U.S. Economic Data Strong for Jobs, Mixed Picture for Manufacturing, Services Sectors
Federal Reserve Taking Wait and See Approach to Tightening Cycle in U.S.
If market watchers were worried about recession fears from early January’s weaker-than-expected manufacturing reports, December’s stronger-than-expected nonfarm payrolls report may have temporarily put those fears to rest. Combined with dovish comments from Federal Reserve Chairman Jerome Powell, U.S. stock markets ended the first week of January on much firmer footing.
At a January 4 conference in Atlanta, Powell said mild inflation would provide flexibility for how the Federal Open Market Committee would set interest rates in the coming year. The FOMC raised short-term interest rates four times in 2018 and it has forecasted another two rate hikes for this year.
“As always, there is no preset path for policy,” Powell said. “And particularly with muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves.”
Powell’s comments acknowledged tightening financial conditions, concerns about downside risks and slowing global growth, among other key factors. He likened current conditions to those of 2016. At that time oil and other commodity prices had tumbled, stocks were under pressure, weakness in the Chinese yuan and economy had sparked concerns about global growth, and credit spreads were widening. The prior year, the Federal Reserve had hiked interest rates in 2015 despite tighter financial conditions.
“No one knows whether this year will be like 2016,” he said. “But what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy should that be appropriate to keep the expansion on track, to keep the labor market strong and to keep inflation near 2 percent.” 1
Financial markets rallied with Powell’s comments, with the Dow Jones Industrial Average gaining nearly 3.29%, the S&P 500 rising 3.43% and the Nasdaq rising by 4.26%. The rally on January 4 follows what marked the worst year for U.S. benchmark stock indexes since 2008.
Another lift for stocks on the final day of January’s opening week was the December jobs report. Nonfarm payrolls rose by a seasonally adjusted 312,000 last month, the Bureau of Labor Statistics (BLS) reported. Average hourly earnings increased by 84 cents for 2018, up 3.2% compared to the prior year and the most since the current economic expansion began back in 2009. 2
The unemployment rate rose to 3.9% from 3.7% the previous month. The increase was partly a result of more people entering the workforce with the labor participation rate at 63.1%, compared to 62.9% in November. The most recent BLS report doesn’t include temporary job losses related to the government shutdown that began December 22 and has suspended work for about 800,000 federal employees.
Data Sends Mixed Picture
Forecasts for the December report for new job growth were well below what the BLS reported. The stronger-than-expected jobs report contrasted with data from the manufacturing sector released prior to the jobs report. The mixed data has added to uncertainty over whether concerns that recession risks for the U.S. economy may be on the rise.
Prior to the jobs report, the IHS Markit U.S. Manufacturing PMI (purchasing managers index) for December came in at a 15-month low, while the Institute for Supply Management (ISM) reported that its manufacturing PMI declined 5.2 percentage points in December to 54.1. The ISM new orders index also fell 11 percentage points to 51.1 – its lowest since August 2016. (See U.S. Manufacturing Sector Showing Signs of Deceleration posted on the Market News section of BCJ Insights.)
A separate nonmanufacturing report from ISM showed that the overall activity in the services sector fell to 57.6 in December (its lowest since July), compared to 60.7 the prior month. An index that tracks business activity slid 5.3 percentage points to 59.9 compared to November’s reading, while the report’s employment index fell 2.1 percentage points to 56.3.
Respondents were generally upbeat going into 2019, though labor shortages and tariffs remain a concern. “We expect lower profit margins and reduced sales for 2019 until our suppliers can source product from other countries, which may not be until late [in the year],” said a respondent in the company management & support services sector. 3
ISM says that the current level of its manufacturing PMI and nonmanufacturing index corresponds to annual growth domestic product (GDP) growth of 3.4% and 3.2%, respectively. While these indexes are viewed as leading indicators and helpful in gauging economic activity, they don’t always correlate on a one-to-one basis with official government data.
The Bureau of Economic Analysis’ advance estimate of fourth quarter and annual 2019 GDP is expected to be released January 30. The Atlanta Federal Reserve’s GDPNow model for real GDP growth for the fourth quarter stood at 2.8% as of January 10. The model is updated generally on a weekly basis as economic data flows in and is available here. The New York Federal Reserve’s Nowcasting Report of real GDP growth forecasts a 2.5% rate for the fourth quarter and 2.1% GDP growth for the first quarter of 2019, as of January 4. This model is also updated typically from week to week and is available here.
Going into the first quarter of 2019 there could be some temporary economic disruption from the government shutdown. For example, only 12% of Internal Revenue Service (IRS) staff are expected to work through a shutdown, according to the agency’s plans. That would leave less IRS staff available to answer questions from taxpayers and practitioners. It could also potentially delay tax refunds, a source of consumer spending. 4
What may be more difficult to determine until future economic data is released is the impact to small businesses from less traffic and activity from government workers.
Real Estate: Housing Market Conditions Loosen Somewhat; Higher Mortgage Rates Could Become an Issue
Home-price appreciation showed signs of slowing in the second half of 2018, while inventory levels for homes on the market began to rise off of tighter levels which the market had been experiencing during the past 18 months or so. Nevertheless, mortgage rates rose throughout the year, adding to homebuyers’ costs.
There are also indications that in some of the country’s “hotter” markets, the pace of sales activity is slowing, which is leading to more homes staying on the market longer. Builders are also beginning to offer more concessions favoring buyers.
In December, according to data from John Burns Real Estate Consulting cited here, 23% of builders lowered net prices, including reductions in the list price and incentives toward options like hardwood flooring, compared to only 4% lowering prices a year ago. While the percentage of builders offering concessions is on the upswing, it is still well below the 43% level during 2010, in the wake of the financial crisis. 5
There are other notable trends that activity in the housing market is easing. According to the December 2018 report on the housing market from Realtor.com, 15% of listings in December had price reductions, compared to 13% a year ago. Inventory increased 5% nationally and 10% in larger markets. In addition, in 19 of the 45 top metropolitan areas tracked by Realtor.com homes are staying on the market longer than the previous year.
“Sellers are adjusting their strategies, especially in slowing, pricey markets with growing availability of homes for sale,” said Sabrina Speianu, an economic research analyst with Realtor.com. “Although buyers may not find a bargain, the price discounts and recently lower borrowing costs may entice upper-tier buyers back into the market. By contrast, entry-level shoppers continue to contend with declining availability of homes for purchase, albeit at a slower rate.” 6
Mortgage rates based on data from Freddie Mac increased by about 55 basis points in 2018, but declined slightly in the second week of January. Rates tracked by Zillow rose by about 70 basis points. Those following the market say that rates need to stay lower than around 5.25% to 5.50% without significantly impacting homebuyers’ affordability. Mortgage rates briefly hit near 5.00% in November prior to falling back in the final weeks of the year.
If rates were to rise to 5.50%, a typical household looking to spend no more than 30% of its income on housing would have to “slash” its home-buying budget by nearly $35,000 to cover the higher mortgage payments. That would eliminate 5.4% of currently for-sale homes, or about 31,700 homes, from a typical buyer’s budget, according to research from Zillow Group.
“As home-value growth slows and for-sale inventory ticks up, one would think that all is well for would-be home buyers. However, mortgage rates continue to grow, taking a big bite out of home shoppers’ budgets and slicing the share of homes available to those looking to buy,” said Matthew Speakman, a Zillow economic data analyst, in a recent research post. 7
New-Year Rally Lifts Stocks from Worst Performance in a Decade
Trade woes, concerns of economic slowdown pressured stocks in Q4
Following the worst year in 2018 for U.S. equity indexes, stocks have rebounded in the first several trading sessions of 2019, as market participants have been taking advantage of lower valuations following the fourth quarter’s selloff. A bounce in oil prices thus far in 2019, for example, has given a lift to energy stocks, with the S&P 500 Energy Sector Index up 8.39% through January 9. The small capitalization Russell 2000 Index has gained 6.69% through the same period.
While this year is off to a positive start with the Dow Jones Industrial Average up 2.36%, the S&P 500 rising by 3.12% and the Nasdaq Composite gaining 4.85% through January 9, U.S. stocks also fared well during most of January 2018 until a widespread selloff at the end of that month into February spooked global markets. It will be interesting, then, to observe whether the late December 2018 lows marked a capitulation point and if the current rebound gains momentum or if early January 2019’s returns are a brief relief rally.
In addition, there doesn’t appear to be much of an appetite from market participants for negative news, particularly ahead of fourth-quarter earnings season. A case in point came January 10 with reports of mixed same-store sales from mall-based U.S. retailers, which partly contributed to a weaker opening for stocks and a selloff in some retail shares.
Looking back to last month, the S&P 500’s monthly decline of 9.18% represented the index’s worst December since 1931, according to S&P Dow Jones Indices.8 All 11 sectors of the index were down for the month and utilities (up 0.50%) posted the only gain in the fourth quarter. For the year, the health care sector was up 4.69%, while utilities rose 0.46%, the only two sectors to post annual gains.
With the fourth quarter’s plunge in oil prices, energy shares within the S&P 500 were 2018’s worst performers, posting a decline of 20.50%, followed by the materials sector, which fell by 16.45%. Industrials also fared poorly, falling by 15.00%. The materials and industrials sectors were under pressure during 2018 from the ongoing trade uncertainty between the U.S., China and other global trading partners, as well as higher labor and input costs, even as oil prices eased. The communications services sector (created in September that includes technology, media and online behemoths formerly within other S&P 500 sectors) ended the year down 16.43%.
According to Howard Silverblatt, S&P’s senior industry analyst, the issues for U.S. markets in the fourth quarter were concerns over the global economic slowdown, trade issues, the increased cost of labor and materials, and geopolitical issues. “The combined uncertainty (and lack of control) has increased anxiety and volatility in the market, as well as eroded confidence,” he said in S&P Dow Jones Indices’ monthly performance recap.
There was no place to hide for investors in small capitalization stocks, an area where some investors had looked for a safe haven from the trade and tariff uncertainty present for much of 2018. Until the latter part of the third quarter, small caps were faring well but corrected in the fourth quarter, with the Russell 2000 entering bear-market territory just prior to the December holidays. The broad measure of small cap stocks finished 2018 down 12.18%, dragged down by the fourth quarter’s price declines of 20.51%.
U.S. Treasury Note Yields Fall
In fixed income, the U.S. Treasury 10-year note ended the year with a yield well below that of the highs which the security had traded at periodically throughout the year – notably in May, October and November when its yield nearly reached 3.25%. The fourth quarter’s shift by market participants to safer assets from risky assets like stocks and high-yield bonds helped add to the U.S. Treasury market’s safe-haven status. The 10-year note ended 2018 yielding 2.68%, compared to a yield of 3.06% at the end of the third quarter (Treasury prices rise when yields decline).
Treasury securities, though, were off their 2017 year-end lows and something to watch will be if the market for U.S. debt resets to higher yields as the U.S. deficit rises. Recent demand for U.S. Treasury securities has been declining as tracked by the bid-to-cover ratios (the dollar amount received versus the amount sold) at recent Treasury auctions.
Recent low bid-to-cover ratios are partly the result of a greater amount of debt being sold to fund the federal government’s growing deficit, yet may still show signs of slowing demand if the trend were to persist. “A declining bid-to-cover ratio increases the vulnerability and probability that investors suddenly will begin to think that a falling bid-to-cover ratio is important. Put differently, all fiscal crises begin with a declining bid-to-cover ratio,” Torsten Slok, Deutsche Bank’s chief international economist, told Bloomberg in this January report. 9
A Look Overseas
International stocks also performed poorly in December and the fourth quarter, pressured by similar trends as those that emerged for U.S. markets in the fourth quarter – namely a repricing a risk based on concerns over the likelihood of a global economic slowdown.
Similar to U.S. indexes, the STOXX Europe 600 finished 2018 with its worst performance in nearly a decade, posting a full-year price decline of 13.24% for the year and 11.88% in the fourth quarter.
Like some sectors of the U.S. stock market, European shares have staged a rally thus far in 2019 after falling at the end of last year to levels that some market participants considered to be oversold. The STOXX 600 is up 2.98% this year through January 9. Sectors that have benefited include oil & gas, industrials, and automobiles & parts, trade sensitive sectors important to the eurozone’s export economy.
“My scenario is that of an economic slowdown but I expect things to get gradually better following a brutal 2018 dominated by tariffs and very harsh commercial rhetoric,” Roberto Lottici, fund manager at Italy’s Banca Ifigest, told Reuters in this January 7 report.10
A recap of overseas markets in 2018 shows that the S&P Global Broad Market Index (BMI) posted its worst monthly performance in December, down 7.36%, since May 2012. The Global BMI fell 11.84% in 2018, and by 16.73% for the Global Ex-U.S. Index, according to S&P Dow Jones Indices.
Commodities: Global Growth Rally Loses Steam in Second Half of 2018
Metals prices remain flat despite January’s bounce in oil prices
It looked as if the planets and stars were aligned in 2018 for persistent strength in commodity markets. The global growth story – in which economies around the world had been experiencing synchronized expansion since around the latter half of 2017 – helped lift prices for oil and industrial metals. Other trends, perhaps not as supportive of open trade, such as tariffs and government policies, were also exerting an upward influence on prices, notably for lumber and steel.
As the year progressed, however, the dollar strengthened. Signs also emerged of slowing global growth and trade tensions between the U.S. and China along with other trading partners. These factors led to a decline in commodity prices. The selloff in riskier assets and rotation out of stocks also pressured commodity prices during the fourth quarter, particularly oil.
For its part, oil prices seemed poised to head toward $100 a barrel in early October as leading strategists believed there would be supply risks from the pending U.S. sanctions on Iran that went into effect the following November.
But Saudi Arabia and other OPEC (Organization of the Petroleum Exporting Countries) members within the Persian Gulf had been increasing output to make up for dwindling supply from Iran. That also came at a time when the U.S. began to surpass Russia and Saudi Arabia in output, ultimately becoming the world’s largest crude oil producer in 2018 based on monthly data.
The crash in oil prices in the fourth quarter plunged the commodity into bear market territory. Overall prices throughout the year averaged $72.00 a barrel for Brent crude and $65.00 a barrel for West Texas Intermediate (WTI). Those averages, though, don’t provide the full picture of the price activity.
In sum, both crude benchmarks closed out the year lower than where they began, according to data from the U.S. Energy Information Administration. Brent and WTI each hit their highest prices during the year on October 3, with Brent at $86.00 a barrel and WTI at $76.00 a barrel. Prices for each benchmark fell rapidly from those highs – with Brent declining to $50.00 a barrel and WTI falling to $43.00 a barrel on December 24, annual lows for each.11
In their bid to establish a floor on falling prices, OPEC and key allies outside the cartel, including Russia, agreed in December to cut production during the first six months of 2019. Saudi Arabia also plans to cut output during 2019 in its efforts to push oil prices above $80.00 a barrel to support domestic budgetary expenditures.
Thus far in 2019, Brent and WTI prices are up 14.20% and 15.30%, respectively, through January 9. The rally in oil prices hasn’t extended to copper and other industrial metals as concerns about the pace of global growth continue to weigh on prices. The Bloomberg Industrial Metals Total Return Index, a broad measure of industrial metals prices that tracks futures contracts on aluminum, copper, nickel and zinc, fell by 11.25% in 2018.
For its part, copper prices ended the year more than 20.0% lower than four-year highs reached in early June. Concerns remain over slowing global demand and slowing economic growth in China, an economy which is responsible for about half of world copper consumption. Figures released in early January by China’s National Bureau of Statistics showed that activity in the country’s manufacturing sector contracted in December. The manufacturing PMI fell to 49.4, its lowest in nearly three years. 12
1 Cox, J. (2019, January 4). Powell says Fed ‘will be patient’ with monetary policy as it watches how economy performs. CNBC. Retrieved from: https://www.cnbc.com/2019/01/04/powell-says-fed-will-be-patient-with-monetary-policy-as-they-watch-how-economy-does.html
2 U.S. Bureau of Labor Statistics (2019, January 4). The Employment Situation – December 2018 [Press Release]. Retrieved from: https://www.bls.gov/news.release/empsit.nr0.htm
3 Institute for Supply Management (2019, January 7). December 2018 Non-Manufacturing ISM® Report On Business®. Retrieved from: https://www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm?navItemNumber=31099
4 Mercado, D. (2019, January 4). Federal shutdown means tax refunds may be delayed. CNBC. Retrieved from: https://www.cnbc.com/2019/01/04/what-the-federal-shutdown-could-mean-for-tax-season.html
5 Khouri, A. (2019, January 11). As the housing market slows, builders are offering buyer discounts. Los Angeles Times. Retrieved from: https://www.latimes.com/business/la-fi-home-builders-slowdown-20190111-story.html
6 Speianu, S. (2019, January 3). December 2018 Data: Housing Market Cooldown Continues As Inventory Increases in December. Realtor.com. Retrieved from: https://www.realtor.com/research/december-2018-data-housing-market-cooldown-continues-as-inventory-increases-in-december/
7 Speakman, M. (2018, December 27). Rising Mortgage Rates Thorn in Otherwise Rosy Conditions for Home Buyers. Zillow Group. Retrieved from: https://www.zillow.com/research/rising-rates-home-buyers-22531/
8 Silverblatt, H. (2019, January 2). U.S. Equities Market Attributes October 2018. S&P Dow Jones Indices Market Attributes®. Retrieved from: https://us.spindices.com/documents/commentary/market-attributes-us-equities-201812.pdf
9 Greifeld, K. (2019, January 9). As federal deficit approaches $1 trillion, investors are losing their appetite for U.S. debt. Los Angeles Times from Bloomberg. Retrieved from: https://www.latimes.com/business/la-fi-treasuries-demand-20190109-story.html
10 Masoni, D. and Reid, H. (2019, January 7). Trade deal optimism boosts European shares as exporters rally. Reuters. Retrieved from: https://www.reuters.com/article/us-europe-stocks/trade-deal-optimism-boosts-european-shares-as-exporters-rally-idUSKCN1P30QK
11 U.S. Energy Information Administration. (2019, January 3). Crude oil prices end the year lower than they began the year. Today In Energy. Retrieved from: https://www.eia.gov/todayinenergy/detail.php?id=37852
12 Alessi, C. (2019, January 3). Copper falls as data signals China slowdown. MarketWatch. Retrieved from: https://www.marketwatch.com/story/copper-falls-as-data-signals-china-slowdown-2019-01-03
Sources for Financial Data:
Dow Jones Industrial Average:
S&P 500 Energy Sector Index:
U.S. 10-Year Treasury Note:
Bloomberg Commodity Index Total Return:
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