January A Ball After Year-End FallInvesting Caffeine
Investors were cheerfully dancing last month after the stock market posted its best January in 30 years and the best monthly performance since October 2015 (see chart below). More specifically, the S&P 500 index started the year by catapulting +7.9% higher (the best January since 1987), and the Dow Jones Industrial Average climbed 1,672 points to 25,000, or +7.2%. But over the last few months there has been plenty of heartburn and volatility. The December so-called Santa Claus rally did not occur until a large pre-Christmas pullback. From the September record high, stocks temporarily fell about -20% before the recent jolly +15% post-Christmas rebound.
Source: FactSet via The Wall Street Journal
Although investors have been gleefully boogying on the short-run financial dance floor, there have been plenty of issues causing uncomfortable blisters. At the top of the list is China-U.S. trade. The world is eagerly watching the two largest global economic powerhouses as they continue to delicately dance through trade negotiations. Even though neither country has slipped or fallen since the 90-day trade truce, which began on December 1 in Buenos Aires, the stakes remain high. If an agreement is not reached by March 2, tariffs on imported Chinese goods would increase to 25% from 10% on $200 billion worth of Chinese goods, thereby raising prices for U.S. consumers and potentially leading to further retaliatory responses from Beijing.
When it comes to the subjects of intellectual property protection and forced technology transfers of American companies doing business in China, President Xi Jinping has been uncomfortably stepping on President Donald Trump’s toes. Nothing has been formally finalized, however Chinese officials have signaled they are willing to make some structural reforms relating to these thorny issues and have also expressed a willingness to narrow the trade deficit with our country by purchasing more of our exports. Besides procuring more American energy goods, the Chinese have also committed to buy 5,000,000 tons of our country’s soybeans to feed China’s hungry population of 1.4 billion people.
Reaching a trade settlement is important for both countries, especially in light of the slowing Chinese economy (see chart below) and the dissipating stimulus benefits of the 2018 U.S. tax cuts. Slowing growth in China has implications beyond our borders as witnessed by slowing growth in Europe as evidenced by protests we have seen in France and the contraction of German manufacturing (the first time in over four years). Failed Brexit talks of the U.K. potentially leaving the European Union could add fuel to the global slowdown fire if an agreement cannot be reached by the March 29th deadline in a couple months.
Source: Wind via The Wall Street Journal
While the temporary halt to the longest partial federal government shutdown in history (35 days) has brought some short-term relief to the 800,000 government workers/contractors who did not receive pay, the political standoff over border security may last longer than expected, which may further dampen U.S. economic activity and growth. Whether the hot-button issue of border wall funding is resolved by February 15th will determine if another shutdown is in the cards.
Despite China trade negotiations and the government shutdown deadlock placing a cloud over financial markets, brighter skies have begun to emerge in other areas. First and foremost has been the positive shift in positioning by the Federal Reserve as it relates to monetary policy. Not only has Jay Powell (Fed Chairman) communicated a clear signal of being “patient” on future interest rate target increases, but he has also taken the Fed off of “autopilot” as it relates to shrinking the Fed’s balance sheet – a process that can hinder economic growth. Combined, these shifts in strategy by the Fed have been enthusiastically received by investors, which has been a large contributor to the +15% rebound in stock prices since the December lows. Thanks to this change in stance, the inverted yield curve bogeyman that typically precedes post-World War II recessions has been held at bay as evidenced by the steepening yield curve (see chart below).
Source: Calafia Beach Pundit
Other areas of strength include the recent employment data, which showed 304,000 jobs added in January, the 100th consecutive month of increased employment. Fears of an imminent recession that penetrated psyches in the fourth quarter have abated significantly in January in part because of the notable strength seen in 4th quarter corporate profits, which so far have increased by +12% from last year, according to FactSet. The strength and rebound in overall commodity prices, including oil, seem to indicate any potential looming recession is likely further out in time than emotionally feared.
Source: Calafia Beach Pundit
As the chart above shows, over the last four years, spikes in fear (red line) have represented beneficial buying opportunities of stocks (blue line). The pace of gains in January is just as unsustainable as the pace of fourth-quarter losses were in stock prices. Uncertainties may remain on trade, shutdowns, geopolitics, and other issues but don’t throw away your investing dance shoes quite yet…the ball and music experienced last month could continue for a longer than expected period of time.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2018). Subscribe on the right side of the page for the complete text.
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