Investment Insights: Fret or fundamentals?

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Photo of oil tanker and rig with stock market figures lightly superimposed over it.Investors are grappling with the fright of a potential decoupling in the market, which is flying in the face of solid economic fundamentals and earnings reports.

Many investors are worried that the precipitous slide in crude oil prices signals a possible slowdown on a global scale. To this degree, the slide has pushed up volatility within the S&P 500, with the CBOE Volatility Index finishing Tuesday at 20.02, slightly above the 20-year average of 19.94. Some market analysts are pointing out similarities to the 2014 slump, which saw oil drop from over $100 per barrel to $45 per barrel over the course of four months, and also witnessed the price level of the S&P 500 enter a choppy, sideways market towards the end of 2014 and through much of 2015.

The rate of decline in oil prices seems to be openly at variance with the U.S. economy’s solid footing, and the lack of worrisome economic indicators which would make our Global Investment Management team turn more bearish on the market. Unemployment is currently at 3.7%, which has not been seen since 1969, with the market still averaging close to 200,000 jobs created on a monthly basis. Earnings for the third quarter are presently at a remarkable 26 year-over-year growth rate, according to Bloomberg data, and consumers as well as businesses are holding fairly high levels of optimism for the future.

That’s not to say there aren’t risks to the positive outlook, but the “normal” recessionary pressures that typically worry investors over the interim simply aren’t quite there yet. Most generally, the yield curve has flattened, but is not currently inverted, and longer term real bond yields, as well as inflation expectations, have increased. Additionally, falling corporate profit margins are not yet in the danger zone. Lastly, there are ample arguments that the Federal Reserve will likely let the economy run a bit hot, in an effort to stoke inflation so as not to get back into a situation – cue Japan’s Lost Decade(s) – where inflation has been stubbornly depressed.

The Global Investment Management team, as well as our Bank of the West Economic team, still don’t see a recession rearing its head in the next 9 to 12 months in our baseline forecast, with our expected timing continuing to put it closer to mid-2020 rather than mid-2019. This estimate hinges not only on the Fed’s planned rate increases, but also on the expectation of an escalating trade war or, at the very least, one which remains unresolved and contributes to a weak global growth picture amongs the emerging markets. For now, our strategies remain slightly overweight equities, shading toward U.S. equities with the prediction that the trade war will continue to negatively affect international markets more than domestic equities. Domestic equity markets continue to hang on to slight positive gains for the year, and when combined with the extremely positive earnings reports over the last few quarters, U.S. stocks will likely finish in the pole position for financial markets at the end of 2018.

Chart showing various market returns as of 11/14/18.

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

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