This certainly has been a volatile year for stocks, and it isn’t over yet.
The volatility has mostly been attributable to the tug of war between President Trump’s bullish and bearish policies. On the bullish side are deregulation and tax cuts. On the bearish side are widening federal deficits and an escalating trade war with China.
On balance, Trump’s policies have boosted economic growth and further tightened the labor market. As a result, Fed officials—who did a good job of prepping the financial markets for a gradual course of hikes in the federal funds rate, aiming for a “neutral” 3.00% level by the end of next year—have recently been chattering about even higher rates, i.e., turning restrictive. Consequently, the trade-weighted dollar has soared. The combination of higher US interest rates and a stronger dollar is suppressing US inflation while depressing commodity prices as well as the global economy, particularly emerging market economies. The situation is akin to driving a car with the left foot bearing down on the accelerator while the right foot taps the brakes, as we’ve noted frequently this year.
The outlook for 2019 is most likely for more volatility. That’s assuming that tensions between the US and China continue to mount, as discussed below. On the bullish side, the latest FOMC statement did hint faintly that a pause in the Fed’s quarterly rate hiking might be possible next year. Meanwhile, the global economy continues to weaken. In any event, the growth rates of both S&P 500 revenues and earnings will certainly be slower in 2019 than this year.
It’s widely believed that the stock market likes gridlock, which now is assured for the next two years given the mid-term election results. However, the country has been experiencing an escalating uncivil war between the Left and the Right. It will only get worse, as explained in the cover story of the latest Bloomberg BusinessWeek titled “Republicans Weaponized the House. Now, Democrats Will Use It Against Trump.” That may contribute to more stock market volatility next year.
Joe and I curbed our enthusiasm for the stock market’s upside in the 10/30 Morning Briefing. We lowered our outlook for earnings growth over the next two years, as we reviewed yesterday. At the end of last month, we also reduced our target for the S&P 500 from 3100 to 2900 for the end of this year and from 3500 to 3100 by year-end next year. We aren’t bearish because we expect that the US economy will continue to grow over the next two years. Furthermore, we remain open to the possibility that productivity will make a long-awaited comeback.
In my meetings with our accounts in Toronto last Thursday, one seasoned equity investment strategist suggested that, given the slowdown in global growth, perhaps it’s time to overweight value and underweight growth (Fig. 1 and Fig. 2). That was a good call based on nature of Monday’s stock market rout.
What about the “Panic-Attack-Relief-Rally” model that has worked so well for us, reassuring us that downdrafts in this bull market are typically short-lived? It worked because in all of the first 60 episodes, there tended to be just one major frightful concern that turned out to be a false alarm. This year’s panic attacks #61 and #62 share common concerns about several issues that might linger into next year (Fig. 3). (See our S&P 500 Panic Attacks Since 2009.) The alarm has yet to be proven false.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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