Monthly Commentary

November 2018 Commentary

For most investors memories of the November market will be of the steady declines through much of the month, taking the market into year-to-date negative territory by November 23. This trend seemed to confirm the dour mood of October, the worst month for stocks in seven years. It may come as a surprise that the month-end rally reversed the losses, pushing the November return for the S&P 500® Index to a 2.0% gain, with the year-to-date advance at 5.1%.

As we saw in October, the market downturn punished the high-flying, speculative stocks, while steadier, more defensive sectors outperformed. This trend tended to flip as the market rallied. By month end, Health Care had produced the best results, with a 7.1% return, while Information Technology’s late rally couldn’t make up for its extended losses, finished with a -1.9% result.

What magic created the dramatic pivot at month end? If there was any magic, it was a familiar act: Federal Reserve (Fed) policy and news on the tariff wars. In a different world, just a month ago in October 2018, Fed Chairman Jerome Powell stated that the central bank was “a long way” from getting rates to neutral. In other words, the Fed was not only likely to raise rates in December but continue to raise rates in 2019. This was considered an ill wind for stocks, particularly interest-sensitive sectors of the economy, such as housing, where rising Fed rates means higher mortgage rates. Then on November 28, Powell read a statement announcing that the central bank’s benchmark interest rate was “just below” neutral. Before he had finished the sentence, the stock market had rallied 1.5%. It appeared that the December rate increase might just be enough to reach neutral, putting the previously anticipated three rate hikes in 2019 in doubt.

Another damper on the market over recent months was the prospect of an additional wave of U.S./China tariffs in January. This uncertainty seemed to have created a wave of corporate nervousness, seen in decreased capital spending around the world, as the economies of Germany and Japan contracted in the third quarter. As the G-20 conference held at month-end in Argentina approached, a consensus grew that positive news might be forthcoming in the head-to-head meeting between the U.S. and China. The emerging news that the two countries had agreed to hold back on additional tariffs, at least for the next three months, confirmed these predictions and the optimism that had helped the market rally. That said, considerable issues remain unresolved and the onus of future tariffs may return in 2019.

The rocky markets of the past months and the increased volatility are signs that the economy is sending out mixed signals. For instance, while the prospect of leveling mortgage rates may be positive for housing, there is some evidence that rates are already at a level high enough to discourage some buyers. This seems particularly true of the younger buyers who are counted on to step into the housing being vacated by aging baby boomers. Surveys show that older Americans perceive current mortgage rates as more than reasonable, but younger Americans, who have lived with record low rates for almost a decade, have the opposite opinion. Housing has weakened recently, perhaps in part due to this phenomenon, and housing has been a reliable early indicator of future economic prospects. Another early indicator is auto sales, which have also been weak. Weak sales and higher costs for steel due to tariffs have been cited behind GM’s decisions to close a number of domestic production facilities, including a Lordstown, Ohio plant employing 1,500.

On the positive side, consumer spending has been strong, and the drop in gasoline prices tends to act like a tax cut – putting more money in pockets. Even as tariffs push up retail costs, predictions are positive for the holiday shopping season, with unemployment at record lows and average wages moving upward.

The past two months have provided stern tests for our expectations that a carefully chosen portfolio of high-quality companies can produce superior results in challenging markets. October’s losses and November’s period of decline, while just limited samples, provided encouraging support for these beliefs. We believe this outperformance in down markets not only can be a comfort to investors, but is also a key to superior returns over full market cycles.

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  • Nothing contained herein is intended to be a recommendation to buy or sell any security. This material is for informational purposes only and should not be taken as investment advice of any kind whatsoever (whether impartial or otherwise). December 4, 2018 - All Rights Reserved.

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