The Markets – The S&P 500 index finished December -9.90% bringing the year-to-date return to -6.20%. The Dow was -9.70% for the month bringing its year-to-date return to -5.60%. The NASDAQ finished the month -13.08% and year-to-date -3.90%, according to the Wall Street Journal.
Many of us remember the Global Financial Crisis of 2008 all too vividly. With the market volatility of late caused by what most folks categorize as a fear of a pending recession, we would like to remind you that not all recessions are crises. A recession is caused by corporate earnings dropping or an interest rate environment that is too high which causes business to slow. At this time we see neither. In fact, Morningstar recently reported that company share buy-backs and personal purchasing of shares by corporate CEOs are at an all-time high. This tells us that insiders do not see a near term drop in earnings. Although President Trump has beleaguered Fed Chairman Powell, interest rates remain at historically low levels. So, what is the problem? Perhaps the extremely tight labor market and the growing corporate debt will be the catalyst that causes a mild recession but neither is cause for crisis.
What we have noted, especially in the closing months of 2018, when it comes to the relationship between economic data and the stock market, “better or worse tends to matter more than good or bad.”
Much ink has been spilled on the yield curve over the past couple of weeks—especially when the “belly” of the curve (5-year minus 2-year Treasury spread) inverted recently. Although this has served as a leading indicator of sorts for the more common yield curves, the near-panic that inversion induced was probably a bit overdone. Perhaps the yield curve that’s proven to be most relevant to the stock market is the spread between the 10-year and 3-month Treasury yields, which recently flattened to less than 50 basis points. While markets remain concerned about various issues; the looming Chinese trade war, the Brexit deal, cracks in the European Union, and the partial government shutdown over border wall budget funding, nothing else comes close to shocking markets like believing there may already have been too many interest rate hikes and that the yield curve will go flat, or worse, invert.
Regarding the market pullback, the median decline for the S&P 500 during those bear markets was -36%, with a range of -20% to -57%. As the global liquidity tide has been receding, there’s been a need for repricing of higher-risk asset classes; which is exactly what’s been happening. A bear markets in; the FAANG stocks, emerging markets, oil, small cap stocks and even broadly the S&P 500 causes us to be concerned as it relates to the expectations of corporate earnings based on most of the next year’s forecasts. Most of which, I have read, don’t yet incorporate certain potential hits to the growth rate. However the recent move toward extreme pessimism could provide at least a short-term boost to the stock market.
A little closer to us folks in Texas; oil had a tumultuous 2018, with prices rising to a four-year high in October before plunging more than $30 in the following months. Oversupply and demand worries are high on the concern list for the industry, making volatility a buzzword this year as well.
There are other power dynamics at play. OPEC’s Viennese waltz in early December was a perfect example of a shift, with Russia brokering a deal to curb output and sharing the reins with traditional leader Saudi Arabia. President Donald Trump’s tweets demanding lower oil prices and U.S. shale producers pumping out unprecedented volumes of crude, threaten to undo all of OPEC and Russia’s years-long work.
There are “major uncertainties” and forecasting trends in 2019 is “even more hazardous than usual,” said Neil Atkinson, head of oil markets at the International Energy Agency. Geopolitical uncertainty is a serious risk to the industry, according to Ryan Lance, chief executive officer of ConocoPhillips.
Since Volatility is the word of the day with regards to equity markets, bond markets, and oil, let’s discuss volatility a bit. The VIX is a measure of the amount of volatility options traders are pricing in over the month ahead. The VIX hit all-time lows early in the year with traders predicting practically no volatility. Recently the VIX is up about 60% in the past month and almost 100% year-over-year. While it is important to note the VIX, as it measures volatility, is significantly up, it remains near multi-year normal ranges. So while the volatility makes us uncomfortable, it behooves us to keep clear perspective. Are you old enough to remember when the speed limit changed from 55mph to 70mph? Those of you who followed the 55mph rule probably felt like you were driving ‘smokin fast’ when you began to drive 70mph. Now that the speed limit is 80mph on the interstate and if you drive west of Kerrville most folks take an extra 5 and drive 85mph. Now when headed back east toward San Antonio, they must slow to 70mph as they approach Kerrville and Boerne and they feel like they are creeping along. The VIX has moved up from 55mph to 70mph, so it feels like 85mph, until it actually hits 85mph, then the 70mph we have today will feel like slow creep. Our point is this; while the VIX has ramped up dramatically in very quick fashion, relatively it is about normal, it just feels uncomfortable because we have been driving so slow…er…the VIX has been so low in recent months & years.
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