November 2018 Market Commentary

November was a tale of two markets for global equities. Equity prices fell sharply in the U.S. and across the globe during the middle of November over investor fears about the growth prospects of technology stocks. Stocks then climbed steeply to end the month. Investors reacted positively to an apparent softening of Fed Chairman Powell’s views from a month earlier about how much higher interest rates might go, as well as growing hope that a solution to the U.S. – China trade dispute might be reached.

The following table contains a summary of November and year-to-date market performance:

Index November YTD Index November YTD
S&P 500 (Total Return) +2.04% +5.11% All Country World Index (Net) +1.46% -2.55%
MSCI EAFE (Net) -0.13% -9.39% Barclays Aggregate +0.60% -1.79%
MSCI Emerging Markets (Net) +4.12% -12.24% 60/40 Blend* +1.16% -2.24%

* 60% All Country World Index/40% Barclays Aggregate

At one point during the month, the S&P 500 index fell over 6% (erasing the entire year’s gains) before rallying sharply to end 2% higher. Non-U.S. developed market and emerging market stock prices reacted similarly to news about interest rates and trade, falling steeply before rising at month’s end. Emerging market equities finished over 4% higher while Non-U.S. developed market stocks ended the month about where they started. Growing questions about economic growth led investors to the safety of U.S. Treasury bonds, pushing bond values higher for the month.

A survey of current and forward-looking economic and corporate data continues to show near record low unemployment, near record high consumer and business confidence, an index of leading economic indicators that continue to increase, strong factory activity and double-digit earnings growth. In November, the ISM U.S. manufacturing index rose from 57.7 to 59.3 (any value above 50 signals expansion) while an index of “new orders” (a forward-looking indicator) ticked higher. However, investors looking out to 2019 are seeing a number of possible challenges to sustained economic and earnings growth and are reacting accordingly.

October’s nearly 7% decline in the S&P 500 was driven by concerns that Fed tightening, rising wages and tariffdriven increases in input costs would lead 2019 expected earnings growth to be revised lower over time. The sell-off continued in November as weakness in revenue and earnings growth among leading technology stocks seemed to confirm investors’ October fears. Apple led technology stocks lower on evidence of softening demand, particularly in China, that led analysts to lower their price targets for the stock. Apple shares fell nearly 20% during the month. The FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) as a group lost approximately $800 billion of market capitalization over a variety of issues, but primarily concerns that additional Fed tightening could slow economic growth and hurt future profits.

Other sectors showing weakness include housing, automobiles and oil. U.S. construction spending fell for a third straight month in November, with housing starts dropping to 865,000 units (annualized), down from 950,000 a year earlier, hurt by mortgage rates rising to a seven-year high. A barrel of WTI oil saw its price fall by 7% in a single day during the month, and the commodity’s price has now fallen from its October high of $76 to just over $50 to end November. While oil prices initially fell on increased OPEC supply, more lately the price has been driven lower by traders believing a trade war with China and rising interest rates could dampen global growth and oil demand.

Investors’ perspective on future growth turned positive in late November following new comments by Fed Chair Powell regarding the bank’s policy rates. After suggesting in late September that the Fed was “a long way” from neutral interest rates (implying more rate hikes ahead), Powell reversed course, stating that the central bank’s policy rate is now “just below” estimates of a neutral level that is neither accommodative or restrictive to U.S. economic growth. The Fed had been telegraphing one more rate hike in December and as many as three more in 2019. Minutes from the Fed’s November meeting showed nearly all Fed officials agreed another rate hike was warranted while acknowledging signs that sensitive sectors are slowing, along with global risks and other factors, that would warrant pausing on planned 2019 hikes.

Powell’s comments were followed by various statements from Trump’s administration that the scheduled meeting with Chinese President Xi Jinping, at the G20 summit in Argentina, could lead to some agreement moving the two nations toward resolution of their growth-dampening trade dispute. Powell’s comments suggest the Fed’s three-year tightening cycle is drawing to a close, and hoping a solution to the trade dispute is in the works, investors drove the S&P 500 up 130 points or nearly 5% the last week of the month.

Emerging market stocks finished higher in November as investors began to perceive a reversal of the external headwinds they have faced this year. Prices were pushed higher on the belief that an end to the Fed’s tightening cycle would lead U.S. interest rates to stop rising and to a softer dollar. Both factors are supportive of emerging market growth. While equity prices rallied, measures of Chinese production, exports and new orders continue to weaken, and hover near levels suggesting economic contraction. While China is the world’s second largest economy, its 6%+ growth rate means that approximately $0.40 of every new dollar of global GDP growth originates with China.

European and Japanese stocks rallied on the same news but ended the month flat, hurt by recent weakness in economic growth. Slowing export growth, rising input costs associated with trade barriers, and political uncertainty (Italy’s budget issues and Brexit) led estimates of 2019 economic growth and forecast earnings to be lowered. German GDP is now expected to grow 1.8% in 2018, down from an earlier forecast of 2.3%. Japanese GDP actually fell 1% in the third quarter, but is still expected to be up over 1% for the year.

U.S. economic fundamentals such as job and wage growth, as well as consumer and capital spending, all point to continued growth in the year ahead. But the volatility of markets over the last month reflects the high level of uncertainty investors face about the sustainability of earnings growth in a business cycle nearing record length. After peaking at 3.2% in early November, the yield on 10-year U.S. Treasury bonds proceeded to fall to 3.0% to end the month, and has since fallen to 2.85% to start December. The decline reflects investor expectations of slowing growth and comes despite the apparent end to Fed tightening and modest progress toward resolving the U.S. – China trade dispute, both of which are positive for growth.

Economic fundamentals in much of the rest of the world also point to continued but slowing growth, the slowdown due in large part to the impact of trade policy. With nearly half of S&P 500 corporate earnings generated outside of the U.S., Caprock believes that concerns about the impact of trade policy on global growth weigh on expectations for U.S. earnings growth. A continuation of the status quo – 10% tariff maintenance on U.S. imports of Chinese goods (or their increase) will lead 2019 corporate earnings to be revised lower, leading equity prices lower. Any resolution to the U.S. – China dispute would likely cause investor expectations of growth to reset higher and lead to a rally in global equity prices. At the present time, Caprock believes U.S. and Chinese policy makers will produce an agreement that avoids contributing to a global slow-down; the costs of not doing so are too high. Any evidence that a growth-sustaining solution is unlikely would lead Caprock to recommend investors reduce their allocation to global equities sooner than would otherwise be the case.

This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but Caprock makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.