December was another strong month for US (+2.8%) and global equity markets (1.8%). Junk bonds gained 1.1% in price while treasury bonds were off, giving the Aggregate Bond Index a slight decline.   Federal Reserve intervention, beginning early September, as a result of the overnight inter-bank lending drying up, has totaled some $400billion.   The rate of additions to the Fed balance sheet, is faster than in QE 2 (Nov 2010-June 2011) which took 8 months to add a similar amount.  QE 3 was larger, adding $1.7 trillion, over 2 years.   Central bank liquidity is the primary driver of 4th quarter equity market gains.  Economic data and earnings growth remain slow and near zero.

Portfolios gained across the board in December averaging approximately 2%; owing largely to our individual stock holdings and exposure to gold and miners.  Bonds were muted and were a drag.  Bonds look best posed to gain in the near term. Gold can extend further, and stocks have hit a speed bump with the turmoil in Iraq/Iran and may be slightly choppy in the immediate term.

Gold and gold miners gained 3.6% and 8%, respectively, in December.  Both bottomed November 26th and earned most gains in the last week of December, prior to the assassination of the Iranian general.  International stock markets have outpaced US stock markets since 10/15 (as forecast in October’s Note).  Commodities, ex-US equities and gold have gained significantly since the US Dollar peaked October 1, and its most recent lower high, on 11/27.    The dollar has broken down and may find support another 1% lower, matching its level in late June, which would be 3% decline off its high on October 1.  A small change in the value and direction of the US $ can have large impacts on metals and other natural resources.

The decline in the US Dollar corresponds well to the Feds telegraphing its intentions to refrain from raising rates in 2020.  The dollar can fall/rise relative to other currencies for a variety of reasons.   The current decline is not getting much attention.  Most finance headlines are full of talk about “reflation”.  Given the SP500 is off its all time high by a mere .75%, its not a reference to stock prices.

Reflation, is the topic du jour.  This term refers to economic data.  Federal reserve interventions impact the markets first with a much longer lag to the general economy.  China’s recent modest liquidity injections are: 1) much smaller than in 2017 and 2014 and take about 6-9 months to impact the US/global economy. Positive economic data from central bank actions will take at least one quarter to begin to show up.  Easing amongst central banks is as significant today as during QE 2.  CBs have completely discarded the concept of ‘normalization’ over the next year.

The biggest risk I see in the immediate term is the start to earnings season.  Earnings estimates for the 4th quarter, as usual, have declined substantially over the past year.  IF stocks can ‘beat by a penny’ reduced earnings estimates, we should get through with only minor stock market fluctuations.  Conversely, if companies’ lower guidance and/or miss low estimates, we could see a more general ‘correction’.  Bonds appear to have completed a 4-month consolidation and any more gain will give it some momentum, while stocks consolidate 4th quarter gains.

Slow economic growth, questionable earnings growth and the ever present geo-political risk are risks to the stock market.  With bonds and gold looking up for a variety of reasons, diversifying across asset classes (into areas not correlated with the stock market) is always a prudent approach.

Adam Waszkowski, CFA

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