In our last Quarterly Market Update and Outlook, we noted that “volatility in the capital markets was even more muted in the third quarter than it was in the prior quarter.” The fourth quarter turned out to be markedly different.
- In the second quarter, the closing price of the S&P 500 was more than 1% above or below the prior close on just 13 trading days, while the yield on the 10‑year U.S. Treasury bond remained in a range of 38 basis points (from 2.73% to 3.11%).
- In the third quarter the closing price of the S&P 500 was less than 1% above or below the prior close on every trading day, while the yield on the 10‑year U.S. Treasury bond remained in a range of 28 basis points (from 2.82% to 3.10%).
- In the fourth quarter, the closing price of the S&P 500 was more than 1% above or below the prior close on 28 trading days, i.e., almost half the time in the quarter (Figure 1), while the yield on the 10‑year U.S. Treasury bond plunged 60 basis points from a high of 3.25% to a low of 2.65%.
It’s likely that the extreme volatility in the fourth quarter was driven by two factors occurring at the same time:
- Falling estimates of 2019 corporate profit growth.
- Contracting Price-to-Earnings (P/E) multiples driven by broad macro uncertainty.
S&P 500 profit growth had been forecast to slow considerably in 2019, given tough comparisons (S&P 500 EPS growth increased an estimated 26% in 2018), and the benefits of the tax cuts wearing off for corporations and consumers. More recently, however, estimate downgrades by companies including Apple and Fedex have highlighted the uncertainty about the 2019 outlook reflecting, in large part, the fragile state of the global economy.
At the same time, political issues have pressured P/E multiples, with the P/E of the S&P 500 (trailing EPS) plummeting from 22x in January to 16x in December. Some of the issues likely behind that multiple contraction:
- The ongoing U.S. trade dispute with China.
- The partial U.S. government shutdown.
- Concerns about the independence of the U.S. Federal Reserve after reports that President Trump looked into firing the Chairman of the Federal Reserve.
- Concerns about the health of the banking sector after Treasury Secretary Mnuchin issued a statement in December declaring that the nation’s six largest banks had ample credit to extend, which led investors to wonder about the reason for the statement.
- Continued turmoil in the White House, with the departure recently of the White House Chief of Staff Kelly and Secretary of Defense Mattis, and a seeming inability to find permanent replacements quickly. (Currently, one quarter of cabinet positions are unfilled.)
- Investigations into President Trump by Robert Mueller and newly empowered Democrat-controlled committees.
It likely that volatility in the equity market will continue in 2019, at least until investors become more comfortable with the outlook for 2019 earnings growth, and some of the macro concerns are alleviated.
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Strategy Overview…p. 2
Equities: Strong Headwinds in 2019…p. 6
Fixed Income: Yields Likely Range-Bound…p. 9
Alternative Assets: Caution Warranted… p. 11
Tactical Asset Allocation…p. 13
Market and Global Sector Performance…p. 14
Key Economic Indicators…p. 16