It is important to remember however, that other risks remain. In his statement, the Federal Reserve chairman cited the slowing global economy, trade tensions, effects of the previous rate increases, the uncertainty due to Brexit, and the impact of the government shutdown. The economic data remains mixed, which will likely mean that volatility will remain. January also witnessed a sharp drop in volatility, with the VIXX declining by nearly 35%.  Investors should be prepared for the return of volatility as some broader economic risks still remain. Stock market participants should also remember that with the rise of short-term interest rate investors have seen something they haven’t seen in a while. After several years of what became know as TINA (there is no alternative), cash assets now offer some return. Given the ability to move to cash as a viable asset class, investors may be more willing over time to be more risk averse.

The economic data helped to confirm, for those wanting to remain in the markets, that the economy remains healthy. The January jobs report was the 100th straight month of jobs creation for our economy. Nonfarm payrolls increased by 304,000 for the month, well ahead of expectations and once again, workers are seeing higher wages. For civilian workers, wages increased by .7% in the last quarter, which represented a 2.9% increase from a year earlier. Private sector workers saw a .6% increase for the quarter which is 3.1% better than a year ago. According to the labor department, the good news is that wages are rising faster than prices. Chief economist of Moody’s Analytics, Mark Zandi, noted, “Despite the severe disruptions, businesses continued to add aggressively to their payrolls. As long as businesses hire strongly, the economic expansion with continue on.”

If you are looking for something to worry about in January, consumer confidence dropped to its lowest level since October 2016. This was the third consecutive month of declines, resulting in the largest three months decline since October 2011. The good news out of the survey is that consumers largely indicated that the government shutdown and the volatility in the equity markets had a large impact on their near-term outlook for the future. With government workers now back on the job and the recovery in the financial markets, we can look forward to consumer confidence rebounding in February. The housing market showed some signs of slowing as the combination of rising rates and limited inventory took its toll. Outside the U.S. several risks remain. China’s manufacturing sector contracted for the second straight month in January and according to China’s National Statistics Bureau, last year ended with the slowest pace of year over year GDP growth in nearly 30 years. The eurozone economy grew at the weakest pace in four years in 2018 as Italy’s economy contracted for the second straight quarter.  

Timing can have an impact on everything as well. The U.S. economy always shrinks in the winter. Since 2002, U.S. gross domestic product has dropped 13% on average from the last three months of the year to the first three months of the next. The seasonal effect of the post-holiday season, families traveling less, and the cold, causing reduced spending on restaurants, bars, cars and houses, all contribute to the slowdown.  The numbers are therefore seasonally adjusted. However, a polar vortex is not a regular slowdown. Many will remember the polar vortex of 2014, which gripped much of the east coast. In that year, GDP declined by 1% in the first quarter. The deep freeze of early 2019 will be one more thing that analysts will be trying to “normalize” next month when the data starts to come out for the full month of January.

As if the political environment in the United States wasn’t already complicated, as we move closer to the 2020 presidential election, we can unfortunately expect it to get more complicated and likely be another source of headline risk for the markets. Two names making headlines that will likely have some lasting effect are, Howard Schultz and Alexandria Ocasio-Cortez. It’s the one-two punch that the Democratic party was not expecting. Howard Scholtz, whom has been recently speculated to have presidential aspirations, did announce his intention to explore his candidacy. What came as a surprise was that he announced he would run under the Independent ticket. For Democrats, they see it as a move that would split the Democratic party. Also, enter Alexandria Ocasio-Cortez, representing a segment of the Democratic party known as the Justice Democrats, a new and central player in the war for the soul of the Democratic party. This group, one of several, has been referred to as a “tea party like populist coalition of voters” with an ambitious plan of replacing the establishment of the party with more radical newcomers, by whatever means necessary. According to the group’s spokesman, “There is going to be a war within the party. We are going to lean into it.” As we move out of earnings season, expect the political headlines to take center stage. Somehow, I am beginning to think that if you thought the 2016 election was a circus, “you ain’t seen nothing yet!”

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