Stocks recovered some ground last week and then stumbled over unemployment.
Major U.S. stock indices faltered Friday after the Bureau of Labor Statistics (BLS) reported on a popular ‘lagging’ economic indicator – unemployment. (Remember, lagging indicators describe what has happened in the past.) The BLS reported:1, 2, 3
“The unemployment rate remained at 3.7 percent in October, and the number of unemployed persons was little changed at 6.1 million. Over the year, the unemployment rate and the number of unemployed persons declined by 0.4 percentage point and 449,000, respectively.”
Reuters reported the number of Americans receiving unemployment benefits was at the lowest level in 45 years. That’s good news, but it’s old news. Again, unemployment is a lagging indicator and the report reflected what happened in October.4
The stock market, on the other hand, is a ‘leading’ economic indicator. It moves in response to investors’ expectations for the future – and recent gyrations suggest investors aren’t certain what to think. Barron’s Daren Fonda wrote, “The market’s 6.9 percent slide in October and the stock averages’ wild swings are testing everyone’s mettle.”2, 5
Economists are uncertain about what’s to come, too. Kevin L. Kliesen, in an Economic Synopses on the St. Louis Federal Reserve website, wrote, “Historically, a trough in the unemployment rate also tends to be a reliable predictor of a business recession…an economic analyst is nonetheless never sure that a trough has occurred. Indeed, the unemployment rate can move up and down over the expansion.”6
There is one thing many analysts think is likely. They expect the Federal Reserve to increase the Fed funds rate so the U.S. economy does not overheat. Paul Kiernan at The Wall Street Journal reported, “Robust hiring and wage gains last month leave the Federal Reserve all but certain to raise interest rates in December and on course to continue gradually lifting them next year.”7
Higher interest rates are expected to keep inflation in check by slowing economic growth.8
Despite Friday’s stumble, major U.S. stock indices finished the week higher.1
Why did the stock market fall when the economy is doing well?
The answer is that one reflects the past and the other anticipates the future.
Last Friday’s advance estimate from the Bureau of Economic Analysis showed the U.S. economy grew 3.5 percent during the third quarter of 2018. Harriet Torry of The Wall Street Journal reported:
“The economy powered ahead in the third quarter, driven by robust consumer and government spending, though Friday’s report included warning signs that the business sector faces turbulence that could hold back the expansion in the months ahead.”
Third quarter’s economic growth was slower than economic growth during the second quarter and stronger than economic growth during the first quarter of 2018.
Economists refer to economic growth as a ‘lagging indicator.’ It is a measure that may help confirm longer-term trends, but offers little information about the future.
In contrast, the stock market is a ‘leading indicator.’ It reflects what investors think may happen over the next few weeks or months. The volatility we’ve seen during the past two weeks suggests investors are uncertain about what may be ahead. Many factors are contributing to uncertainty. For instance, investors are concerned:
“Now, on third-quarter calls, companies have begun to spell out tariff impacts in greater detail. Calculating the ultimate impact of tariffs isn’t easy or precise. A fair calculation would include not only costs but also changes in demand and the possibility of supply-chain disruptions. The result could be significant. The International Monetary Fund lowered its global growth expectations when it released its recent outlook because of, in part, ‘escalating trade tensions.’
You have probably heard the saying, “Markets hate uncertainty.” Recent volatility seems to be the result of uncertainty and it is possible uncertainty will cause stock markets to bounce around for some time.
When stock markets are volatile and headlines describe the action with words like ‘plunge’ and ‘erase,’ it’s easy to let emotion get the better of you. Before making changes to your portfolio, please give us a call. We can discuss your concerns and any changes you would like to make to your long-term financial plan.
The world remains full of opportunities and challenges.
Although we’ve seen global markets moving in tandem in recent years, Sara Potter of FactSet pointed out, “…we’re starting to see the end of the synchronized global growth that has prevailed over the last two years. While the U.S. economy remains strong, growth in Europe and Japan is moderating, and emerging markets are under increasing economic and financial market pressure.”
Strong economic growth and robust earnings helped U.S. stocks significantly outperform other regions of the world during the third quarter of 2018. In addition, the resolution of some trade tensions, namely the signing of a United States-Korea trade deal and the renegotiation of NAFTA (North American Free Trade Agreement), helped soothe investor concerns, reported Jeffrey Kleintop of Schwab.
The trade relationship between the United States and China, however, remains an itchy rash marring the outlook for economic growth in both countries. The Economist Intelligence Unit reported:
“Since the start of 2018 trade policy has become the biggest risk to The Economist Intelligence Unit's central forecast for global economic growth. We now expect this risk to materialize in the form of a bilateral trade war between the United States and China, with negative consequences for global growth…The trade war comes at a challenging time for the Chinese economy…The trade war will also affect the U.S. economy…the escalating trade dispute with China will start to weigh on growth later in 2018 and into 2019 – we now expect growth to slow in 2019 to 2.2 percent (2.5 percent previously). The U.S. manufacturing and agricultural sectors, in particular, will be hit by the trade dispute, and rising interest rates will cause private consumption to slow.”
China’s economic growth slowed during the third quarter. The nation experienced its slowest growth since 2009, reported Reuters.
Chinese stock markets generally lost value. However, some Chinese indices performed better than others, depending on the type of stocks included in the index. For example, the MSCI China Index, which measures large- and mid-cap stocks of various share types that trade on the mainland and in Hong Kong, was down 8.45 percent during the quarter.
In contrast, the MSCI Red Chip Index, which is comprised of stocks that are incorporated outside of China, trade on the Hong Kong exchange, and are usually controlled by the state or a province or municipality, was up 3.25 percent for the quarter and flat year-to-date.
Emerging markets were weak performers overall during the third quarter, but there were bright spots. Schroders explained, “Turkey was the weakest index market amid a sharp sell-off in the lira…By contrast, Thailand recorded a strong gain and was the best performing index, with energy stocks among the strongest names. Mexico outperformed as the market rallied following general elections and an agreement with the United States on NAFTA renegotiation. Taiwan, where semiconductor stocks supported performance, also outperformed. Despite ongoing risk of new U.S. sanctions, Russian equities also finished ahead of the benchmark, benefiting from crude oil price strength.”
Political strife continued to hamper the European Union and the United Kingdom during the third quarter. Overall company profits weren’t particularly impressive in the region and neither was economic growth, reported BlackRock.
As the third quarter came to a close, Barron’s conducted its Fall Big Money Poll. Vito Racanelli reported almost two-thirds of professional money managers from across the country said the U.S. stock market was fairly valued – and that was before the market slid lower early in the fourth quarter. While the money managers’ assessment doesn’t mean all U.S. stocks are fairly valued, there may be opportunities to invest in sound companies at attractive prices.
Trade tensions, inflation trends, and central bank monetary policy are likely to affect the performance of markets during the remainder of 2018 and into next year.
Like an unexpected gust of wind that blows the hat off your head or flips your umbrella inside out, last week’s stock market performance startled investors.
Looking back, it’s easy to identify some of the factors that may have contributed to investors’ unease and shaken confidence in the markets. Ben Levisohn of Barron’s offered a brief rundown that included:
Some analysts believe a desire to take profits also helped fuel the downturn, according to Barron’s Randall W. Forsyth.
Whatever combination of events was responsible, the result was markets losing value on Wednesday and Thursday of last week before regaining some lost ground on Friday. Forsyth wrote, “What turned the U.S. markets around Friday – when the Dow and the S&P 500 managed to pop more than 1 percent and the NASDAQ Composite bounced over 2 percent – wasn’t much clearer than what set off the slide. Market Semiotics’ Woody Dorsey says that his proprietary sentiment polling found a bullish reading of absolute zero on Thursday, a contrarian indication that “panic” would be short-lived.”
While sharp drops in share values are never comfortable, it’s important to consider the bigger picture. A contributor to Bloomberg Opinion wrote, “This decline follows a market that has tripled since 2009, had zero volatility in 2017…This was the 20th time since the bear market ended in 2009 that the Standard & Poor’s 500 Index had a one-day loss of 3 percent. The NASDAQ-100 Index had its eighth 4 percent down day (although it was the biggest one-day fall since August 2011).”
In other words, selloffs are normal and we have experienced them before.
So, what should you take away from last week?
“Other leading indicators, including jobless claims and credit spreads, also held up. ‘I don’t see this all leading to recession,’ says Ed Yardeni, president of Yardeni Research. ‘And, without a recession, I don’t think we get a bear market.’”
No matter how intellectually rational these points seem, downturns tend to leave everyone feeling jittery and uncertain. So, take a moment. Think about your portfolio and how it was built to help you achieve your financial goals. Now, ask yourself:
If the answer to either of these questions is, ‘Yes,’ call us. We’ll sit down, review your goals and risk tolerance, and make sure your portfolio is structured appropriately.
We’re hoping for calmer markets ahead, but we may be in for a bumpy ride.
The stock market tends to be a leading economic indicator.
Last week offered some insight to economics and stock market behavior. The U.S. unemployment rate reached its lowest level since 1969 and wages moved higher, yet major U.S. stock indices lost value.
Why didn’t stock markets move higher?
The answer is stock prices tend to be leading indicators. They reflect investors’ expectations for the future. Last week, investors may have been thinking like this:
When unemployment is low, companies cannot always hire enough workers…
To hire more workers, companies raise wages…
Higher wages give workers more spendable income…
More spendable income produces higher demand for goods and services…
Higher demand for goods and services leads to higher prices…
Higher prices (inflation) cause the Federal Reserve to increase the Fed funds rate…
An increase in the Fed funds rate pushes interest rates higher…
Higher interest rates make borrowing more expensive…
Higher borrowing costs may slow business spending…
Slower business spending may cause profits to fall…
Falling profits may cause investors to sell shares…
When investors sell shares, stock prices may drop.
In general, “…while it usually takes at least 12 months for any increase or decrease in interest rates to be felt in a widespread economic way, the market's response to a change (or news of a potential change) is often more immediate,” explained Mary Hall on Investopedia.com.
At the end of last week, 10-year Treasuries yielded 3.2 percent. Daniel Kruger of The Wall Street Journal reported, “U.S. government bond yields rose to their highest level in years Friday as investors reconsidered the strength of the U.S. economy while selling off stocks that could be hurt by higher borrowing costs.”
One way to manage stock market volatility is to have a well-allocated and diversified portfolio.
It wasn’t headline news…
But, if newsprint was still popular, last week’s key economic news would have appeared below the fold.
The Federal Reserve raised rates for the third time in 2018, as expected. In addition, the Federal Open Market Committee projects economic growth will continue for three more years, although its median numbers show growth slowing from 3.1 percent in 2018 to 1.8 percent in 2021. (Remember, forecasts, no matter how venerable the source, are best guesses and not bedrock.)
Investors weren’t enthusiastic about the Fed’s actions or its expectations, and the onset of United States-China tariffs didn’t lift their spirits. Ben Levisohn of Barron’s explained:
“The Dow Jones Industrial Average dropped 285.19 points, or 1.1 percent, to 26,458.31 on the week, while the S&P 500 fell 0.5 percent to 2913.98. Neither could be considered life threatening, and the S&P 500 still rose for a sixth consecutive month. So, while we need something to blame, we needn’t get too worried. Last Monday kicked off with the implementation of tariffs by the United States and China and continued with a Federal Reserve rate hike. Neither was a surprise, though the Fed might have caught a few napping when it removed the word ‘accommodative’ from its statement.”
What does it mean when the Federal Reserve removes the word ‘accommodative?’
The Fed pursues ‘accommodative’ or ‘easy’ monetary policy when it is encouraging economic growth. Accommodative policy may include lowering interest rates or, in unusual circumstances, quantitative easing.
By removing the word, the Fed may be signaling that policy will be ‘tightening’ in an effort to prevent the economy from overheating, reported Sam Fleming of Financial Times. There is debate about whether rates are at a neutral level; one that won’t cause the economy to run too hot or too cold.
Let’s hope for a Goldilocks economy.
Did you hear the news?
A tech company introduced a microwave you can turn on using Wi-Fi – as long as you have one of the company’s voice assistants at home, reported Kaitlyn Tiffany of Vox. Soon, the voice assistants will be built with neural networks that will formulate hunches about whether their owners might like to be reminded to lock the door or turn off a device.
Some people love the idea. Others don’t.
Internet-enabled appliances weren’t the only show in town last week. The strong performance of the U.S. economy earned a standing ovation from investors who pushed the Dow Jones Industrial Index and the Standard & Poor’s 500 Index to new highs. Many global stock markets moved higher, too. Ben Levisohn of Barron’s reported:
“One need only look overseas for a sign that investors are feeling better about the state of the world – or at least better enough to do some bargain-hunting. China’s Shanghai Composite rose 4.3 percent this past week, though it is still down 21 percent from its January high…”
The news in a FactSet Insight written by John Butters may dampen some investors’ enthusiasm.
With the third quarter earnings season ahead, Butters reported 98 of the companies in the Standard & Poor’s 500 Index have issued guidance. The majority (76 percent) issued negative guidance, meaning they anticipate earnings will be lower than analysts’ mean earnings per share estimates.
It’s important to remember that, historically, the U.S. economy has moved in cycles. We may be in the latter stages of this expansion. The next stage is contraction and no one can predict exactly when it may occur.
All investors are consumers, but not all consumers are investors.
The September installment of University of Michigan’s Consumer Sentiment Survey reported Americans are feeling pretty optimistic. Consumer sentiment rose to the second highest level since 2004, and consumer expectations reached the highest level since 2004. Surveys of Consumers chief economist, Richard Curtin, wrote:
“Consumers anticipated continued growth in the economy that would produce more jobs and an even lower unemployment rate during the year ahead…The largest problem cited on the economic horizon involved the anticipated negative impact from tariffs. Concerns about the negative impact of tariffs on the domestic economy were spontaneously mentioned by nearly one-third of all consumers in the past three months, up from one-in-five in the prior four months.”
Investors weren’t as optimistic, according to the American Association of Individual Investors (AAII). Last week, the AAII Investor Sentiment Survey reported bullish sentiment dropped more than 10 percentage points. The results were:
Despite the apparent shift in investor attitudes, stock markets moved higher last week. Vito J. Racanelli of Barron’s wrote:
“The stock market radiated confidence this past week, finishing about 1 percent higher despite choppy action. There was a plethora of good economic news – from lower-than-expected inflation to sky-high business and consumer confidence numbers – that drove shares up. Not even a ratcheting up of tough tariff talk Friday on the part of the U.S. could dampen investor enthusiasm for long.”
Some believe the AAII Sentiment Survey is a contrarian indicator. Last week, that may have been the case.
Remember: Volatility is normal.
Major U.S. stock market indices climbed into record territory during August. They gave back some gains last week. Peter Wells of Financial Times explained:
“Speculation about a fresh round of tariffs on Chinese imports from the Trump administration weighed on U.S. stocks, handing the S&P 500 its first four-day losing streak in a month. A strong jobs report only hardened expectations that the Federal Reserve views the U.S. economy as healthy enough to withstand a probable interest rate rise later this month.”
Strong economic growth and rising wages have the potential to push inflation – increases in prices of everyday goods – higher than the Fed’s 2 percent target. The Fed battles inflation and promotes financial stability by raising the Fed funds rate. Usually, higher rates make borrowing more expensive and slow economic growth, reported Katherine Reynolds Lewis at Bankrate.com.
Rising rates in the United States have an effect on emerging markets, too. Colin Dwyer of National Public Radio reported higher interest rates in the United States have enticed investors and they have moved money out of riskier emerging markets investments.
Last week The Wall Street Journal reported, “Emerging markets tipped into bear territory…The MSCI Emerging Markets Index’s 0.3 percent decline Thursday, led by selloffs in Russia and the Philippines, pushed that gauge of stocks in poorer countries 20 percent below its recent peak, the common definition of a bear market.”
Where is our country’s biggest export market?
Markets were fired up last week after the United States and Mexico agreed on new trade rules. The Standard & Poor’s 500 (S&P 500) Index reached an all-time high and finished the month of August up about 3 percent, reported Michael Sheetz, Thomas Franck, and Alexandra Gibbs of CNBC.
During the latter half of last week, though, the S&P 500 gave back some gains. A hitch in the giddy-up of trade talks between the United States and Canada caused the index to stumble. Damian Paletta, Jeff Stein, and Heather Long of The Washington Post explained:
“High-stakes trade negotiations between the White House and Canadian leaders unraveled Friday, a major setback in President Trump’s effort to redraw the North American Free Trade Agreement…the United States and Canada have interwoven economies, with integrated supply chains and vast amounts of trade. The value of goods and services sold between the two countries last year reached $673.1 billion, making Canada the United States’ largest export market for goods.”
The United States exported about $341 billion of goods and services to Canada in 2017, according to The Office of the U.S. Trade Representative website. Our top exports to Canada during 2017 included:
Trade talks are expected to resume next week.