There are many things on investors’ minds these days. In this memo, we identify ten questions that are frequent topics in the news and may have an impact on the global markets.
1. What is the latest on the trade discussions between the U.S. and China, and how do these discussions affect the economy and the stock market?
President Trump and China’s President Xi spoke about trade and other issues at the G-20 Meeting in Argentina in late November/early December. The sentiment coming out of this meeting was positive. They agreed to defer (for three months) the December 31, 2018 deadline for the increase in US import taxes on Chinese goods. Additionally, China agreed to buy more agriculture and start to address the intellectual property issues. Several days after the meeting, there seemed to be a mixed message on the amount of progress that was achieved. Markets began to sell-off when it was clear that the two countries were not on the same page. A recent positive development has been China lowering the tariff on imported U.S. automobiles. No one can predict when both sides will approve a comprehensive trade deal. When it does, it should be very positive for the global stock markets. Until then, we expect to have elevated levels of volatility.
2. What is meant by yield curve inversion, and what are the ramifications if this occurs? Historically, longer-term treasury bonds have higher yields than shorter-term treasury bonds. This difference in yields compensates investors for taking more risk in long-term bonds. In the past, when short-term bonds yield more than long-term bonds (referred to as yield curve inversion), it can be (but is not always) a pre-cursor to an economic recession. This situation can be very difficult for financial institutions, such as banks, who depend on an upward sloping yield curve and are very important to our economy. Recent Federal Reserve action has influenced the 2-Year Treasury significantly, causing its rate to approach 2.7%, while the 10-Year Treasury has been in a range of 2.8% – 3.2%. This indicates that, while the yield curve has flattened, it has not yet inverted.
3. What is the Federal Reserve’s plan when it comes to raising short-term interest rates?
The Federal Reserve (Fed), now headed by Chairman Jay Powell, has raised short-term interest rates nine times since 2015 (from 0.25% – 2.50%). By comparison, in the 2004 to 2006 timeframe, the Fed raised interest rates 17 times. In normal economic environments, the Fed funds rate is somewhere between 3.0% and 4.0%. Why is the rate important? Because it affects the Prime Lending Rate, credit card rates, and auto and home equity loans. It is not clear how many more rate hikes may occur in 2019, but it is safe to say that the Fed is at or near the stopping point.
4. Is it bad that the Federal Reserve is reducing its balance sheet by not reinvesting in the U.S. Treasury and Mortgage bond market?
The Fed bought Treasuries and Mortgage bonds for many years after the 2007 – 2009 financial crisis. They did this to stabilize the markets, keep interest rates low for housing and auto loans and encourage investors to put money to work in areas like stocks and real estate. When the economy reached the point that it no longer needed the economic stimulus, the Fed stopped buying new bonds and has been letting the existing inventory of maturing bonds roll off its balance sheet. This process has been very gradual and does not appear to have rattled the markets.
5. Why are oil prices so volatile, and how does this impact gas prices at the pump?
Oil prices are very sensitive to supply and demand. If oil production is reduced outside of the U.S., this can cause prices to spike. Strong worldwide demand can have the same impact. However, if demand is flat or declining, while the U.S. continues to increase production due to fracking and other technological advances in oil/gas extraction, prices can move lower. Just in the last few years, we have seen prices above $100/barrel and below $30/barrel. These price swings can impact consumers as they fill up at the pump. While lower gas prices are good for the consumer (providing more discretionary spending in other areas), a plummeting oil market can raise concerns about a global economic slowdown. Most economists believe that oil should be trading in the $45 – $65 range. At these levels, energy companies can continue to be profitable, while consumers benefit from relatively low gas prices.
6. How might a “government shutdown” affect the markets?
In the past, government shutdowns have not been catastrophic for the markets because they are relatively short-lived. The current concern is that there will be a shutdown if Democrats do not approve the spending bill, which includes $5 billion for a southern border wall. We will soon know how this will play out. Also, in the first quarter of 2019, Congress will be voting on whether to raise the debt ceiling. This will be a more closely watched event, as the U.S. Government’s credibility in paying back its debts will be on the line.
7. When will “Brexit” officially occur, and why has it been so controversial?
Brexit has been somewhat of a back-burner issue for over 2 years now, but recently it has come back in to focus. Theresa May, who has been in charge of the reconfiguration of trade deals between the UK and the European Union (EU), has been struggling to build consensus among her peers. This difficulty has led some people to believe that a second referendum may be on the horizon (giving the UK a “do-over” when it comes to whether or not to leave the EU) or worse, a “no deal” result, which could really cause disruption in Europe and in global financial markets. Investors will be monitoring this closely in the weeks ahead.
8. What are some other things about which investors seem to be concerned?
Corporate earnings growth has clearly been strong in the U.S. in 2018, but investors are forward-looking, and they see potential for slowing growth in 2019, not only in the U.S. but also in China. While the U.S. will not have the impact of tax cuts to boost growth next year (the way it did in 2018), Corporate America still seems to have optimism, while China will likely require some type of economic stimulus to get things back on track. Another concern is whether the housing market is beginning to slow in the face of rising interest rates.
9. What are some reasons for optimism?
Unemployment continues to be near historically low levels; and corporate earnings growth is expected to be between 5% and 10% next year (markets tend to do well when growth is in this range). Over long time periods, earnings (profits) are what drives stock prices. Additionally, small business owner optimism is robust and interest rates/inflation are still low, compared to history. Market valuations have also become more attractive, as the Dow and S&P 500 have declined in an environment of surging profits.
10. Why is it important to be a long-term investor?
Short-term market timing is extremely difficult, if not impossible, to pull off successfully. Investors who have a long-term view and do not panic when markets get volatile tend to do well and achieve their goals. It is interesting to note that the probability of positive returns for the U.S. stock market on any given day is only about 53%; if you increase the time horizon to three months, the probability of positive returns goes up to about 70%. At one year, the probability is above 75%; and for three-, five- and 10-year periods, the probability of positive returns ranges from 87% – 97%. It is important for investors to have the right mix of stocks and bonds that will allow them to weather any market downturns that may arise.
As we approach 2019, you will hear prognosticators giving their forecasts for the next 12 months of market performance. We believe predicting short-term returns is like throwing darts against the wall; however, decades of research have shown that being patient, sticking with your long-term investment plan and avoiding the short-term market/media noise can lead to a positive market experience. We hope this list of questions and answers has provided some clarity on those topics about which you may be hearing.