November Review and Outlook - December 4, 2018
- Corrective price action continued throughout much of November.
- Dovish comments by Fed Chairman helped fuel a historic relief rally late in the month.
- Treasury Yields reversed lower despite late month risk-on sentiment.
- S. and China agree to 90-day extension before any additional increases in tariffs.
- Oil has worst decline in ten years; 2 nd worst decline in 25 years.
The Fed Taketh and Giveth
November was a roller coaster ride for equities which spent the better part of the month continuing the corrective price action that started back in early October back when rates spiked sharply higher and Fed Chairman Powell proclaimed we are a long way from neutral. Heading into the final week of November the Nasdaq 100 (NDX) was down 6.3% MTD, the Dow Jones Industrials -3.3%, and S&P 500 (SPX) -2.9%. Then last Wednesday Chairman Powell reappeared before The Economic Club of New York to give a much anticipated speech on financial stability. The interest of course was not with the topic of speech but whether or not Powell would provide clarity on the committee's projected three rate hikes for 2019; and the chairman did not disappointment. In an about face Powell's prepared statement acknowledged rates are "just below" neutral. His shift to flexibility was not unwarranted given the slowing global growth, declining breakevens, declines in housing and auto prices, widening credits, and strengthening dollar. From there it was off to the races as the major indices rebounded sharply to close out the month with their best weekly performance since 2011. It was also a reflection of the deep, bearish sentiment prevalent throughout the U.S. markets. In the final week alone the NDX gained 6.5%, the Nasdaq Composite +5.5%, Dow Jones Industrials +5.2%, SPX +4.8%, and Russell 2000 +3%.
Despite the end of month euphoria, a dark cloud of uncertainty remained with the unresolved trade war between the U.S. and China. However at the G20 summit in Argentina right after the month ended, leaders Trump and Xi deescalated fears by temporarily agreeing to not raise rates further as both sides continue negotiating a range of complex trade-related topics with a three month deadline. With the stakes high and the bar set low, at least in the near term, markets are responding favorably to this temporary ceasefire. The agreement is viewed as a short term win for both sides, yet it remains to be seen if this will translate into longer term gains. Leaders kicked the can, but concrete follow-through is necessary in order to avoid a repeat of escalating trade fears and uncertainty throughout Q1.
At the end of the day we have a Federal Reserve that remains data dependent but seemingly less hawkish than just one month ago, and an unresolved trade war with China that was given a 90-day extension. A trade resolution with China will likely be one of the primary considerations towards the number of rate hikes in 2019, and yet the strength of the U.S. and Chinese economies could impact how much leverage each side has in negotiations. And what impact will this all have on long term rates which interestingly enough are now making lower lows, or the stalling housing market? And is trade uncertainty and a supply glut the driver behind oil's worst performing month in ten years or is the global economy slowing faster than we appreciate?
Midcaps were the top performing group with the S&P Midcap 400 Index gaining 3%, followed then by the SPX +1.8%, DJIA +1.6%, Russell 2000 +1.5%, and Nasdaq Composite +0.3%. The NDX was the only major index in the red with a modest 0.3% decline, however it did mark the third consecutive monthly decline which may not be a bad thing if recent history is a guide. The last time the NDX was down three straight months was February 2016 which then marked the end of a longer seven month correction, followed by a 2 year rally. The current three month decline gave up 16.2% which is in line with the 17.9% decline over three months' time ending in Q1'16.
Nearly all of the major equity indices (INDU, SPX, NDX, CCMP, Russell 2000) retested their October lows or made lower lows in November. The November pullbacks were deeper than what we expected but we were optimistic for a rebound based on the breadth of the market which had noticeably improved. For the SPX more than 18% of its index made fresh 52-week lows in October. However when price was making slightly lower lows in November, just 8% of the index was making new 52-week lows (chart below). The same bullish divergence was evident in all of the above aforementioned indices, including the Russell 3000 which is captures 98% of all publically listed U.S. companies.
Healthcare was the top performing sector in November with a gain of 6.8%. The S&P 500 Healthcare index has returned + 14.7% YTD making it the best performing sub-index in the S&P 500. The sector got a bump early in the month following the mid-term election results, but gave back those gains as market volatility took hold of the broader market. The final week of November saw the index return +5.9% for its best weekly performance in four years. Fed Speak was a clear catalyst for the broader market rally, but also the closure of CVS's acquisition of Aetna.
The Consumer Discretionary sector benefitted in late November as more than 165 million Americans shopped between Black Friday and Cyber Monday. The National Retail Federation (NRF) said that average shopper spend over the 5 day period was $313.29, down from last year's average of $335.47. However the early Thanksgiving this year extends the shopping season. Older millennials and Gen Xers were the biggest spenders averaging $413.05 each. Christmas holiday retail sales in the U.S. are expected to climb above the $1 trillion mark for the first time this year, on the back of low unemployment, solid income growth and higher consumer confidence. The S&P 500 Consumer Discretionary (S5COND) index finished middle of the pack for a monthly gain of 2.6%, however it was the top performer in the final week with a 6.4% gain. The S&P 500 Retail sub-index (S5RETL) was up only 1.9% in November but returned nearly 8% since Thanksgiving. This comps nicely to the 1.8% gain in the broader based S&P 500 index for November and 4.2% return since Thanksgiving.
Energy and technology were the worst performing sectors with declines of 2.2% and 2.1%. Energy was weighed down by the underlying commodity crude oil which saw its worst performance in more than ten years. WTI crude declined 22% in November to close at $50.93 after losing more than 10% in the prior month. November tied for the 2 nd worst decline in more than 25 years, outdone only by the 33% crash in October 2008. The 2.2% decline in the S&P 500 Energy Index was relatively modest vs. crude's historic decline, however the energy index declined 11.3% in October. Oil started December on a strong note following reports that Saudi Arabia and Russia, the world's largest exporters, were in talks to "better manage" the oil market.
Within Technology, Semis/Semi equipment was up slightly despite the relative choppy performances from some bellwethers. The biggest winner was Software and Software Services. The sub sector remained strong throughput the month (+3.42%) largely immune to the broader trade issues that was weighing on the rest of tech. The largest decliner was Hardware and Equipment, -11.98%.
Rates and the Dollar:
The U.S. dollar remains strong with the DXY making new 52-week highs in early November. Diverging central bank policy, rate differentials, and a strong economy continue to attract inflows which recently are making their way into treasuries. The 10-year yield peaked in early November at 3.25%, nearly identical to its October high, before pulling back to a current yield of 2.98%. The trough between the two tops is down at 3.05% which is the top of a key support zone, 3% - 3.05%, and represents the "trigger" of a "double top" technical pattern. The long yield dipped below this support in the final day of November despite the "risk-on" sentiment in equities. It could certainly recover from here, however if it fails to do so the breakdown carries a measured move to 2.75% which has not been seen since late May. The recent strength in treasuries is noteworthy and may suggest there is good reason(s) investors should remain cautious about the intermediate term outlook for riskier assets.
December is generally a strong month for equities, with eight positive return months for the S&P 500 out of the last ten. Investors are hoping that the Powell comments on rates and the "cease-fire" in the U.S./China trade war can allow for another Santa Clause rally. Heading into 2019 however, stock investors are taking signals from the bond market with falling yields and rate curve inversions (3yr / 5yr) signaling a possible slowdown. Concerns about "peak earnings", slowing global growth, "hard Brexit", Italian Debt and a return of trade frictions are among the factors that could make further gains challenging.
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