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Market update: Is it time to shift focus?

Anthony Saglimbene, Ameriprise Global Market Strategist

December 2018

Looking back

  • The U.S. and China agreed to a trade ceasefire, but tensions remain elevated.
  • Stock prices have been more volatile since fourth quarter 2018 began.
  • Market sentiment is decidedly more negative, and “caution” is the prevailing sentiment.
     

Up ahead

  • Global growth is likely to slow in 2019, but remain positive.
  • Tariffs and a potential Fed policy “mistake” are the two largest threats to the U.S. economy.     
  • Investors should emphasize high-quality investments in their portfolios.
     

Data Source: FactSet

The markets downshift into year-end

Markets have remained turbulent in recent weeks despite some apparent easing of concerns over the pace of Federal Reserve (Fed) interest rate hikes. The ongoing trade dispute between the U.S. and China, however, has seen mixed results and thus continues to act as an overhang on investor sentiment.

Following the G20 summit in Argentina earlier this month, the U.S. and China agreed to a 90-day trade ceasefire. The temporary cooling-off period is designed to allow both sides more time for negotiations as they strive to reach a formal and lasting trade agreement. However, the devil is still in the details. Importantly, the U.S. is looking for substantial changes in Chinese economic policies, particularly on how Beijing treats U.S. businesses and how it competes globally. Changing how China respects and views intellectual property and technology are key items the U.S. is looking to influence through trade discussions. Such policies could prove very difficult to change over such a short window. As such, investors appear to view the trade ceasefire with a degree of skepticism.

Additionally, the threat of slower growth, prompted by rising interest rates, may have been reduced over recent weeks. Comments from the Federal Reserve provided indications that it may be able to limit interest rate hikes going forward, a pronouncement that was favorably viewed by the markets. This could give the market and economy some much-needed breathing room heading into the new year.

Investor sentiment shifts

We expected the Fed’s interest rate stance and the temporary calming of trade tensions to have a positive influence on stock prices. Based on recent performance, however, investors are clearly heading into 2019 with a cautious attitude.

Since selling pressure began in October, the S&P 500® Index has failed to stay above a price level of 2800 (the Index ended November at 2760). Also, the S&P 500 has moved above its longer-term trading average three times since October only to fall back below the key trend line. For investors, these technical signals indicate potential market weakness. Recent catalysts on trade and interest rates have done little to shake investors from their “sell first, ask questions later” approach, which has dominated market direction since the fourth quarter began.

With the year coming to a close, investors find themselves in a far different environment compared to how the year started. Optimism about accelerating growth across the globe, lower U.S. taxes, and a business-friendly environment that were prevalent early in 2018 have given way to fears that tariffs and higher interest rates could eventually stall growth, potentially leading to a recession. While we do not believe a recession is in the cards for 2019, the truth in these opposing views could fall somewhere in the middle.

A time to focus on quality

Despite our expectations for a downshift in global growth next year, U.S. fundamental conditions remain positive. We expect S&P 500 earnings growth to slow, but profits could still grow by as much as 5% to 8%. Such earnings growth would be in line with longer-term averages for large-cap U.S. stocks. Conversely, with stock prices now trading at attractive valuations compared to historical averages, we believe recent price weakness offers a better entry point for longer-term investors willing to stomach the near-term uncertainty.

Nevertheless, the investment environment next year could prove very challenging and volatile. Investors should use the recent weakness in markets as an opportunity to strengthen their exposure to higher quality investments. For equities, we believe that includes increasing exposure to companies with predictable earnings streams, strong balance sheets, and competitive advantages. For fixed income, that means increasing portfolio exposure to higher-quality debt instruments and resisting the desire to stretch for yield in below investment-grade debt at this point in the cycle.

Indices

The numbers

As of December 13, 2018

Data source: Morningstar Direct

S&P sector returns YTD


Standard & Poor’s (S&P) 500 Index
The S&P 500 is a basket of 500 stocks that are considered to be widely held. The S&P 500 index is weighted by market value (shares outstanding times share price), and its performance is thought to be representative of the stock market as a whole. The S&P 500 index was created in 1957 although it has been extrapolated backwards to several decades earlier for performance comparison purposes. This index provides a broad snapshot of the overall U.S. equity market. Over 70% of all U.S. equity value is tracked by the S&P 500. Inclusion in the index is determined by Standard & Poor’s and is based upon their market size, liquidity, and sector.

Dow Jones Industrial Average 
The Dow Jones Industrial Average (The Dow), is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities.

Russell 2000 Index 
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. The Russell 2000 includes the smallest 2000 securities in the Russell 3000.

MSCI EAFE Index
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. As of June 2, 2014.

MSCI Europe Ex UK
The MSCI Europe ex UK Index captures large and mid cap representation across 14 Developed Markets (DM) countries in Europe. With 337 constituents, the index covers approximately 85% of the free float-adjusted market capitalization across European Developed Markets excluding the UK.

MSCI United Kingdom
The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 109 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK.

MSCI Emerging Markets Index
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. As of June 2, 2014.

Bloomberg Barclays US Aggregate Bond Index (Abbreviated as Bloomberg US Agg in table)
The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).

Bloomberg Commodity Index
Formerly known as the Dow Jones UBS Commodity Index. The Bloomberg Commodity Index is calculated on an excess return basis and composed of futures contracts on 22 physical commodities. It reflects the return of underlying commodity futures price movements.

Dow Jones U.S. Select REIT Index
The Dow Jones U.S. Select REIT Index intends to measure the performance of publicly traded REITs and REIT-like securities. The index is a subset of the Dow Jones U.S. Select Real Estate Securities Index (RESI), which represents equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded in the U.S. The indices are designed to serve as proxies for direct real estate investment, in part by excluding companies whose performance may be driven by factors other than the value of real estate.

Indexes are unmanaged and are not available for direct investment.

IMPORTANT DISCLOSURES
The views expressed in this publication reflect the personal views of the Ameriprise Financial Services analyst authoring the publication. The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Information provided by third parties is deemed to be reliable but may be derived using methodologies or techniques that are proprietary or specific to the third-party source.

Past performance is no guarantee of future performance. Asset allocation and diversification do not assure a profit or protect against loss.

In general, equity securities tend to have greater price volatility than debt securities. The market value of securities may fall, fail to rise or fluctuate, sometimes rapidly and unpredictably. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole.

Except for the historical information contained herein, certain matters in this report are forward-looking statements or projections that are dependent upon certain risks and uncertainties, including but not limited to, such factors and considerations as general market volatility, global economic and geopolitical impacts, fiscal and monetary policy, liquidity, the level of interest rates, and historical sector performance relationships as they relate to the business and economic cycle.

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