We view last week’s market decline as a retest of the October–November lows. The S&P 500 Index fell 4.6% last week, leaving the index in line with the low of the autumn correction and 10% off the September highs [Figure 1]. Losses were driven primarily by three issues: the risk that U.S.-China trade talks fall apart, concerns about a Federal Reserve (Fed) policy mistake, and sharply lower oil prices, all of which contributed to increasing concerns about slowing global growth or potential recession. This week, we summarize our views on these issues and discuss prospects for a potential stock market rebound based on technical analysis.
TRADE PROGRESS HAS BEEN MADE
We continue to see the U.S-China trade dispute as the biggest headwind for stocks. Against that backdrop, it’s understandable that stocks threw a tantrum after U.S. trade officials walked back part of the apparently overly optimistic initial recount of the Trump-Xi meeting at the G20 summit that has given rise to the admittedly already overused “he said, Xi said” phrase on Wall Street (Xi is pronounced “she”).
The initial reaction to the Trump-Xi dinner at the summit was positive, with the United States suspending plans to raise tariffs to 25% on January 1 while the two countries intensify talks to work toward a resolution over a 90-day period (a so-called “trade truce”), ending March 1. After the G20, we emphasized that, while not a resolution, a path toward progress on trade should be viewed favorably. Unfortunately, mixed messages have come from both sides in recent days. For more on trade, see today’s Weekly Economic Commentary.
We do not expect the arrest of an executive from Chinese telecom equipment provider Huawei to derail a possible trade deal. Importantly, credible Chinese officials expressed optimism for an eventual agreement after that news came out.
Risk of a full-blown trade war with China and some potentially concerning market signals have increased fears of recession. One such signal is the inversion of the short end of the yield curve, including the spread between 2- and 5-year Treasuries.
But the yield curves that have historically been more predictive of future recessions (2-year and 10-year, and 3-month and 10-year Treasuries) have not inverted. And even if they do, history shows stocks can continue to go higher for a year or two. We believe the bond market is sending a slower growth signal, and is not signaling a recession in 2019. Low interest rates overseas continue to put downward pressure on long-term rates in the U.S.
Sharply lower oil prices are also being cited by some as a sign of an impending recession. But oil’s weakness has been driven mostly by supply issues, including Iran sanctions, record levels of U.S. production, and elevated domestic inventories. We think OPEC’s decision to cut 1.2 million barrels of production at its December 6–7 meeting is a positive step toward resolving oil’s supply problem and can help stabilize prices.
Bottom line: When we look at these and our other favorite leading indicators, we believe the odds of recession in the U.S. in the coming year are low.