Fourth Quarter Review
The stock market closed the year with a dramatic selloff due to the dual threats of higher interest rates and trade tensions. Most major stock market indices entered bear market territory having fallen more than 20% from the highest point. During the late stages of the economic expansion, heightened volatility is common and is likely to continue until the end of the next recession. Higher quality investments such as large capitalization U.S. stocks significantly outperform lower quality assets such as small capitalization and emerging market stocks as illustrated in 2018. Investors hope for easing of trade tensions and softening of Federal Reserve tone on rate hikes in 2019.
Despite the stock market weakness, economic fundamentals continue to support reasonable growth. Job creation remains strong and wage growth is healthy. Retrenchment in interest rates over the last three months may spur the weak housing market. Recent passed tax cut and government spending bills would continue to stimulate the economy in the first half of 2019. Avoidance of a recession should support a rebound in the stock market.
One of the brightest spots in the economy is hiring which has not shown any sign of weakness. Employers are having difficulty finding qualified applicants and wage growth remains strong. This should continue to boost consumer spending which accounts for more than 70% of the U.S. economy.1 However, a sustained monthly job growth less than 100,000 would be a important warning signal of impending economic weakness.
Another point that we are monitoring closely is the potential for a yield curve inversion as defined by the 2 year Treasury yield rising above the 10 year yield. An inversion would raise alarm bells because it has preceded every recession since 1955.2 As interest rates rise and yield spreads compresses, economic growth tends to slow significantly and often leads to recessions. However, the current spread remains positive.
Happy New Year and a prosperous 2019!
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