Published December 14, 2018
2018 was supposed to be the year that financial stocks took charge. Rising interest rates were expected to provide profitable fuel for banks to substantially increase profits. Instead, financial stocks are some of the worst performers of the year.
The fuel for financial stocks was to be rising interest rates, which yield fatter profit margins for banks. However, the trade battles bled over into concerns about the future growth of the U.S. economy which, in turn, pushed investors out of stocks and into bonds lowering interest rates. We see that on the chart below. But we also see that interest rates are volatile, with moves higher usually punctuated by a retracement of the move – a couple of steps forward; 1-2 steps back.
The fall in 10-year interest rates come at the same time as sharply rising Fed Funds (e.g. very short-term) rates. Banks pay out the short term rates to customers in the form of CDs and interest on deposits (short term rates shown in red below). They lend out the money for longer periods of time at higher rates (the blue line below). The difference between what they are lending money out at and what they are paying depositors provides the bank’s profit (the green line below). That green line has been shrinking but remained above +1%. Now, it has fallen quickly to +0.6% (circled). It’s no wonder bank stocks have been under pressure!
As a result of the above, a stock market desperate for new leadership continues struggling to find the next new idea to calm investor fears and send stocks back upward. The bloom has somewhat come off the tech sector as high valuations, trade friction, and a global slowdown have conspired to bring sellers into that space. Those same trade troubles and global issues keep industrials and materials sectors on the ropes. Financials offer no help for the reasons shown above. Tumbling oil prices have kept energy stocks adrift. That leaves the consumer, which accounts for 70% of the U.S. economy. Spending remains strong. However, corporate profits, somewhat “juiced” in 2018 from tax cuts, will decline in 2019. Will corporate profits grow at a rate high enough to calm investor fears and prevent a full-on bear market? Given the interest rate trends above, investors are now expecting the Fed to increase short-term rates only ONCE in 2019. A little more optimism on the economic growth front and stocks can easily avoid the bear. One thing seems certain: with a March 2019 deadline on the China-U.S. trade front AND a March 2019 deadline on the UK “Brexit”, volatility will likely remain the order of the day in the coming weeks.
The bulls made an effort this week to turn the tide on this negative market, only to be repelled once again. The seeming onslaught of negative news regarding the uncertainty in the global economic picture kept the bulls from making any progress. Monday brought a sharp reversal higher with stocks recovering from a -2% intraday loss to close with slight gains. UK Brexit jostling took center stage with Prime Minister May postponing a vote on on the deal. That uncertainty fueled the market selloff, though buyers bought shares once European markets closed. The reverse situation occurred Tuesday with an agreement to reduce auto tariffs in China spurring a +1% rally early in the session. However, the bulls could not maintain the momentum as an afternoon skirmish over the U.S. budget and a potential shutdown seemed to derail the bullish enthusiasm. Over the two days, stocks swung almost 4% with the net result a market essentially unchanged. Wednesday brought further optimism on U.S.-China trade pushing the Nasdaq to its third straight positive finish; this time a +1% rise. However, transportation stocks were hammered in what has become a very negative month of December for the group (down -12% for the month). Inflation data came in with little change, an encouragement to those concerned about interest rate rises. The market is now expecting short-term rates to change little over the coming year. Investors took a defensive posture Thursday with large-cap indexes little changed while small cap stocks fell amid ongoing fears of a softer domestic economic outlook. The wheels came off for the bulls in Friday’s session with indexes tumbling -2%. A weak economic report out of China pressured international markets overnight. That selling bled over into U.S. indexes with shares falling throughout the day. Johnson & Johnson (JNJ) took a -10% slide to hurt the healthcare sector, which has been one of the few places of refuge over the past couple of months. J&J was sold off after a report claiming that the company has known of problems in its baby powder product. Elsewhere, Costco (COST) and Adobe (ADBE), both among the strongest stocks of the bull market run since 2009, fell hard on disappointing earnings reports.
Stock investors continued to struggle this week with indexes maintaining their volatile ways and pressure building on certain cyclical sectors. The S&P 500 (SPY) fell -1.18% with all of that loss coming in Friday’s slide. The Nasdaq 100 (QQQ) held relatively firm with a -0.19% weekly tally. Small cap shares (IWM) slid -2.37% on the week to set a new low point for the year.
Warm wishes and until next week.