A Crisis of Confidence

As the year winds down, investors are suffering a crisis of confidence brought about by a confluence of factors that is seemingly causing a buyer’s strike in the markets.  For the first time since 2008, all three major U.S. market indexes (Dow, S&P 500, NASDAQ) will end the year in the red. The declines for the year are mostly greater in international equity markets. Europe is down 13% and China (Shanghai Composite) is down 24%.

US economy, risks ahead

The recent market decline seems somewhat incongruous with the state of the real economy right now. While most economists are forecasting slowing growth for the U.S. economy in 2019, this notion is widely shared and hardly a surprise.  After a transitory sugar high from this year’s corporate tax cuts and ramped up fiscal spending, it is quite reasonable to expect a moderate deceleration of U.S. GDP growth from 3.5% now to 2.0%-2.5% next year.

Sour News Cycle

Contributing to investor hand-wringing is the news cycle we are in.  After reporting record profits for the third quarter during the months of October and November, companies have not been saying much.  With the exception of a very strong earnings report from Nike and robust nationwide holiday sales (up 5% year-over-year, the fastest growth in six years, according to Mastercard), there has not been much in the way of corporate news.  Instead, the news cycle has been dominated by the Fed, White House and Congress, and it has dented investor confidence about 2019.

Fed Out of Sync?

The current decline in stocks began in earnest after the Federal Reserve meeting on December 19th.  As expected, the Fed, citing a strong economy, raised the Fed Funds Rate by 0.25%. However, investors apparently felt that the Fed was not giving sufficient credence to the recent market signals of a more pronounced slowdown to come.  Higher interest rates have already caused a weakening in cyclical sectors such as housing and autos while inflation remains quiescent.  The market seems to be viewing the Fed’s current rate hike forecast of one or two hikes next year as too aggressive for the economy to handle. Plainly, investors want to hear Fed Chairman Powell speak more directly to their concerns.

Consumers Uncertain

While the economy remains in good shape today, there is certainly a risk that stock market turmoil will spill over into the real economy and hurt consumer confidence, making the fear of a sudden economic slowdown a self-fulfilling prophecy.  This week the Conference Board reported that its consumer confidence index had dropped this month by 8.3 points, pointing to a weakening in consumer sentiment most likely driven by stock market volatility, a sour tone in Washington DC over the Federal government shutdown, President Trump’s criticism of the Fed and uncertainty about the course of trade talks with China.

Pessimism Pressures Valuations

U.S. equities are trading at their most undemanding valuations in years.  With indexes down for the year and corporate earnings up a very robust 20%, stocks are essentially 25% cheaper than they were a year ago relative to their earnings. For markets to get back on track in 2019, in my view, investors will need to see a continuation of strong corporate results, perceive some progress on trade and hear a more dovish tone from the Fed.  Headway on any of these issues would likely give investor sentiment a nice boost.

Please don’t hesitate to get in touch with me if you would like to discuss your portfolio or the markets.

 

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Peter Thoms

About the author

Peter Thoms, CFA, founded Orion Capital Management LLC in April 2002. Peter has an extensive background in crafting investment solutions for high-income clients in a wide variety of circumstances.