Market Commentary: December 2019

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Investment Strategy Team
January 15, 2020
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Holiday Cheer

  • What a difference a year makes. In contrast to the equity market carnage of December 2018, this December brought equities their fourth-straight month of strong gains, outperforming fixed income by 363 basis points (bps). As robust as September, October, and November were (outperformance of 268 bps, 246 bps, and 253 bps, respectively), December surpassed them all. Nevertheless, our equity versus fixed income model ended the month with its strongest possible momentum reading, while relative value indicates stocks continue to be efficiently priced compared to fixed income.
  • Strength was broad-based, both globally and domestically.
  • International stocks put up another strong month—their fourth in a row. Although U.S. large cap posted a solid total return of 2.9%, international equities across all categories outperformed. International developed large cap, international developed small cap, and emerging markets were up 3.3%, 4.4%, and 7.5%, respectively.
  • In the U.S., while large-cap growth moderately outperformed large-cap value, both indices broke out to all-time highs with a total return of 3.0% and 2.7%, respectively.
  • The Federal Reserve (i.e., the Fed) left the Fed Funds rate unchanged.
  • This was in line with what the Fed Funds futures market expected, meaning investors were comfortable with the Fed’s three cuts in 2019.
  • It was not only the equity market that was comfortable with the Fed staying put; the bond market showed little concern, as the yield curve remained upward-sloping after reversing its inversion a few months prior.
  • The Trump administration announced a "Phase One" trade deal with China, which includes a commitment by China to make meaningful purchase of U.S. goods and services, notably agricultural products. As a result, the administration did not impose extra tariffs on Chinese goods, paving the way for a potential reduction of tariffs when Phase Two negotiations commence.
  • On the domestic economic front, we received positive news in December:
  • The labor market remains strong, with unemployment persisting at record lows of 3.5%, the U6 unemployment rate[1] falling to a record low of 6.7%, and the workforce participation rate continuing to increase as the civilian labor force grows. Importantly, annual nominal wages grew by 3% for the first time in a decade, with blue-collar wages continuing to post solid gains.
  • Holiday sales grew 3.4%, despite losing a week due to Thanksgiving falling on November 28.
  • The yield curve, which reversed its inversion months ago, steepened modestly, as rates on the short end came down a bit while rates in the middle and long end of the curve rose.
U.S. Treasury Yield Curve - November and December 2019

Sources: FactSet and Balentine

What We're Watching

The Federal Reserve

Although the Fed left rates unchanged in December, it signaled a clear change in tone during 2019. At the very end of 2018, its hawkish stance led to equity market distress, prompting the Fed to reevaluate what it was signaling to the market. In the middle of 2019, the Fed indicated a willingness to act as necessary to sustain an expansion. It went on to aggressively cut rates in the fall, in response to the inverting yield curve and signs of economic slowdown. The three interest rate cuts in the back half of 2019 were enough to quell concerns, thus leading to stability in the bond market and a continuation of the recent risk-on mentality in the equity markets.

We anticipate this dovish turnabout will continue in 2020, especially since two of the Federal Open Market Committee’s (FOMC) most noted hawks—Boston Fed President Eric Rosengren and Kansas Fed President Esther George—have rotated out as voting members.

We do not expect the Fed to take any action during its January meeting, as rate cuts are usually conducted at the quarterly meeting (i.e., March, June, September, December), with limited exception. But we do look forward to seeing what the Fed is thinking and how its language changes in light of recent strength in the equity markets and reduced concerns about an economic slowdown. Its statement will be a helpful clue as to how 2020’s interest rate policy will unfold.

The Next Leg of this Bull Market

At the end of August, during the onset of this new bull trend, we wrote: “As fear begins to abate, we expect the equity bull market to enter its next leg, which is affirmed by the momentum and relative value signals we are seeing in our model at this time.”

Sources: FactSet and Balentine

This is what has played out, as market fear has been replaced by a less pessimistic outlook on the economy and the state of ongoing geopolitical events.

Sources: FactSet and Balentine

China's Economy

Chinese equity prices have been strong (beginning in mid-August and accelerating after the Phase One deal announcement), as Chinese economic data surpassed expectations while the deceleration in growth began to slow. In tandem, the yuan (CNY) has strengthened against the U.S. dollar, an important harbinger of the market’s level of risk aversion. We want to see if this can be sustained.

The U.S. Dollar

Is recent weakness in the U.S. dollar the beginning of a new trend? In addition to the recently bearish price action in the US. Dollar Index (DXY)—which is showing potential signs of a cyclical top—commodities are also sending a potential signal. A continuation of this trend into 2020 should continue to buoy equities, in general; more specifically, it would be most supportive of a shift toward international equities.

DXY Index

Sources: FactSet and Balentine

A Potential Pullback

The market’s recent run has been very strong, with the trajectory somewhat reminiscent of the early days of 2018, which led to a sharp pullback and a two-year consolidation. We do not anticipate another consolidation, as consolidations in such close proximity are rare. This said, we would not rule out a pullback, as the short-term market trend is indicative of an overbought condition, a situation which is historically unsustainable. Such a pullback would likely be garden variety, with the effect of bringing the market back closer to its longer-term trajectory—a healthy sign.

Sectors and industry groups indicative of a risk-on mentality (e.g., tech hardware, semiconductors, biotech, internet communication services) are beginning to strongly outperform, while those indicative of heightened anxiety (e.g., utilities, consumer staples, wireless telecom) are beginning to lag. We expect this trend to persist if the market continues its structural ascent, and a mean reversion in this dynamic if the market takes a breather.

[1] The U-6 rate, or U6, includes discouraged workers who have quit looking for a job and part-time workers who are seeking full-time employment.

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