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Monthly Financial Outlooks are provided by HomeStar Trust Services. HomeStar Trust Services’ experienced team of trust advisors can provide you with the knowledge, tools and personal service needed to assist you in meeting your financial and estate planning goals.
The August payroll report, released in early September, indicated that the economy is continuing to expand at a solid pace despite the current business cycle being one of the longest in history at nine years. Non-farm payrolls expanded by 201,000 jobs in August even with a small decline in the manufacturing sector, which had been a bright spot following the 2016 election. Payroll growth has averaged almost 200,000 per month over the past year, more than twice the level needed to absorb net new entrants into the labor force. Fortunately, enough workers have come off the sidelines and returned to the labor force to keep the unemployment rate from plunging below the current 3.9% rate. With the tightening labor market, wage gains accelerated to a cycle high of 2.9% on a year-over-year basis, but this is still well below previous cycles when they routinely increased by more than 4.0%.
Solid growth in corporate earnings should continue to support the labor market as well as fuel increases in capital expenditures. Nonresidential fixed investment, a proxy for business capital spending, increased by 8.5% in the second quarter which followed an 11.5% increase the previous quarter, making it the highest two quarter average in six years. The Institutes for Supply Management (ISM) surveys indicate continued growth on the horizon with both its manufacturing and non-manufacturing indices near record highs. Small business optimism is also near the highest on record.
With jobs readily available and gains in home and stock prices, consumer confidence is the highest since the Dot-Com bubble from 1998 to 2000. For the previous quarter (Q2) overall GDP was revised slightly upward to 4.2%, and now into the final month of the third quarter, the consensus expectation is that the economy is still growing at a rate just above 3.0%. If that number is accurate, this will be the best six-month period for the economy in four years.
Housing appears to have peaked and auto sales have stalled. More important to the overall economy are our trade relationships and the economic stability of our trading partners. China remains in the crosshairs of the administration on the trade front and there are signs a prolonged dispute will be disruptive to both economies. Likewise, fears of a trade war and current accounts imbalances have hurt the financial markets of many of the world’s emerging economies, with more than a few facing a recession in 2019. We will also continue to watch the yield curve for signs of an impending slowdown, whether by an overly aggressive Fed policy, or by a significant flight out of riskier markets into the U.S. Treasury market.
ISM indices hit near record highs
Payroll growth remains solidly above the natural growth of the labor market
Invigorated capital expenditures should bolster productivity gains
Housing starts drop again this month, near the levels that existed in 2015
Auto and truck sales run about 16.6 million units (annualized), similar to 2014 levels
Success in trade negotiations, particularly with Canada, Europe and China
Mid-term elections and the ability to pass further pro-growth legislation
Investors seeking a safe haven in rocksteady U.S. equities finally capitulated under the weight of rising uncertainty. Concern over a global economic slowdown weighed on markets with the S&P 500 dropping 9.0% in the final month of 2018, the worst December since the 1930s. The index also finished the year in negative territory for the first time since 2008, falling 4.4%. Concern over progress on the trade conflicts and worry that the Fed may overshoot on their rate policy also continued to plague equity markets.
U.S. markets provided a bit of refuge throughout 2018 as markets abroad struggled. However, in December, international markets actually held up better as the MSCI EAFE Index (developed international) fell 4.8% and MSCI Emerging Markets gave up just 2.8%. Domestically, losses were felt across all styles and sizes in December. Value and growth equities fell nearly in tandem. The Russell 1000 Value Index and Russell 1000 Growth Index dropped 9.6% and 8.6% respectively. Smaller U.S. stocks declined as well. The Russell Midcap Index gave up 9.9% while the Russell 2000 (small cap) suffered an 11.9% decrease.
The turn of the calendar offers fresh perspective and renewed hope. We believe the recent pullback in equity markets offers investors a unique buying opportunity. Volatility will likely remain high over the coming months as markets continue to digest uncertainty. However, the Trump administration and China are likely to reach some sort of trade agreement in 2019, which should provide a major catalyst for global stock markets. Fed policy makers are likely to walk back the number of pending rate hikes. Brexit should reach some still unknown conclusion. Washington will be mostly grid-locked, which won’t be pretty, but is typically positive for Wall Street.
Economic growth is slowing somewhat, but the environment for corporate America remains healthy. We expect equities to rebound in 2019 amid increased volatility. Investors with a medium to long-term time horizon should look for opportunities in the near future to rebalance equity allocations back to their targeted objectives.
Equity valuations historically reasonable
Extreme pessimism and oversold conditions typically coincide with buying opportunities
Slowing economic growth domestic and abroad
Potential policy mistake by the Federal Reserve
Brexit path and impact
Duration of the US/China trade war
The decline in Treasury yields that began in November continued nearly unabated during December. By December 19th, when the Fed concluded a two-day meeting of the Federal Open Market Committee (FOMC), the equity markets had already dropped more than 13% from recent highs, credit spreads had spiked by over 40 basis points (bps), oil prices slid by 40% and there were plenty of signs that global economic momentum was slowing. De- spite these ominous signals and despite criticism from President Trump (and possibly because of criticism from President Trump), the Fed yet again followed through on their well-telegraphed plan by increasing the overnight interest rate by another 25 bps to a range of 2.25% to 2.50%.
This was certainly the most controversial of the Fed actions since they began increasing rates three years ago. The accompanying statement and subsequent press conference were not nearly “dovish” enough to comfort investors’ anxieties. The markets were looking at the dark clouds ahead while the Fed was clearly looking at the sunny skies behind them.
The 10-year yield ended the year at 2.68%, 30 bps lower for the month and 56 bps lower than the early-November closing high. The 2-year note also declined 30 bps to 2.49%, nearly 50 bps lower than the November high. At this level, the market is pricing in very little probability of further overnight rate increases by the Fed. With the increasingly uncertain economic outlook and fears that the Fed might be embarking on a policy error, investment-grade credit spreads increased by another 10 bps to a multi-year high.
We hope that Chairman Powell is listening to the markets and becomes the pragmatist that he is reputed to be. We understand the need to assert independence from political pressure, but not at the cost of a policy error. Recent messages from the chair as well as other officials lead us to be optimistic that they understand that now is the time for a pause in the cycle. We believe that the next change in policy is about as likely to be a cut as an increase. We also believe that we have seen the high in rates for quite a while and that the 10-year will struggle to get over 3% again anytime soon.
Stock market volatility with directional weakness
Weakening global economic outlook
Plunging oil prices
Average hourly earnings growth above 3%
Short-term rates have removed all future rate increases
Trade negotiations with China are the biggest uncertainty to influence all markets
Contact HomeStar Trust for questions or to schedule an appointment:
Jackie Bruhn, Trust Officer
Speedbump Modal Called Incorrectly!