Why has the U.S. market had such a hard time while the U.S. economy and U.S. corporate profits are so strong? There are many ideas, but we believe the main causes of a weak U.S. market have been three:
- Trade fears;
- Fears that the U.S. economy and U.S. corporate profits would be hurt by a slowdown in Europe and Asia; and
- Higher interest rates on short-term U.S. Treasury bills, which compete with stocks for investment funds. Further, there has been an expectation that the Federal Reserve would continue raising rates, and thus holding short-term government paper would produce even higher returns over time.
The return on two-year U.S. T-bills moved up rapidly in September; shortly thereafter, in early October, the stock market began to sell off. By that time, yields on two-year T bills were about 2.8% — well above the dividend yield of the S&P 500. Obviously some investors thought, “Why fight the difficult trade environment? Just hold two-year T-bills and earn interest.”
The market subsequently fell, and since that time, the Federal Reserve has tempered their expectations for interest rate hikes in 2019. In spite of the lower outlook for interest rates by the end of 2019, market pessimism has since fed on itself. Fear of further declines has grown; many fear that a recession will pop up before 2019 has ended. We do not see a recession in 2019. However, we do see weakening economies abroad, which are a legitimate concern. In an interconnected global economy, this could slow U.S. economic growth.
As regular readers know, it is our strategy to reduce clients’ exposure to stocks under conditions like these, and for some time we have been holding a great majority of cash in all types of accounts — awaiting the beginning of a return of market optimism.
We believe that the U.S. will grow in 2018 at a slower rate than in 2018. How will stocks do?
In our view, there will be a difficult period for stocks in parts of 2019. In spite of that, we will not be surprised to see a positive return for U.S. stocks by the end of 2019, but it will begin from lower levels than where the market currently finds itself. We expect any market rally to be followed by market corrections in early or mid-2019.
We remain potentially interested in British stocks and the pound, but not until we know how Brexit negotiations turn out. If Brexit takes place, British stocks and currency could appreciate substantially. In general, we are not thrilled about the prospects for Europe, because the European Central Bank has announced that quantitative easing (QE) will be replaced by quantitative tightening (QT) in January of 2019. This is a negative, since QE is the reverse of QT. QE stimulated Europe and led to a rally in European stocks — QT could have precisely the opposite effect.
Emerging Market Stocks
Some observers are pointing out that emerging market stocks, especially in Latin America, have been outperforming the U.S. for the last few weeks. We believe that the only way that emerging market stocks can outperform the U.S. over the longer term will be if the U.S. dollar begins to fall in value versus other currencies. During 2018, the U.S. dollar has increased in value versus the Chinese yuan, Indian rupee, South African rand, Brazilian real and Russian ruble. If an emerging currency can rally against the U.S. dollar, there is a chance that their stock market can do better than the U.S. Our outlier pick for emerging markets remains the Indian market, although it will be very volatile; and the Brazilian bond market, if the new President, Jair Bolsonaro, can get Brazil’s economic house in order and cut corruption.
Gold will rally a lot if the U.S. dollar falls; if the dollar remains strong, we expect small appreciation for gold in 2019.
See our note above. The crypto markets remain opaque and frequently untrustworthy and manipulated. Initiatives are ongoing that will eventually render these markets more transparent and reliable. Crypto speculators, as we have repeated ad nauseam, should pay close attention to regulatory developments and to new solutions aimed at institutional investors — developments of which we will try to notify you in these pages.