Key Points

  • U.S. equities have rebounded as some macro concerns have eased. However, risks remain and we don’t believe that stocks are yet fully in the clear—volatility will likely persist and our tactical recommendations remain modestly defensive.

  • Recession concerns have receded somewhat, alongside waning worries that the Federal Reserve will go too far. That said economic growth is slowing and the Fed still has a difficult road to navigate—especially given its dual mandate of price stability and full employment.

  • Brexit drama continues but the need for investors to worry may be limited.

“When events change, I change my mind. What do you do?”
- Paul Samuelson

Changing dynamics

Stocks have staged a nice rebound following the sharp selling that culminated on Christmas Eve. It seems clear that market dynamics have changed somewhat, from the “sell first, ask questions later” attitude that dominated last year’s final quarter; with the tenor of the post-Christmas rally fairly healthy from a breadth standpoint (read more at Every Rose Has its Thorn: Healthy Rally but Risks Linger). Many individual stocks are still getting punished for genuinely bad news—such as a few retailers recently on weaker-than-expected holiday results—but for now those concerns have not translated into broader economic or stock market carnage. While more positive, all is not clear in our view and obstacles to a sustainable uptrend remain in place. There have been some positive developments in the China/U.S. trade dispute but a deal remains elusive; the Federal Reserve has backed off some of the more hawkish rhetoric, but the risk of a monetary mistake remains; Brexit remains a major uncertainty (more on that below); and the U.S. government hasn’t done a lot to inspire confidence recently, with its record-breaking shutdown.

Trade, economic, monetary policy, and earnings risks are what led us to move to a modestly defensive investment posture last year, reducing our rating on emerging markets, while moving to a slightly defensive posture with our Sector Views. But our view that volatility would bring sharp moves in both directions is why we didn’t go to a more drastic defensive stance. We continue to believe that the odds of a U.S. recession in the near-term are fairly low; however, trade (and the government shutdown) will likely provide guidance as to the length of runway between now and the next (inevitable) recession.

Economic growth slowing, but not drastically…yet

There is little doubt economic growth is downshifting as 2019 gets underway. Both the manufacturing and services Institute for Supply Management (ISM) surveys declined over the past month, with the New Orders component of the Manufacturing Index (a forward looking indicator) falling sharply to 51.1—dangerously close to the 50 dividing line between expansion and contraction.

ISMs show economic growth slowing

ISM manuf. vs ISM non-manuf

Coinciding with these declines, we’ve seen small business optimism weaken, alongside weakening larger company CFO optimism.

As does the NFIB Optimism Index

NFIB Small Business Optimism Index