In the past, the Fed announced their clear intention to use quantitative easing to stimulate the economy. They even named QE2, operation twist. This time, it has been much more stealth in nature. While the Fed has signaled its intention to pause on interest rate cuts, they have reversed course in shrinking their balance sheet and may instead drive it to new highs in 2020. This is clearly a short-term positive for risk assets and has sent the stock market to record highs.
"If we’re both going crazy, then we’ll go crazy together, right?" — Mike, Stranger Things
In today's world, it feels like we are all going crazy when you deal with the upside down world of negative interest rates. While negative rates haven't landed in the US yet, the 30-year Treasury rate fell below 2% for the first time ever. It is likely inevitable that we will have to deal with the situation in the not too distant future. So what is life like in the upside down?
Back in 2016, we wrote "Watch out! Negative interest rate policy is coming to the US sooner than later." To us, the future feels inevitable with virtually all the other developed nations in negative territory again in 2019. PIMCO's Joachim Fels echoed this thought saying that it's "no longer absurd to think that the nominal yield on U.S. Treasury securities could go negative."
The trade dispute between the two largest economies continues to deteriorate and this is not a surprise to us. It has been very clear that the current US administration is unlikely to make a deal with the China. The gap is too wide between the two countries so it is hard to envision a deal coming together. It seems to be getting worse and we don't expect a deal anytime soon. Back in our January conference call for clients, we pointed to VP Pence's speech from October 2018 at the Hudson Institute. If you want to understand the big issues, this is a must watch.
This morning, the much watched yield curve has inverted for the 2nd time with 10-year Treasury yields (2.27%) dropping below 3 month T-bill rates (2.36%). Many view the yield curve inverting as an early signal of recession. For those that view the glass as being half full, most people look for the 10 year vs the 2 year inversion and that hasn't occurred yet. Secondly, once the inversion takes place, the market often doesn't peak until months later. For those that view the glass as half empty, the inversion is a sign that the bull market is nearing an end.
European growth peaked at the end of 2017 and has been slowing ever since. Despite the ECB saying there is no recession in Europe, there is mounting evidence that Europe is entering a recession. Germany, which is often seen as the engine of the Eurozone, saw its GDP contract in the 3rd quarter and its manufacturing PMI fell below 50 in January. Italy has waived the white flag and is already in recession with the European Commission forecasting just 0.2 percent growth for 2019. The ECB just stopped its asset purchase program in December and now may have to try to stimulate again.
We are currently in the thick of earnings season as companies are reporting their quarter ending December 31st. Expectations are for S&P 500 earnings growth of over 20% which is an extremely strong number especially considering that the previous year grew a healthy 12%. However, lapping that type of growth is going to be a challenge, and forecasts are being revised down quickly for the first half of 2019. That is why we believe there is a growing likelihood of a slight earnings recession occurring in 2019.
The stock market has rallied nicely to start 2019 but we think there is a big problem. The major central banks, the Fed, ECB and BoJ, have pumped up asset prices since 2008 with a massive liquidity injection of $11 trillion. They kept interest rates at ridiculously low levels on the short and long end of the curve and investors were forced into risk assets. This grand experiment is known as quantitative easing. Now is the more difficult part called quantitative tightening, the central bankers are trying to normalize policy.
This is one of my favorite posts to write every year as we get to look back on Wall Street predictions and see how they panned out. We have done this in 2014, 2015, 2016, 2017 and 2018 so it is a tradition to see which strategists did well and which missed the mark.
Last year, the strategists predicted a bull market for 2018 with an average target of +6%, 2850, for the S&P 500. Those predictions looked pretty good heading into the fourth quarter, but after a sharp decline, all of them badly missed the mark as the S&P 500 suffered through a terrible stretch and hit a year to date low of 2346 on Christmas Eve. The best of the best was Citibank's Tobias Levkovich and UBS's Ben Laidler who both predicted a slightly down year. Now let's take a look at their thoughts on 2019...
Since the end of September, the market has been shaken by the China trade dispute, Fed rate hikes and a government shutdown. On October 31st, I wrote "Is the Fed triggering the next bear market?" and Runnymede began taking some risk off the table for client accounts. We believe this is prudent given that we are in the 2nd longest economic expansion in history. While economic data hasn't shown signs of a recession as of yet, growth has certainly slowed and the government has less ammunition with its ballooning budget deficit. With stock market risks rising, the current administration is looking for answers and trying to instill calm, but it has had the opposite effect.
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Runnymede Capital Management, Inc.-"Runnymede"), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Runnymede. Please remember that if you are a Runnymede client, it remains your responsibility to advise Runnymede, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Runnymede is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Runnymede's current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: Runnymede does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Runnymede's web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.