The markets took a wild ride in 2018 and uncertainty is one of the biggest drivers for volatility. We have another unpredictable year ahead with economic, national and geopolitical uncertainty.
1. U.S. Political Uncertainty
There are two major U.S. current events you’ll want to keep an eye on: if the Fed continues to raise rates and the ongoing government shutdown.
The Fed raised rates on Dec. 19 which was expected, but uncertainty over whether the Fed would pull back from a tighter policy path, whether they would continue with rate hikes and Jerome Powell’s comment on the Fed not changing its strategy for shrinking the balance sheet all caused the markets to drop to the year’s lows.
Fast forward to Jan. 4 when stocks soared after Powell made an appearance at the American Economic Association conference where he said the Fed can adjust policy quickly and flexibly if the they see problems and would not hesitate to change their course including the balance sheet. Powell stated, “We’re listening carefully with sensitivity to the message that the markets are sending and we’ll be taking those downside risks into account as we make policy going forward.” According to Bloomberg, there is a higher probability of a rate cut than a hike for the U.S. toward the end of 2019 (see below).
In addition to doubt surrounding the Fed, the now weeks-long government shutdown is adding additional uncertainty into the markets. Parts of the U.S. government have been shut down for over two weeks after Trump refused to sign a bill that excluded substantial spending to continue construction of a border wall.
The government shutdown has left hundreds of thousands of government workers without pay. The operations of nine departments have been affected by this shutdown, one being the Internal Revenue Service (IRS) with only 12 percent of the agency’s employees working right now.
During a shutdown—and please sit down for this if you are not already—the IRS generally does not pay tax refunds which could delay billions of dollars to those expecting one this year. According to The Wall Street Journal, the IRS paid $12.6 billion in refunds by Feb. 2, 2018, and by Feb. 16 they paid $101.2 billion in refunds. But have no fear, if you owe money you are still expected to pay up!
Trump is intent on keeping the government shut down for as long as he has to and has even said he would resort to declaring a national state of emergency to build a wall along the border of U.S. and Mexico. House Democrats have threatened to sue Trump should he declare a national emergency to build it. Serious uproar will ensue if this shutdown continues.
2. Geopolitical Uncertainty
Geopolitical uncertainty is also affecting the markets. One of the biggest events currently transpiring is the U.S.-China trade war.
The U.S.-China trade war posed a constant disruption to markets for nearly all of 2018. President Trump has demanded that Beijing stop requiring U.S. firms to partner with Chinese firms when they want to do business in China, and Trump believes China has stolen intellectual property of U.S. firms and Trump wants an end to it.
When Trump and Chinese President Xi met for talks in Buenos Aires in December they agreed to a cease-fire of tariffs on billions of goods which go into effect on Jan. 1. They also agreed to a 90 day cease-fire to ease trade tensions until March 1. However, even with the cease-fire, ongoing tensions already damaged the profits of many companies. Apple recently reported the sales of iPhones in China were dropping, bringing down the company’s profits substantially. Apple is now down 30 percent from its highs this year.
It is clear that there is a growth slowdown across the global economy. China’s economy is growing at its slowest pace in a decade. Both the U.S. and China are hurting from this trade war so it is in the best interest of both countries to come to an agreement. On Dec. 29 Trump and Xi spoke on the phone and Trump reported that “big progress was being made”.
On Jan. 4 it was announced the Trump Administration and China will continue their talks in Beijing today to end punishing tariffs and strike a trade deal. If trade negotiations go well companies who are intertwined with China would benefit.
3. Economic Uncertainty
A very healthy December jobs report was released on Friday. It was expected that December would add 177,000 jobs, but the report showed that 312,000 jobs were added and that there was the largest increase in payrolls since February. These results blew expectations out of the water.
One of the biggest concerns for investors is the growth slowdown, and with the ISM reporting last Thursday that the manufacturing activity slid to 54.1 (a reading of above 50 means the economy is expanding), it signaled our economy is still expanding but is in a growth slowdown. When the jobs report came out on Friday it signaled hope for the economy giving a boost to the markets. This provides hope for investors—if the economy is still expanding and there is a strong labor market, how can we be in the midst of a recession?
The last event to really keep an eye on is fourth quarter earnings season. The majority of companies within the S&P 500 will report their earnings starting in late January through February.
Last season, companies who reported negative results were severely punished while companies who reported positive results saw flat to little price appreciation. Last earnings period, price reactions for stocks were based on the revenue stories. The fourth quarter expectation bar was lowered after last season.
This season will focus again on the margin outlook of companies. The beacon of hope for companies reporting will be that profit expectations are lower which will make it “easier” to beat estimates. This could cause near term relief for equities.
Last quarter EPS growth came in around 26 percent, and this quarter the projections suggest for earnings to moderate to 16 percent year-over-year.
Bottom line: There are a lot of events to keep an eye on. As far as U.S. political uncertainties are concerned, keep a watchful eye on what happens with the government shutdown and how the Fed reacts to the economy. The main geopolitical uncertainty to keep on your radar is the U.S.-China trade war as the outcome will affect the global economy including the U.S. markets. The tariffs could substantially change companies' profit margins within the U.S. which in turn could significantly hurt our economy.
The U.S. remains the best house in a bad neighborhood. The job report data and ISM report coming in at 54.1 leads us to believe the economy is still doing well, but we are showing signs of a growth slowdown. National, geopolitical and economic uncertainty create a mix for great volatility in the markets. I’d advise you to keep an eye on these major events as they’ll determine how 2019 will pan out.