Happy New Year! We have a lot to cover today. Before we dive into today’s payrolls report let’s take a look at some of the market moving events of the past couple of weeks. A sleepy holiday period it was not. The S&P 500 logged its worst month since the financial crisis, capping off a miserable fourth quarter for risk assets. There was nowhere to hide for investors as assets of all stripes sold off. To underscore the frenzy of financial markets in the final weeks of 2018 and first couple of days in 2019, I have done my best to break down some of the most salient drivers below.
The macroeconomic environment isn’t what it was in years past- we have opined in this from time to time. The desynchronization of global growth has caused much angst in the emerging world, as entities struggle to repay or refinance existing debt with currencies that continue to weaken relative to the USD. Should the dollar continue to appreciate, then this theme would likely continue into 2019. At TWP, we do not see any reason or set of factors that would compel us to suspect the greenback will weaken in the year ahead, as we maintain our bullish outlook for USD on a trade-weighted basis into the new year. It is also noteworthy that emerging markets in general suffered a miserable 2018 as the downside risk of diminishing growth was only augmented by trade issues, rising borrowing costs, and weakening currencies. Clearly, there are many pieces to this puzzle, but China is the flashpoint in the emerging world. We will be monitoring developments between Washington and Beijing very closely. Moving west on our trip around the globe, we find Europe in a state of disarray. Brexit continues to plague both the continent and the halls of parliament, as Theresa May’s struggling government attempts to avoid a “no deal” outcome. Meanwhile, the Italians are doing their best to play a tough hand with the EU. It is difficult for the European Central Bank (ECB) to do much on the policy front in this sort of environment. However, we must point out that Mario Draghi, the president of the ECB, will be stepping down from his post in the coming year. Interestingly, German chancellor, Angela Merkel, also announced that she will not be seeking reelection.
Across the pond, the House of Representatives in now firmly in the hands of its newly elected Democratic majority with Nancy Pelosi holding the gavel as speaker. The government remains partially shutdown, however. What’s the issue? Funding for the border wall. The drama that unfolded in the final days of December was stunning on Capitol Hill. At one moment, a deal appeared likely, then in a sudden shift, the administration signaled it was prepared for a protracted fight over border security. These sorts of mercurial moves are nothing new for the Trump administration. In fact, they have become a hallmark of the President’s dueling strategy. Aides, allies, and enemies have all been forced to contend with Trump’s “unique” approach. Enter Fed Chairman, Jay Powell, and his brood of governors. Before the December FOMC meeting, President Trump’s twitter account was active. He noted that it was “incredible” for the Fed to be considering raising rates. The Fed had, of course, telegraphed that a rate increase was likely at the end of 2018 and raised rates at the December meeting by 25 bps. However, Chairman Powell failed to assuage market fears regarding future rate increases and balance sheet reduction in his press conference. In the days that followed, headlines broke that the President was considering firing the Chairman. Some damage control soon followed but the market was well on its way to closing out the worst month since the financial crisis. In the final act of 2018 performance, President Trump dubbed the market drubbing a “tremendous opportunity to buy.”
On the economic front, 2019 did not start on the right foot. PMI data reflected Chinese manufacturing in the throes of a contraction. European inflation data is subdued and yesterday’s ISM report on the current status of US manufacturing was dour. The administration wasted no time in the new year by terming the December market rout “a little glitch,” but the ISM would beg to differ, as its index signaled a precipitous drop in activity since the November reading. Half of the respondents listed in the report specifically cite tariffs as an issue. The only silver lining was that customer inventories were low- perhaps a harbinger of future demand. It is important to note here that the ISM had held up quite well in spite of all the 2018 political wrangling regarding trade but uncertainty is beginning to bite into the real economy. In other news, Apple Inc (AAPL) shocked markets with a surprise letter cutting guidance for the upcoming quarter. Citigroup (C) has already slashed its 2019 market forecast, continuing jobless claims ticked up yesterday morning, the Japanese Yen endured a “flash crash,” and it’s only the 4th of January. This brings us to the present and the closely watched nonfarm payrolls report.
Overnight financial markets received a relief salve as authorities signaled that discussions will take place between US and Chinese officials on January 7th and 8th. As an aside, it does not appear that prolonging the trade war is in anyone’s best interest at this point. If trade tensions begin to cool between the US and China and the Fed takes a dovish path in 2019, then any positive economic data will likely be greeted with enthusiasm. Well, we certainly got that this morning- it is a stunning report. December payrolls in the US expanded by 312,000! Unemployment ticked up to 3.9% as more Americans return to the workplace. Labor force participation and employment to population ratios came in at 63.1% and 60.6% respectively. Moreover, wages jumped 3.2% year over year and revisions to October and November previously reported figures indicate an incremental increase of 58,000 jobs. That’s quite a report.
Market Outlook: Bullish USD, Neutral Duration, Neutral Equities