Eye on the Markets - 2018


Markets Stabilize a Bit after a Volatile Month

By Ketu Desai

The markets remained on edge in November, as investors focused on trade concerns and potentially an aggressive Fed. At the core of the correction is uncertainty about 2019. It is widely expected that the economy will weaken from the pace of the second and third quarter. Estimates for growth for the current quarter are around 2.5 percent, and estimates for next year range between 1.8 percent and 2.5 percent. Fed policy and trade are critical determinants of where we end up within that range. The Fed will almost certainly raise rates in December; however, the uncertainty is around how hawkish or dovish the Fed will be next year. Most measures of inflation are stable around 2 percent and recent market moves such as the dollar rallying, commodities such as oil falling significantly, and weakness in housing and autos, should further anchor inflation. The most recent speech by Chairman Powell and Fed meeting minutes indicate that the market moves are certainly causing the Fed to consider a more dovish policy for 2019, which caused a mini-rally towards the end of the month. The wildcard is how trade talks develop after the Trump / Xi meeting, as they could swing earnings growth from high single-digits to low single-digits.

The breadth of the concerns has led to the market repricing nearly all asset classes. In fact, Deutsche Bank put out a study during the month, indicating that 90 percent of the 70 asset classes they track are posting negative returns, the highest percentage since they have data, going back to 1901. During the month the selling spread to pockets of the market that had held up, including high-yield bonds. Weakness in energy-related high yield caused spreads to widen, as oil prices have fallen more than 20 percent. The negative sentiment even spread to investment grade bonds, despite the 10-year Treasury yield moving back near 3 percent, as investors worried that nearly half of the investment grade universe is rated just one notch above high-yield (up from 20 percent in 1990), and if rates rise and/or the economy materially weakens, these are at risk of downgrade. The key investment grade credit to watch for downgrade is General Electric.

Within equity markets, investors bid up defensive sectors such as consumer staples, healthcare, and utilities. Many defensive names are trading at a significant premium to the market. For instance, Proctor & Gamble, Coca-Cola, Clorox, Colgate, and McDonald's trade at forward multiples of 19.8x, 22.1x, 24.7x, 20.7x, and 22.8x, respectively. This is relative to the Nasdaq 100 trading at 19.2x forward earnings, and names such as Microsoft, Google, and Intel trading at 21.9x, 23.1x, and 10.6x, respectively. Given such valuation discrepancies, and some positive fundamental data points that came out towards the end of the month, technology might be in position to stabilize and rally. Part of why technology and the broader market sold-off so viciously is poor technicals, as many indices and stocks breached support levels and feature death crosses on their charts. This caused many quant funds and hedge funds (some of the biggest owners of tech shares), who are also facing redemption pressure, to further liquidate equities. As the month progressed we started to get some positive data points out of technology, including, Cisco, Workday, Splunk, and Salesforce reporting very strong earnings and guidance, indicating corporate technology spend remains strong.

We even got some positive data points from semiconductors, late in the month reports came out that graphics processing unit (GPU) pricing is starting to turn up 10 percent to 15 percent from the September lows. Further, Micron's CEO spoke at a conference and said that its earnings are tracking toward the higher end of their guidance, and supply issues are improving. Technology is the largest sector in the market, and for a sustained and meaningful move up in markets, tech needs to participate.

With the speech from Chairman Powell late in the month, and some of these data points from tech companies, the markets were able to stabilize. Looking forward, the market will follow trade discussions with China, and refocus on earnings and the economy.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com