Vigilare Wealth Management Q4 2018 Commentary
By Jason@vigilarewealth.com on January 7, 2019 in Investor Lounge
The volatility spikes that began earlier in the year in the riskier corners of the global economy hit the U.S. markets in the 4th quarter. Only the “Cash” asset class was a positive performer for the year and many markets including Europe, Japan, China, and even U.S. small caps were down well over 10% making for the worst year in a decade.
In our first quarter commentary of 2018 we wrote “…the economy is growing at a brisk pace, confidence is high, and earning growth is projected to be in the double digits for the next few quarters. This supports higher equity prices. We are however concerned that if the Fed raises rates too quickly, it could stall the recovery and cause stock prices to fall…. The recent trade negotiations with China could also escalate into something disruptive to global growth…” Later in our mid-year commentary we continued “…Our view is that a Fed misstep would occur if the Fed raises rates too quickly, but it appears the new Fed leadership is aware of this risk and willing to address…”
The uncertainty of trade continued to weigh heavily on global growth and as the year progressed it became more apparent that major economic blocs were slowing. Japan and Germany posted negative GDP quarters while China’s economic data signaled a substantial slowdown, especially in the second half of the year. Juxtapose this to the U.S. data which has been robust: U.S. GDP up over 3% year over year, Consumer Confidence at decade highs, strong employment and wage growth, manufacturing surveys in strong expansion, and earnings growth of close to 30%. The unusual strength of the U.S. economy gave reason for the Federal Reserve to hike rates for the ninth time on December 19th and to project two more rate hikes in 2019 and another in 2020. This proved too much for a fragile market which was already showing anxieties as reflected across a variety of market signals.
It may sound like an overused cliché, but markets really do hate uncertainty and we have had an abundance of that in 2018, even to an extent where markets were awful against the backdrop of a standout year of economic performance.
What does 2019 have in store? The markets are already priced for a slowdown or even a mild recession. The P/E ratio on the S&P 500 sits at a little over 14 which is the lowest since 2012. The U.S. economy is growing at a nice pace, but there is some emerging softness in interest rate sensitive areas like housing and autos. Confidence is still high, yet very fickle, and persistent uncertainty (China trade, Fed tightening, and Federal Government intransigence) can start to have a damaging effect on the economy.
Recessions usually lead to deeper and prolonged bear markets. For this reason, we should have a balanced approach, vigilant in diagnosing economic conditions. Economic recessions are usually triggered by: 1) Commodity shock, 2) Overzealous Fed, 3) Bubble/Systemic risk. As many economists say, expansions do not die of old age, they are murdered. Markets have experienced similar drawdowns to 2018 on many occasions (1987, 1994, 1998, 2011, 2016 to name a few) in which there were quicker rebounds and where no recession occurred. We will be paying close attention to leading indicators of economic data for clues of recession.
Despite all the negativity, we see positives headed into 2019. For one, we expect a positive surprise in consumer spending in the early part of the year due to better than expected tax refunds (2018 tax reform) for middle to lower income Americans. This could keep consumer confidence elevated which is large part of our economy. Secondly, Fed Chair Powell (in a forum setting at the time of this writing) signaled a major reversal of their December meeting hawkishness. In our view, the statements made by Powell, Yellen, and Bernanke at this forum hit all the marks and could go a long way in reducing Fed uncertainty regarding unabated tightening. Third, the economic and market pressures facing China (and more recently, the U.S.) could be just the needed elixir to induce an agreement. Fourth, the U.S. will be running a trillion-dollar deficit in the current fiscal year and it would really be something to have an economy contract with that much spending.
The month of December saw a record exodus from equity funds and extreme lows on investor sentiment, both of which are historically reliable contrarian indicators. We anticipate a strong market rebound in 2019 if we can get though some of these prevailing market uncertainties.
Thank you for your Trust.
The Vigilare Wealth Management Team
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