The S&P 500 saw its third 5% or more decline in the past three months last week. This time it was renewed pressure on tech stocks, the arrest of a key Chinese executive that fueled uncertainty about a China-U.S. trade deal and growth concerns after what some viewed as a disappointing jobs report. In this weekly, we wanted to outline some of the factors driving the market weakness and our view for the near term.
Five factors driving flight to quality: The recent price action is a clear flight to quality as opposed to some of the past sell-offs in 2018 that were driven by rising interest rates and fears that the Fed would need to be more aggressive. Investors have shed almost all risky assets in favor of the safety of Treasuries.
- Mixed messages from the Fed: Fed officials have whipsawed investors by making comments such as rates are near the “neutral rate.” While others have suggested the economy needs more rate hikes. Investors can handle rate hikes but do not like mixed messages from the Fed. Uncertainty leads to risk aversion.
- Global slowdown. The U.S. economy has been resilient and is likely to post another quarter of 3.0%+ (QoQ) growth in 4Q. However, the effects of Brexit, U.S. tariffs and reforms are weighing on many major global economies.
- Cold war fears. The trade uncertainty and political tension between the U.S. and China has been too much for investors to absorb. Especially in regard to technology which had been a bright spot for most of the year. Apple, the largest company in the Nasdaq, had been up nearly 40% YTD in early October but lost all its price gains for 2018 last week.
- Bear market in oil. Oil prices have been in a steady decline since early October and as they have entered bear market territory, it has fueled investors’ fears over a major global slowdown.
- Yield curve flattening. Historically, a recession is preceded by an inverted yield curve. Last week the difference between the 10YR yield and the 2YR yield fell to the lowest level (14 bps) since June 2007, which was six months before the start of the Great Recession (December 2007).
Verdence View. In the near term, the trade and growth uncertainty will likely keep investors hesitant to add risk, especially at year-end. At this point, we are positioned for the volatility we are experiencing and have cash to deploy. We are looking at technical, fundamentals and valuations which suggest there will be additional opportunities for long-term investors to adjust asset allocation.
- Technicals suggest caution in the near term. The S&P 500 saw a “death cross” last week when the 50D moving average crossed below the 200-day. For technicians, this warrants caution in the near term, but it doesn’t mean the bull market is over.
- Fundamentals. The global economy is slowing but that is expected after the robust growth. Our base case is that the U.S. economy will expand through 2019 but further clarity is needed to sustain another uptrend in equities.
- Valuations. Valuations are more attractive with the recent pullbacks but not necessarily cheap enough to warrant getting aggressive. What remains uncertain is the earnings component of P/E, especially in technology.
Source: Data as of December 7, 2018.
Footnotes: Bloomberg Finance LP, Verdence Capital Advisors.