Key Market/Economic Observations
U.S. Markets Grapple with Tightening Financial Conditions; Risk-Off Sentiment and Heightened Volatility Persists
The S&P 500® moved into bear market territory as investors reacted to a confluence of tighter monetary policy, the fading tailwinds of U.S. fiscal stimulus, deficit pressures, trade tensions, and broader geopolitical uncertainty. As risk-off sentiment spread, the technical backdrop continued to deteriorate: less than one-fifth of S&P 500 constituents are trading above their respective 200-day moving average, considerably worse than during the sell-off earlier this year. Furthermore, the 10-day advancing volume ratio (the volume of advancing stocks over that of declining stocks) is stretched to its lowest level since early 2016. Ultimately, we believe the difficult month across U.S. stocks is more of a reflection of the uncertain backdrop over the short term rather than a harbinger or longer-term forecast.
International Developed Markets
Italian Budget Progress Overshadowed by Market Volatility
International developed markets were not immune to volatile U.S. equity markets in December. While Japanese equities have been among the best performers (by country) for the year on a relative basis, the recent downturn pushed the Nikkei 225 into a bear market (down over 20%) for the second time in two years. U.K. Prime Minister Theresa May survived a no-confidence vote from within her own party; however, a Brexit deal continues to face significant challenges within parliament, causing ongoing uncertainty for U.K. investors. The months- long Italian budget dispute saw some progress in December as a compromise bill was passed by the Senate. The legislation still requires approval from the lower house by year end. Italian equities have been among the worst performers for 2018.
Emerging Markets (EMs) Stocks Outperform Developed Counterparts; United States and China Continue Incremental Progress on Trade Front
Amid a growing list of concerns across developed markets, EM equities avoided much of the market sell-off. On a relative basis, EMs outperformed developed market stocks over the month and were down approximately 4% (as of December 24). We view the resiliency across EM stocks as a positive, possibly indicating a shift in investor sentiment within the asset class. As we’ve discussed, our near-term bear versus bull case for EMs rests primarily on investor expectations of Chinese economic growth. Over the month, developments on China growth were mixed, but there is reason for a constructive outlook. Specifically, we point to incremental yet positive progress on the U.S. trade front, continued support by the Chinese government to prop up growth through supportive fiscal and monetary policy, and a stabilizing dollar.
Weak Finish to 2018 for Commodities as Crude Outlook Dims for 2019
Commodities continued their recent decline, with the Bloomberg Commodity Index now down 15% from its late-May high, finishing 2018 more than 10% lower. Energy prices similarly languished as crude oil reached year-to-date lows, trading below $50 per barrel. A combination of diminished demand forecasts for EMs and an improved supply outlook are expected to lead to building crude oil inventories throughout 2019. Agricultural commodities received a boost in sentiment following a Chinese agreement with the United States to resume the purchase of U.S. soybeans and other agricultural products, while inventories continued to weigh on prices. Overall, the decline in commodities has led to lowered inflation expectations and less input cost pressure for companies. This will likely prove conducive to company margins and consumer health alike as we move into 2019.
An Inverted Curve Is No Reason for Investors to Swerve
Market headlines stoking fears of a yield curve inversion have become increasingly prevalent after the 2-year Treasury yield briefly rose above the 5-year Treasury yield (this is known as a 2- to 5-year inversion) in early December. While an inverted curve serves as a signal the current expansion is in the later stages, the portion and percentage of the yield curve inverted is not necessarily indicative of an imminent economic slowdown. Since 1977, yield curve inversions (for example, a 2- to 10-year inversion) have preceded U.S. recessions by an average of 21 months. However, a historically low term premium today may actually lead to more frequent yield curve inversions over the near term, but not necessarily a greater frequency in economic contractions. This development potentially makes curve inversions a less reliable indicator of economic slowdowns than its historical relationship would imply. Ultimately, we believe investors should remain invested and maintain their strategic allocations given the historical propensity for strong returns post-yield curve inversions.