Monthly Insights - January 2019

2018 is now in the books. It was a less-than-stellar year for most investment classes. In many respects it was a tale of two markets. The first three quarters of the year were very good. Markets gained, confidence grew, and risk-on was the name of the game. In contrast, the fourth quarter marked a nearly 20% decline in the S&P 500 from peak to trough, confidence waned, and protecting capital became more important. Since bottoming on December 24th, equity markets have staged a nice recovery, regaining nearly half of the decline. However, increased volatility (both to the upside and downside) may not be over, at least not until some of the big issues are resolved. 

AllegiantPA Economic Dashboard Portrait January 2019Today our Economic Dashboard has one yellow indicator and one red indicator while the other four indicators remain green. Thelone yellow from last month, the S&P 500 versus its 20-month moving average, has turned red. As I mentioned last month, this is the one market-based indicator on Allegiant’s Economic Dashboard. While worth noting, without signs of economic distress, it may not have much significance as a standalone warning signal. 

Additionally, the interest rate yield curve is now flashing yellow. The spread between the ten-year treasury rate and the three-month treasury rate recently moved below 0.25%. Barring any changes in the long-term rate, this equates to one Federal Reserve rate hike away from an inverted yield curve. This is the point to start paying close attention. However, being on watch does not mean immediate problems will materialize. The yield curve can remain flat for years before it inverts. Even more, once the yield curve inverts it can take a year for a recession to begin. 

The flatness of the yield curve has cornered the Fed in a very difficult place. After systematically raising rates over the pasttwo years, the Fed is losing the ability to continue pushing short-term rates higher. This is important because without higher rates, the Fed lacks some ability to stimulate the economy during the next recession. The market, which controls long-term rates, is telling the Fed to stop raising short-term rates. The message: the economy is notstrong enough to handle tighter monetary policy.

The most obvious interest rate sensitivity has occurred in the housing market. As mortgage rates moved higher, housing activity slumped, and the monthly supply of new homes has ballooned. It may take a while for the increased inventory to work through the system. However, longer-term interest rates receding over the last month may help spur a revival. 

Elsewhere, increased trade tariffs are beginning to impact economic activity. Business confidence is declining as many businesses are unsure what the future will look like. How can they invest capital if they lack certainty in the trade environment? The government shutdown has also had a meaningful impact on economic activity. The three-week reopening helps, but politicians still need to agree on a long-term solution. Estimates abound, but suffice it to sayevery week of the government shutdown equates to approximately 0.1% subtraction from GDP. This means first quarter GDP growth may register weak. 

Here’s the good news, these are relatively self-inflicted wounds. A new trade deal with China, accompanied with a longer-term agreement to reopen the government, could quickly revive growth. However, the longer these issues remain unresolved, the larger the negative impact. Next on our radar is the U.S. government reaching the currently approved statutory debt ceiling. Let’s hope politicians find common ground and approve legislation for the good of the Country. 

If you would like to see more data and charts about the economy and various financial markets, please download our Monthly Insights book.

Benjamin W. Jones, CFP®, AIF®
President, Chief Investment Officer, Principal