Here Comes the Fed
Market struggles, what it means for investors
With the equity markets continuing to struggle to find their footing over the last several weeks, it is clear that the overhang of tariffs and the Fed has given way to something more meaningful for investors. To put the declines in perspective, the S&P 500 has fallen almost -13% since the recent period of volatility began in late September, while small cap names have fared even worse, off almost -18%. Outside of the United States, stocks have also faced headwinds, with the MSCI EAFE down almost -13% as well, while emerging markets names, as represented by the MSCI Emerging Markets index, lost a little over -6% in the period.
The bond market, for its part, has struggled as well, with portions of the yield curve inverting – albeit not the “predictive” 2-10 curve which garners the majority of the attention. Bonds have however provided some protection during this most recent period of volatility, as the Barclays Bloomberg Intermediate Gov’t/Credit index has gained +1%, while the Barclays Bloomberg 5 Year Municipal index earned +1% as well.
So what has caused this sharp pivot away from the equity markets? By most accounts, the U.S. economy remains on strong footing. Employment is strong, wages are growing incrementally, and GDP growth has been above the pace set over the last several years. Sentiment, and momentum, however, indicates that investors are peering past the recent data and mining for cracks in the façade of this bull market run. Admittedly, global PMIs are softening, and the lack of inflation appears to indicate that incrementally higher labor prices are not transmitting to end prices, not just in the U.S., but in developed markets generally. The housing market has cooled on the back of higher mortgage rates, and this could transmit to a more conservative consumer over time, despite the lower levels of household leverage relative to 2007-2008.
Commodities, too, have fallen in value this year, as a combination of difficult-to-control energy supply coupled with fears of waning demand – particularly from a slowing China – have weighed on prices. Earnings growth is expected to slow, albeit off of historical levels posted in 2018, and corporate management teams are attempting to quantify the effects of higher rates and a potentially more isolationist trade policy as they create their forecasts for 2019.
With that said, the economic data is not flashing red – or even orange, in most cases. The U.S economy remains in expansionary territory and leading economic indicators show that it is likely to continue to remain so over the next 12-18 months. Even outside of the U.S., where data has softened modestly, the threat of a recession in 2019 appears slim. Valuations have been reset to at least fair value territory, with certain portions of the equity market looking attractively valued, even by historical standards. The consumer is likely to continue to prop up the economy, even if the holiday season is a looking a little light right now, and companies have yet to fully invest back in their businesses following the tax cut they received early this year.
For investors, today's Fed meeting is of particular interest. While it is likely the Fed will raise rates at this juncture, the statement should help to clarify some of the Fed’s mixed messaging over the last several weeks, and give investors an indication of whether or not the expected “pause” in tightening in 2019 is really on the table. The uncertainty that has been created around Fed policy over the last several weeks has contributed to some of the weakness in equities, so additional clarity could be a positive catalyst.
In short, however, our view is that the current decline in the equity markets does not point to greater declines in 2019. We believe volatility is here to stay, and that we are likely to become more conservative over the course of next year, as the economic cycle continues to mature. At current levels in the equity market, we believe we are at the lower end of a range, and therefore we are not looking to trim exposure here broadly. With that said, our equity team is focused on higher quality, lower leveraged companies, while our fixed income team continues to move portfolios towards higher quality positioning.