The Market: January 2019

2019 could not have arrived sooner for investors. The 4thquarter 2018 was terrible for stocks, culminating in the worst December since The Great Depression year, 1931. During the 4thquarter a combination of events tipped the market over after the new highs at the end of September. From October 1 to December 31, the S&P500 fell 14%. The risks that spooked the market were and maybe still are: 1) the Federal Reserve and its path of rate increases; 2) the China-US trade issue; and 3) Brexit. All three put into question the ability of the global economy to continue to grow. Stocks violently sold off to discount the possibility of recession. This response was incredibly fast and steep, possibly to degrees much greater than the risk of recession warranted. There is a good argument to be made that computerized, algorithmic trading exaggerated the response to recession fears. Year-end tax selling and light holiday trading volume also played a role in the sharp decline in stock prices. Stocks were not the only assets to go into a free-fall. Crude oil also experienced a massive price decline. Demand for oil falls in a recession, and the oil market moved quickly on fears that demand would dry-up. Here too computer trading is likely to have made the down move larger and quicker than it would have been before the advent of algorithmic trading. Despite all this negativity, the calendar changed over to 2019 and stocks and oil have rebounded. It helped that the Chairman of the Federal Reserve had soothing comments. He signaled the Fed is not tone deaf to market moves and will not blindly push the economy into a recession. With the Fed more conciliatory and stock valuations pushed lower by the 4Q18 correction (practically bear market), there is reason to look forward to 2019. Much will depend on how the China-US trade situation gets resolved. If a deal is reached that doesn’t include tariffs or supply chain disruptions, the market will feel global GDP can continue to grow. My guess is that a benign resolution will happen. If corporate earnings can continue to grow and interest rates remain low, stock prices can rise and 2019 will be a good year. Many stocks and sectors practically re-traced the upward swing created by the corporate tax cut. I’m not sure the market fully appreciates the benefits of the lower corporate tax rates. Other things being equal, companies have higher after-tax cash flows. Despite the positives, a lot can go wrong in 2019. The US budget deficit continues to grow. More government bonds will have to be issued and that could put upward pressure on interest rates. Further, the markets are still subject to the volatility inherent in computer/algo trading. Outflows from equity funds were similar to 4Q 2008 when we were in the grip of a financial crisis. Investor confidence needs to be restored for stocks to rise. — Ian Green, Pendragon Capital Management