Bob’s Journal (12/13/2018)
It is important for investors to ignore the whipsaw actions of the markets during the last few months, because they’ve been caused by short-term news and events.
Presidential tweets and rumors about policy changes cause most of the daily fluctuations in the markets. Most of the focus has been on trade conflicts with China, causing stocks to rise when the tensions seem to be receding and to fall when conflicts increase.
When investors don’t have trade news to react to, short-term Fed-watching moves markets. Investors guess whether rates will be raised at the Fed’s December meeting and how many times the Fed will hike rates in 2019.
The short-term focus takes investor attention away from the events that really matter.
The Fed has been tightening monetary policy since 2015 and increased the rate of tightening in 2017 and 2018. Monetary policy affects the economy with a substantial lag. Even if the Fed stopped raising rates this month (which it won’t), growth would continue to slow because of the policies it put in place over the last few years.
Interest rates aren’t the only tool the Fed is using. The Fed is shrinking its balance sheet by not replacing some bonds and mortgages as they mature. That’s another form of tightening and could be more powerful than raising short-term rates. The Fed will continue this slow, steady reduction of liquidity.
While the Fed is reducing its balance sheet, the federal government’s debt is increasing. The markets need to find buyers other than the Fed for those bonds, and that’s going to require higher interest rates.
At the same time, the fiscal stimulus that boosted growth and offset a lot of the Fed tightening in 2018 is losing its effect.
The European Central Bank (ECB) is joining the Fed. The ECB engaged in its own form of quantitative easing for several years. But it plans to stop buying bonds and shrink its balance sheet in 2019. This will cause Europe’s already shaky growth to decline and perhaps risk a recession.
Since the end of the financial crisis, investors have been used to central banks supporting investment markets. But, for now at least, central banks are ending that role.
Trade conflicts and other news have effects, but monetary policy is the main driver of the economy and asset prices.
Almost all investment assets have declined in 2018. Tighter monetary policy that began a few years ago is the major cause.
Whatever happens with the trade conflicts and various political issues, lower growth is likely because of recent central bank policies. It probably will be accompanied by lower-than-expected earnings growth and declining prices of most investments.
The Data
The services sector of the economy continues to do well, according to two surveys.
The PMI Services Index declined slightly to 54.7 from 54.8. Domestic orders declined while export orders increased.
The ISM Non-Manufacturing Index increased to 60.7 from 60.3. This is the third consecutive month above 60 and the fourth month of beating expectations. Most components of the report were strong.
Small business owners are less optimistic, according to the NFIB Small Business Optimism Index. The index declined to 104.8 from 107.5 and now is at the lowest level in seven months. The biggest declines in components of the index were in expectations that the economy will improve and that real sales will increase.
The manufacturing sector is losing some strength. Factory Orders were down 2.1%, and last month’s growth was revised down to 0.2% from 0.7%. The volatile defense and aircraft orders accounted for much of the decline. But core capital goods also stayed weak. They were unchanged, and that follows declines of 0.6% and 0.2% the previous two months.
Consumer Sentiment, as measured by the University of Michigan, held steady at 97.5. That hovers well above the historic average but below the highs achieved in early 2018. There remains a substantial gap between current conditions (very high) and expectations (average and falling).
Declining energy prices are keeping inflation in check.
The Producer Price Index rose 0.1% for the month (compared to 0.6% last month) and 2.5% over 12 months (2.9% last month). Excluding food and energy, producer prices increased 0.3% for the month and 2.7% for 12 months.
The Consumer Price Index (CPI) was unchanged for the month (compared to a 0.3% increase last month) and rose 2.2% over 12 months (compared to 2.5% last month). Excluding food and energy, the CPI increased 0.2% for the month and 2.2% over the past 12 months.
The labor market remains strong, according to last week’s Employment Situation reports. The number of new jobs created was a bit below expectations, but the unemployment rate was unchanged.
The big news was wage growth. In the past 12 months, wages have increased 3.1%. That’s low by historic standards for this stage of the economic cycle, but it’s the best 12-month increase since 2009. High wage growth is what the Fed fears, so it could be enough for the Fed to keep its current tightening policy.
The JOLTS (Job Openings and Labor Turnover Survey) also indicated the labor market is strong. Job openings increased again by 1.7%, so they are just below the record set in August and are about 1 million higher than the number of unemployed. But the number of people quitting jobs declined 1.4%, though that rate has increased 5.7% over 12 months.
New unemployment claims plummeted by 27,000 to 206,000 for the week. That is near the historic low of mid-September.
The Markets
The S&P 500 tumbled another 1.77% for the week ended with Wednesday’s close. The Dow Jones Industrial Average fell 1.93%. The Russell 2000 declined 1.83%. The All-Country World Index lost 1.47%. Emerging market equities gave up 1.49%.
Long-term treasuries returned 0.45% for the week. Investment-grade bonds rose 0.91%. Treasury Inflation-Protected Securities (TIPS) declined 0.64%, while high-yield bonds gained 0.04%.
On the currency front, the dollar rose 0.23%.
Energy-based commodities lost 2.07% for the week. Broader-based commodities fell 1.55%. However, gold rose 0.59%.
Bob’s News & Updates
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