Highlights
• Seasonality, coupled with solid earnings, suggest positive market finish to 2018
• Fed continues to promise gradual rate hikes through 2019
• Complex China tariff issues could disrupt supply chains
The most common definition of “heads or tails,” according to the Merriam-Webster dictionary, refers to “a simple gambling game in which a coin is tossed and won by the player who successfully calls the side that lands upward.” Betting on the direction of the markets since the Federal Reserve began its quantitative easing (QE) program at the end of 2008 until completing the many phases of QE in 2014 meant either side of any coin won the toss. That’s hardly a gamble. How could it be, with the Fed providing an extraordinary amount of liquidity as its balance sheet grew to approximately to $4.5 trillion in 2014 from $850 billion at the end of 2008, and with the European Central Bank (ECB) launching QE in March 2015, joining the Federal Reserve and the Bank of Japan to envelop global markets in unprecedented monetary liquidity—all providing the underpinning and a sure bet that markets would thrive?
To be sure, a few detours along the way through eurozone-related pressures, geopolitical worries, Brexit, mounting tariff concerns and an assortment of headline issues occasionally engulfed markets in fear that soon subsided thanks to the fungibility of global central bank largesse. The tax package passed by the U.S. Congress in December 2017, coupled with broad deregulation, has also helped cushion U.S. markets as the Fed continues to raise interest rates.
U.S. markets, in particular, have thrived with a Federal Reserve that has declared, in terms of forward guidance, that its policies remain “accommodative.” Forward guidance, while taking different forms among central banks, essentially telegraphs the trajectory of monetary policy. However, during a May panel discussion in Stockholm, Fed Chairman Jerome Powell made it clear an important change was coming: “I think forward guidance was very useful in the crisis, and I think it will have a much smaller role going forward.”
And almost on cue, at the September Federal Open Market Committee (FOMC) meeting, the word “accommodative” was removed from the Fed statement. Mindful of how traders—and algorithms—parse every word and nuance, Powell followed up at a press conference by emphasizing that policy remains accommodative. Further, as discussed in Stockholm, “accommodative” used as forward guidance when the Fed had begun raising rates in December 2015 had done its job and was no longer necessary. “This change does not signal any change in the likely path of policy,” he said. “We still expect, as our statement says, further gradual increases in the target range for the Fed funds rate.”
The FOMC looks toward another rate hike in December and a series of moves in 2019. The question for investors is whether the economy can withstand higher rates, and whether Chairman Powell can negotiate the elusive “soft landing.” Although he emphasized the strength of the economy is being heavily supported by fiscal policy, with household spending and business investment expanding and financial conditions remaining accommodative, questions remain regarding how long the expansion can last. The tug-of-war within the market is focused on when the next recession begins, with 2020 the consensus estimate.
The fourth quarter, statistically, and in terms of seasonality, is the strongest for the year absent an unintended shock. But given that markets look ahead, we may begin to hear more discussion regarding a shift toward international markets where valuations are increasingly more attractive. Uncertainty surrounding the effect of a higher interest rate environment, the underlying longevity of fiscal stimulus, tariffs, and midterm elections could make the climb to the end of the year choppier than usual. Still, on a fundamental basis, solid leading economic indicators, combined with strong earnings growth, should propel the fourth quarter to a favorable finish. Over the past 27 years, the S&P 500 has registered a positive return 85 percent of the time. The returns are usually clustered during November and December, many times following a difficult October.