Walking on Eggshells

Walking on eggshells.  Markets sold off yesterday over Fed rate hike fears, potential economic slowdown, and an increasingly more frequent use of the word “recession”.  Following Friday’s selloff traders could not quite get their emotions in check during yesterday’s session as all the major indices sold off leaving the small cap Russell 2000 in bear territory.  In case you didn’t notice I used the word “emotion” in the last sentence.  I did it intentionally to bring up a point which will become a central theme of not only the markets, but the economy going forward.  Yesterday featured no real news other than the continued trouble for Johnson and Johnson which helped pull the healthcare sector down.  The vacuum that exists before a Fed meeting is a ripe environment for traders to imagine what would be an expected rate hike’s impact on an economy that is showing some signs of tiring.  Traders did just that as the financial news stations featured a line up of famous investors making their cases for the Fed not to raise interest rates this week.  Not surprisingly, the President himself joined the group.  The case they all made was that the domestic economy is already slowing down, as evidenced by slowing in the housing and automobile sectors, and a rate hike now could push the economy into a recession.  The recession discussion began to intensify in recent weeks as the treasury yield curve began to flatten with one portion of it even inverting.  The flat yield curve has historically been a good predictor of recession fueling the bear case.  Did the chance of a recession increase yesterday?  Not in an economic sense, but there is something to be said about the emotional reaction I eluded to earlier.  Recession really happens when consumers stop consuming!  People slow down their purchases when they lack confidence, which is more of an emotion.  Most average people don’t look at economic releases or know what R-star is (most industry professionals may not even know what it is), but most are aware of the state of the stock market.  Investors who are in the markets are acutely aware of recent drops in the market, which certainly will have an effect on their confidence to make purchases.  For all of those consumers who are not fortunate to have an investment portfolio, they rely on the news and other signs to gauge their confidence and if an increasing number of consumers lose confidence, a recession is soon to follow.  Negative emotions are driving investors to sell and negative emotions can cause consumers to hold off on purchases.  I say “can” because it is not evident that consumer confidence is broken, but further drops in the market and news of tightened credit can start to weigh on consumers in the new year.

Yesterday, the S&P500 hit a low close for the year trading off by -2.08% for the day.  The index is down around -13% from the highs it achieved earlier in the year putting it in correction territory but not quite in bear territory, which is technically -20% below highs.  Likewise, the Dow Jones Industrial Average is off by 12% from its October high after slipping by -2.1% yesterday.  The NASDAQ 100, is not quite in bear territory as it gave up -2.22% yesterday.  The Russell 2000 did slip into bear territory yesterday as it traded off by -2.32% leaving it a little more than -20% off the highs it achieved in August.  As expected, the 10 year treasury yield slipped yesterday giving up 3 basis points to close around 2.86%.  The 10 year will start this morning's session slightly lower at 2.283% and the two year note starts the day with a 2.65% yield to maturity.

Today, the FOMC begins its deliberations over whether or not to go through with the highly anticipated rate hike to be announced tomorrow afternoon.  While Fed Funds futures indicate that there is still a 71% probability of a 25 basis point hike, the decision can go either way given not only the state of the US stock market, but also recent signs of a global economic slowdown.  Even though the actual stock market is not factored into the Fed’s decision, the governors are certainly aware that falling markets can have a detrimental effect on consumer confidence.  On the hard numbers front we will get some reads on the housing market today.  Housing starts are expected to show flat month over month growth versus last month’s increase of +1.5%.  Building permits are expected to recede by -0.4% month over month versus last period's pull back of -0.6%.  Today's news cycle will continue to ponder rate hikes and more recession talk making it another volatile session.  Please call me if you have any questions.

daily chartbook 2018-12-18