Dow Surges as Fed Signals Patience; China Slowdown Hits Global Economy
U.S. stocks surged Wednesday, and bond yields fell, as the U.S. Federal Reserve (Fed) held its benchmark interest rate steady and delivered its strongest signal so far that further interest rate hikes are on hold. Before the announcement Wednesday, markets had been trending positive, lifted by technology stocks and better-than-expected fourth-quarter earnings reports. U.S. Data Wednesday showed the U.S. private sector added more jobs than anticipated this month.
In the latest signal of waning economic activity overseas, data showed the French economy slowed sharply in 2018, dampening the eurozone’s outlook for 2019. France’s economy grew just 1.5% in 2018, a significant slowdown from 2.3% in 2017, as months of anti-government protests weighed on consumer spending and business investment. Meanwhile, the German government cut its growth forecast for 2019 to 1% from 1.8%, citing mounting geopolitical and trade risks.
Oil prices gained more than 2% Tuesday after the U.S. imposed sanctions on state-owned Venezuelan oil company PDVSA, a move likely to reduce the country’s crude exports and relieve some global oversupply worries. However, U.S. crude prices settled lower on Thursday as uncertainty over global trade and the slowing Chinese economy dampened bullish news about production cuts and the Fed’s new patience on rate hikes, which had driven prices higher early in the trading day.
The loonie, which outperformed its peers this month, strengthened against the U.S. dollar on Thursday as signs of progress between the U.S. and China offset data showing a domestic economic contraction. According to Statistics Canada, the country’s GDP declined 0.1% in November from October, attributed to declines in wholesale trade, as well as finance and insurance. For the month, the loonie gained 4%, tops among G10 currencies, thanks in large part to resurgent oil prices. The loonie fell nearly 8% in 2018.
Dovish Fed Stance Helps Lift Markets
For the four days covered in this report, the Dow surged 263 points to close at 25,000, the S&P 500 added 39 points to settle at 2,704, while the tech-heavy Nasdaq gained 117 points to close at 7,282. In Canada, the TSX climbed 175 points to end at 15,281.
The renewed investor optimism that characterized the start of 2019 could fade in the second half of the year. Yesterday, the S&P500 Index ended its best January since 1989 amid conflicting headlines. The U.S. Federal Open Market Committee (Fed) signaled a lengthy pause in policy rate adjustments as it deciphers market "crosscurrents" relating to global trade concerns and European politics. For 2019, we expect U.S. equity markets to outperform their Canadian and international peers and investment grade corporate bonds to outshine their high yield counterparts. Further, we expect fixed income portfolios with longer duration to provide a buffer in the event of yield curve inversion.
Given the maturity of the current business cycle, we have made modest downward revisions to our long-term total return expectations. Lower expected returns reflect an increased likelihood of recession over our forecast horizon and rising input and financing costs. As we approach the end of the business cycle, we expect to make further changes to our guided portfolios to reinforce our high quality bias. We may also make further changes to our tactical asset allocation models.
In January, the probability of a U.S. recession, based on our internal model, rose from ~20% to slightly over 30%. We are mindful of this increase but note the probability remains below the critical 40% threshold. As for the possibility of a Canadian recession, we believe that the Bank of Canada (BoC) will likely follow, not lead, the Fed in policy rate increases. This suggests Canada will track a path similar to that of the U.S. toward any future recession. We expect two 25 bps rate hikes from the Fed this year and one from the BoC. On balance, we view the risk of recession in 2019 as relatively low in both Canada and the U.S.
This publication has been prepared by ScotiaMcLeod, a division of Scotia Capital Inc. (SCI). This publication is intended as a general source of information and should not be considered as personal investment or tax advice. We are not tax advisors and we recommend that individuals consult with their professional tax advisor before taking any action based upon the information found in this publication. Opinions, estimates, and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither SCI nor its affiliates accepts liability whatsoever for any loss arising from any use of this publication or its contents. This publication is not, and is not to be construed as, an offer to sell or solicitation of an offer to buy any securities and/or commodity futures contracts. SCI, its affiliates and/or their respective officers, directors, or employees may from time to time acquire, hold, or sell securities and/or commodities and/or commodity futures contracts mentioned herein as principal or agent. SCI and/or its affiliates may have acted as financial advisor and/or underwriter for certain of the corporations mentioned herein and may have received and may receive remuneration for same. All insurance products are sold through Scotia Wealth Insurance Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank Group. When discussing life insurance products, ScotiaMcLeod advisors are acting as Insurance Advisors (Financial Security Advisors in Quebec) representing Scotia Wealth Insurance Services Inc. This publication and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions contained in it be referred to without in each case the prior express consent of SCI.
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