Markets hit their “worst year on record”. Fed holds a semi-dovish stance as all assets fall.

The Santa Clause rally in 2018 was nothing but wishful thinking from investors as the year and quarter are drawing to a lower close. The announcement of the week which many could attribute to a lot of the downside stemmed from global growth worries.

The FED and Jerome Powell increased rates by 25 basis points midweek and there were concerns of the FED’s outlook on economic growth and how they were going to incorporate those worries into their rate policy statement.  The rest of the world, in Europe and China, presented us with further economic concerns helping the bears moves equities, commodities, and oil lower. 

This Wednesday, Jerome Powell took the stand at the FOMC meeting minutes to raise rates by 25 basis points. Everyone was expecting a more dovish tone after markets dropped significantly however the downside opened up.

There was an emphasis that the FED would remain data dependent in the coming year. Even though FOMC members now forecast one less than the three rate hikes anticipated in 2019 the market took a dip. This is due to the given US economic conditions, the reason for the Fed trying to hold back on another hike is that they do not believe in the strength of the economy as much as they did a few months ago. Forecasting a drop in economic growth and GDP growth in 2019.
The dovish language was brushed off by investors and traders alike as the downside opened up and the sellers remained unbothered. The February lows broke on this news, Nasdaq finally broke the 2018 open, then the lows and finally entered a bear market sliding over 8% this week alone. The Dow and S&P 500 had rough weeks as all equities dropped over 5%. 

More news out of the US as Washington threatened a government shutdown, due to a disagreement between Trump and Congress. The two sides argued over the funding of the Mexico border wall. On that note, a Go-Fund-Me page was opened for the funding of the wall which outlined if 63 million Americans all pledged $80 they would have the funding they need. As of Friday, December 21st they’ve raised over $13 million, just over 200 000 people have donated. Meaning on average each person has contributed roughly $60 to the $1 billion goal. 

Gold spiked after having dropped along with equities, clearly the $1270 level on Thursday, a level not seen since June 2018. Gold continued to drop off the $1270 resistance as equities continued to plunge. The VIX went to and through the 30 level for the first time since we had our little 12.5% “retrace” in February. 

Here is a look of last week’s stock market on a daily basis (red vertical lines split days).

Stock Market and Sector Overview

Here is a break down of the weekly performance in various stock market sectors (top chart):

  • Energy stocks down 9.08%
  • Technology down 7.67%
  • Financials down 5.31%
  • Retail down 7.02%
  • Utilities down 4.93%

Overview of key markets last week (bottom chart):

  • Crude oil down 11.37%
  • S&P500 down 7.27%
  • Silver was  up 0.27%
  • Gold up 1.33%
  • US dollar down 0.67%

2018-The Worst Year Ever.

Banks are tumbling, assets are tumbling, even risk off assets like gold can’t hold a bid. Is this possibly the worst year for financial markets. One Deutsche Bank seems to think so. At the end of October 89% of assets at the bank had a negative return year to date in dollars. That number is now 93%. This trumps the previous negative record return set back in 1910 (84%).

Deutsche said “this is what happens when the vast majority of global assets are expensive historically due to extreme monetary policy. When the tide goes out you’re more likely to get en masse negative months rather than rotation from day equities to bonds or visa-versa“. Last year was the best year at Deutsche as only 1% of assets finished negative.

This week alone, the world experienced 9 central bank meetings, in which 5 hiked rates. The central banks could be the number one leaders to the downturn in risk assets this year and we can continue to look for the downside until the tightening ends.

As we mentioned, Deutsche Bank has announced that 93% of assets are red for the year, the 7% that are not are cash and the USD. Here is a list of the year to date returns of assets in 2018:

  • USD +5.3%
  • Cash +1.8%
  • Gov.Bonds -1.2%
  • HY Corp. Bonds -2.6%
  • IG Bonds -3.4%
  • Global Equities -8.6%
  • Commodities -9.0%

Large outflows were experienced in these assets, especially global bonds ($8.3 billion). While the global stock market cap lost $16.7 trillion since the beginning of 2018. The 9th Fed hike since 2015 has helped a record outflow from financials.

Its no surprise that the FED hiked rates to 2.50% from 2.25% this past Wednesday, December 19th 2018. On the news and the press conference US equities dropped 1.5%. Fed Chair Powell expressed that the Fed’s primary concern was the US economy and not the markets, however, the two are intertwined on a high level.

Powell and the Fed decreased their expectation for inflation in 2019 from 2.0% to 1.9% which had everyone wondering why they were still adamant on hiking rates. He mentioned that inflation was near 2.0%, if that is the case and there is no real indication that inflation would rise in 2019, why hike rates? He failed to adress still-quiescent inflation and the Fed’s consistent over-estimateion of this hald of the Fed’s dual mandate.

There was a lot of talk of the Fed’s balance sheet in relation to the Fed’s bullish outlook. Just this past Friday, Fe’ds Williams stepped up to the mic. His answers added to the already unstable markets. No matter what he said, traders and investors alike knew there would be a slew of volatility. His initial comments were about the Fed. He said that the Fed will continue to be data dependent and move to a more data dependent approach. This suggested that they will continue in the best interests of the economy without influence from markets. This helped US equities spike aggressively. Which brought a lot of optimism in a market that needed a desperate pick me up. That was quickly canceled out when he mentioned that he and the Fed would not reconsider a balance sheet unwind at this point. This ate away at all the gains made by the previous comments and then some.

There was further bearishness that came out after this news into Friday’s close. Due to Navarro, that address some trade tensions. He said it was highly unlikely that the US and China would come to an agreement after the allotted three month period. “Unless Beijing was prepared for a full overhaul of its trade and industrial practices”. Concerns came from the “China 2025″ initiative that has recently died out. Navarro said, ” China is basically trying to steal the future of Japan, the U.S, and Europe, by going after our technology”. Navarro also notes China is pursuing acts of economic aggression such as “debt-trap financing to developing countries” and “dumping below cost into foreign markets”.
Navarro mentions that the two rate hikes suggested for next year are two too many and that an agreement between economic powerhouses will not come together unless China addresses all of America’s concerns.

S&P 500 Futures Friday December 21st 2018.

The image above is Friday’s trading session on ES E-mini futures on a 5-minute chart.
The three main market driving events are outlined with the three arrows and comments on the chart. It’s evident that the market is sensitive to whatever news comes out, the VIX did jump above 30 after all.

The Fed and futures rate decisions

After the December rate hike, the dot plot changed significantly for future rate decisions. The previously proposed three rate hikes in 2019 changed to a proposed two rate hikes. Below is the September to December dot plot.

Fed Dot plot-provided by Bloomberg

The hollow green circles represent the September sentiment from voting governors. The colored in green circles represent the December sentiment for voting governors. The larger the circle the more governors hold that sentiment for the projected rate.

There was drop off in projected rate sentiment after the December hike. This is suppose to hold up the Fed’s data dependent stance. As Powell addressed the dot plots mixed track record in the past. Overestimating 2016, being on the mark in 2017 and underestimating 2018.

Fed’s Williams who rocked the market this Friday did address the connection between the market and the economy. He went onto say that the “Fed is listening to markets very carefully” and is “hearing markets concerns about risks to the economy”. Some might interpret this in different ways after Powell said that the market was not the Fed’s main concern.

This may be a hint to the “Fed Put” that was discussed months ago when the first drop came out in October. The data dependent Fed will have to be careful in the coming monthly meetings as the volatility in markets could continue to rise.

Weekly Economic Calendar

As we come into the core of the holiday season, leading into the last week of the year, the economic calendar thins out to anemic levels. There are only two events this coming week that are considered high impact events.

Monday, no high impact news. Christmas Eve.

Tuesday, no high impact news. Christmas Day.

Wednesday, BOJ Governor Kuroda goes on the wire.

Thursday, CB Consumer Confidence out of the US in the morning.

Friday, no high impact news.

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