We want to start by wishing each client, friend, and reader a very Happy New Year! It honestly seems like only a very short time ago we were anticipating 2018. Now as we say goodbye to 2018, we are ushering in the last teen year of the 21st century. The nagging question is how will 2019 treat us? Will it be good?
Despite the uncertainty surrounding the markets and what they will and will not do, we can examine some of what the data is telling us as well as look back at history to find any useful indications. The first thing we need to understand is that the current environment. While volatile, it is not yet indicating imminent recession.
Hot Topic #1: Unemployment
Unemployment is at a low point that has not been seen since the 1970s. At 3.7%, the unemployment rate is at a 40+ year low, which would not support a recession prediction at this time.
A recession is technically declared with two or more quarters of negative GDP growth. Our latest GDP report was from the end of the 3rd quarter 2018, which was over 3% annualized growth. It would not be surprising to see this drop. Predictions can vary, however consensus predictions still anticipate positive GDP growth, and therefore, do not support a recessionary outlook quite yet.
Hot Topic #2: Inflation
The biggest reason for this is that as inflation pressure grows, the Federal Reserve Bank tends to raise interest rates. Often, this can be a sign of the end-phase of economic expansions. In fact, we have been in a Fed interest tightening cycle for two years now, and it is largely being blamed for much of the recent market turmoil.
The reason this is watched so closely is that, although the Federal Reserve does not directly control interest rates of bonds, it controls the amount of money in circulation through the banking system indirectly. The tendency is, that as rates rise, lending becomes more difficult to obtain and interest rates rise eventually.
Hot Topic #3: The Yield Curve
One of the most talked about and often most followed items that is a great dinner conversation starter is the yield curve. This refers to a comparison of short-term treasury rates to longer-term treasury rates. There are quite a few ways at looking at this, but a more simplified and accurate way would be the 10-year treasury rate minus the 2-year treasury rate.
When 2-year treasury rates are higher than 10-year treasury rates, it can be a signal that the economy is at risk of turning-over or entering contraction. This indicator does tend be somewhat mixed and can become “inverted” months or even years before a recession, more specifically, inverted curves tend to precede a recession by up to 24 months. Currently, the curve is not yet inverted.
In addition to the data from these “hot topics”, we must also consider recent market movements and take a look at the greater economic cycle and trend.
Although a recession could develop down the road, bear markets within greater bull markets are not as severe or long-lasting. Unfortunately, they are not without pain, anxiety or even bewilderment, either.
The real issue is that we view cyclical bear markets, like the one we are currently in, as phases in the broader market cycle that can set up the next move-up. The key is to watch the data for signs that a bottoming process is taking place. There was some positive indication that we might be able to establish a bottom in this bear market sometime in the next few months. There are still some ongoing risks that need positive outcomes for markets to resume their upward motion longer-term.
Hot Topic #4: What are we looking for?
We are looking for resolutions to the ongoing USA/China trade dispute, indication that the Fed is not likely to over-hike interest rates and we are watching the European developments in the Brexit negotiations.
Geopolitical risks combined with economic slowdowns create accentuated volatility at a time when many investors are worried about the possibility of the end of our current economic cycle. Risks are rising, but it is too early to say whether we will begin a recession in the next year or two. It is simply too early to begin recession talk. We may even continue to expand for a while longer.
Data is key and there are some periods of heightened risk that some investors may want to avoid. However, an important part of investment success is to have a plan for how you are going to behave under various market risk conditions and stick to your well-designed plans.
As we move into 2019, there are a few likely outcomes from this bear market:
- Resolutions to our geopolitical problems will emerge and markets will become more confident and gains will be likely.
- Continued breakdown in economics will combine with geopolitical risks to conspire to continue this cyclical bear market for longer. In this case, we would expect markets to struggle for at least the first quarter or two of 2019.
Ongoing monitoring of the situation is vital to understanding what will happen in 2019.
I will be hosting a Live Market Update Webinar on January 10th and invite all my readers to register for this call. I will be covering these topics and more, and taking a look at what all this current data is telling us about the markets looking into 2019. You can register for this webinar HERE.
Hopefully our vision will continue to clear up as we get into the first few months of this New Year!
1-U.S. Markets. Ned Davis Research. Amy Lubas, CFA and Chad Ellis. November 21, 2018 [11/23/18]
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