Market Data for the quarter ending March 29, 2018:
• S&P 500 Stock Index: 2641, down 1.2%
• Ten-year Treasury Note Yield: 2.74%, up .33%
• Gold: $1,327 per ounce, up 1.4%
• Oil: $65 per barrel, up 8.2%
After advancing strongly in January on the excitement of the corporate tax cut signed into law the previous month, stocks ran into turbulence for the remainder of the first quarter. The first spasm was triggered by fears of higher inflation driven by stronger than expected January wage growth, the second was due to rumblings of trade war emanating from the White House, and the third was driven by the data scandal at Facebook, which led to heavy selling in high flying technology shares that have dominated the market. Overall, in spite of the late wave of selling, technology was the only sector to advance in the first quarter. Other sectors suffered at the hands of higher interest rates, fears of trade disruptions, and the emerging possibility that growth will not be as strong as was anticipated earlier in the quarter.
Our view is that growth will disappoint current expectations, interest rates will remain at historically low levels, and shares of income oriented sectors will outperform, with technology and growth oriented shares lagging. On economic growth, we do not see the basis of a sustained acceleration as the tax cuts will primarily benefit wealthy shareholders, who are more likely to pocket than spend their windfall. We are skeptical that the tax cuts will lead to a pickup in investment as claimed by the tax cut’s advocates. Furthermore, the Federal Reserve is raising overnight interest rates, while the Treasury is flooding the market with short-term bills, further increasing short-term interest rates. This is not a recipe for stronger growth. Tellingly, the gap between short-term and long-term interest rates, known as the yield curve, has narrowed to its lowest level since before the financial crisis. This indicates that growth will likely decelerate over the medium term.
The greatest risk to the market is that the Federal Reserve will be too aggressive in raising overnight interest rates, throwing the economy into recession. To wit, eight of the eleven postwar tightening cycles resulted in a recession. Assaults on international trade will only serve to weaken growth and dampen business sentiment, so present a further risk to the market. As we have discussed previously, the Chinese economy is heavily indebted and thus fragile. A credit crisis in China would be highly disruptive to the world economy and financial markets. Finally a war on the Korean peninsula or in the Persian Gulf would likely tip the economy into recession and lead to heavy losses in stocks. The recent appointment of John Bolton as national security advisor particularly increases the possibility of conflict with Iran given his historic extreme hostility toward the Islamic Republic.
Going forward, we expect continued volatility as the markets grapple with the issues discussed above. As of now, we are not predicting a recession or bear market, but are paying close attention to the yield curve and the actions of the Federal Reserve. If the yield curve were to “invert”, i.e. short-term interest rates trade higher than long-term interest rates, the likelihood of a recession and bear market would increase significantly. For the remainder of the year, we project the US stock market, as represented by the S&P 500 stock index to trade in a range of 2500 to 2900. It currently stands at 2641.