Our Top Market Takeaways for the week ending December 20, 2019.
Another decade, come and gone. One of the biggest challenges in investing can be sifting through the noise and identifying what really matters for markets. Here are 10 events from the past decade that we think did matter, in that they helped shape the macroeconomic and investment environment that we’re in today.
May 6, 2010: The Flash Crash
By Andreas van den Hombergh and Madison Faller
“Glitches send Dow on wild ride”—CNNMoney, May 6, 2010
“Stock Selloff May Have Been Triggered by a Trader Error”—CNBS, May 6, 2010
“Dow Takes a Harrowing 1010.14-Point Trip”—Wall Street Journal, May 6, 2010
“Was the Stock Market Sabotaged?”—Gawker, May 6, 2010
On the afternoon of May 6, 2010, the S&P 500 plummeted over -5% in about 4½ minutes.1 An unprecedented bout of market volatility and irrational buying and selling soon brought U.S. equities to intraday lows down -9 to -10%,2 causing nearly one trillion dollars of market cap1 to evaporate without an identifiable fundamental reason.
In this sudden lack of liquidity, exchange-traded funds (ETFs) and stocks suffered extreme price fluctuations. Notably, shares of Apple, which opened at $36.26, soon spiked to around $100,000, and Accenture shares, which had opened at $41.94, fell to one cent (yeah, you read that right).1,3
Shortly thereafter, the market recovered its losses, and trading continued in an orderly fashion. The whole thing lasted just 36 minutes. Shocked market participants were left wondering, “What just happened?”
This event has since been coined “The Flash Crash.”
The day began with some bad news related to the ongoing European debt crisis…nothing too wild for the time, but it created a backdrop of “unusually high volatility and thinning liquidity.” Later that day, at 2:32 p.m., a large fundamental trader initiated a transaction to sell approximately $4.1 billion of equity futures contracts2 (in other words, an agreement to buy or sell something at a predetermined price at a specified time in the future). Here, we should mention that computers have made markets more efficient and trading strategies more powerful, but like all emerging technologies, they can be dangerous. In this instance, this trade was a large position, and the trader used an automated execution algorithm that only took trading volume into account…without regard to price or time.
As the sale was going on, high-frequency traders (HFTs)—who specialize in buying and selling futures contracts quickly using algorithms—jumped in to buy…only to turn around and sell as the market moved against them (at the same time that trader we mentioned was still selling). Cue cross-market arbitrageurs—who try to take advantage of dislocations between index futures, ETFs and individual equities—and you have a recipe that spilled over into broader equity markets.
All this to say that the extreme price fluctuations in the futures market infected the broader equity market, leading market participants to widen bid-ask spreads, reduce liquidity or withdraw completely from the market. Come 2:45 p.m., the equity futures market was paused for five seconds by the Chicago Mercantile Exchange (CME).2 From there, absent a fundamental reason for the event, selling pressure decreased, buying interest increased, and the market recovered.
So, what did we learn?
The Flash Crash showed the world that, when market conditions are under stress, the interaction of automated execution algorithms and HFT algorithms can quickly erode liquidity. Further, the interconnectedness of markets and the existence of cross-market arbitrageurs can spread stress across financial markets.
Fifty to sixty percent of equity trades executed on U.S. exchanges are placed by algorithms.5 With trades executed in milliseconds, a stable marketplace requires controls that ensure trading algorithms can be stopped automatically if something runs amok. Following the Flash Crash, a number of changes were made to marketplaces to help prevent such an event from reoccurring. A rule was instituted to suspend all U.S. shares and ETFs for five minutes when they move more than 10% in five minutes. Rules for market makers were also tightened, requiring all quotes to be no more than 8% away from the best bid or offer price. And, brokers are no longer permitted to provide HFTs with unmonitored trading access, and are required to look for erroneous or other potentially damaging orders they are submitting.
Nonetheless, even with these rules, there have been a number of other major flash crashes since 2010, like 2014’s bond flash crash and 2015’s NYSE flash crash, as well as some smaller-scale events that have all taken place in individual securities. In a modern world where trading is dominated by algorithms, investors should remember that markets are sometimes only as rational as the algorithms are coded.
1Source: Aldrich, Eric Mark and Grundfest, Joseph A. and Laughlin, Gregory. “The Flash Crash: A New Deconstruction” (March 26, 2017).
2U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission. “Findings Regarding the Market Events of May 6, 2010” (September 30, 2010).
3Source: Bloomberg. Data is as of May 6, 2010.
4Source: Kirilenko, Andrei; Kyle, Albert S.; Samadi, Mehrdad; Tuzun, Tugkan. “The Flash Crash: The Impact of High-Frequency Trading on an Electronic Market” (May 5, 2014).
5Source: Financial Times. “How high-frequency trading hit a speed bump” (January 1, 2018).
July 26, 2012: Draghi’s bumblebee speech: “Whatever it takes”
By Madison Faller
On July 26, 2012, Europe was in the trenches of a sovereign debt crisis and former European Central Bank (ECB) President Mario Draghi stood up to give a speech about the challenges facing the economy. The usual. But Draghi’s remarks quickly became famous for his pledge to do “whatever it takes” to support the euro. Save for the heavy topic, Draghi actually started his speech talking about bumblebees, of all things….
“The euro is like a bumblebee.” Before you start scratching your head, let us try to explain what Draghi meant. At its crux, the euro is a unified currency for 19 distinct countries. Nonetheless, for a long time, many felt the euro was working—defying the gravity of its inherent complexity. In Draghi’s words, the euro, like a bumblebee, is “a mystery of nature because it shouldn’t fly but instead it does.” But after the euro reached an all-time high of $1.59 versus the U.S. dollar in 2008, it began a steady trend downward ($1.23 by the time of his speech in 2012)1 …“something must have changed in the air” amid the financial crisis. To move forward, Draghi said, the euro must next “graduate to a real bee.”2
Okay, we admit that the analogy isn’t perfect, and while his intro might have been lofty, what Draghi said next stuck:
“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Whatever. It. Takes. Those three words catalyzed a definitive shift in not only the euro sovereign debt crisis, but also the ECB’s approach to monetary policy to this day. Financial markets responded immediately—by the end of the day, the Europe Stoxx 600 had rallied +2.5%…and it kept climbing until it hit a peak in 2015.1 Government bond yields likewise began subsiding, relieving borrowing costs after a steady climb higher for years.
Draghi followed up his pledge with a new program to buy countries’ distressed debt in return for structural reforms. It seemed the words were enough, though, as that program was never actually utilized. Less than two years later, in June 2014, the ECB cut its deposit rate into negative territory for the first time ever, and in March 2015, it began an asset purchase program that turned into a €2.5 trillion quantitative easing (QE) program.3 All this together, the euro area has since experienced 24 quarters of consecutive growth.4.
Aside from steering a new path for policy and growth in the Eurozone, Draghi’s bumblebee speech had two important implications:
- It represents a prime example of the power of words for modern central bank policy. Draghi’s pledge to do whatever it took to support the euro area economy was enough to spur stocks higher, help bonds recover, and start getting growth back on track—all without employing any formal policies for another two years. While perhaps not as dramatic, we still see a similar trend today. Markets, as sentiment-driven machines, react to how policymakers see, and might react, to economic conditions in the future.
- One of Draghi’s requirements for the euro area to transform into “a real bee” necessitated that national governments pursue structural economic reforms. While Draghi’s mantra had a profound effect on markets, his call for governments to act hasn’t gained too much traction—institutionally, the region is quite similar to how it was in 2012. He’s also argued that to see a true rebound in growth in the Eurozone, fiscal stimulus is needed. However, the governments that want to act, like Spain and Italy, are limited by ballooning deficits, and those that can, like Germany and the Netherlands, seem unwilling. But with monetary policy’s impact growing more constrained in the wake of negative interest rates, economists and policymakers alike continue to call for a profound fiscal stimulus effort in Europe.
All in all, Draghi’s words continue to echo the halls of the ECB—well over seven years since they were first spoken. But for that bumblebee to really fly, national governments have to go to work.
2Source: European Central Bank. “Verbatim of the remarks made by Mario Draghi” (July 26, 2012).
3Source: BBC. “ECB ends €2.5tn eurozone QE stimulus programme” (December 13, 2018).
4Source: EuroStat, Bloomberg. Data is as of September 30, 2019.
September 13, 2012: The dose of monetary medicine that spurred a sustained recovery
By Elyse Ausenbaugh and Tom Kennedy
On September 13, 2012, Fed Chairman Ben Bernanke and his colleagues emerged from their policy meeting unsatisfied with the U.S. economy’s recovery after the global financial crisis. The unemployment rate remained stubbornly high (around 8%) and, despite more than three years of zero percent policy rates, businesses were still apprehensive about borrowing to invest. In hopes of jumpstarting the U.S. economy, Bernanke took the mic at the Fed’s post-meeting press conference to announce the start of a massive, open-ended stimulus package. Spoiler alert: it worked.
First, some background: Imagine the U.S. economy as a patient, and the Federal Reserve as a doctor. When the economy gets “sick” and weak, Dr. Fed can give it a dose of monetary medicine in pursuit of a cure. Sometimes, it takes a few rounds of treatment for a patient to start showing promise of a sustained recovery. In the wake of the crisis, that was certainly the case.
In December 2008, the U.S. economy was in critical condition, and policymakers thought it needed something akin to CPR. GDP growth was contracting at its quickest rate in 50 years, and the labor market was bleeding hundreds of thousands of jobs every month. In an effort to stabilize the economy, the Fed rapidly cut interest rates and started an experimental treatment in the form of Quantitative Easing (QE)—a policy that involves the large-scale purchase of assets in order to ease conditions and pump liquidity into the financial system.
The first round of QE involved total purchases of $1.75 trillion in a combination of mortgage-backed securities, Treasuries and federal agency debt. Alas, it didn’t give the economy the boost it needed, so the Fed began a second round of asset purchases in November 2010. There was also the 2011 Operation Twist experiment (which sought to achieve an effect similar to QE without having to expand the Fed’s balance sheet expansion).
Despite these policy moves, the economy was still stuck in a malaise at the time of the Fed’s September 2012 policy meeting. As mentioned above, that’s when the Fed announced it would launch a third round of QE. This time, the plan was to keep buying assets until the economy was healthy and well. Fed Chairman Bernanke said, “We’re not promising, you know, a cure to all these ills. But what we can do is provide some support.”1
It’s worth noting that while the QE decision was being made, the Fed also wanted to make it clear that it had no intention of hiking interest rates anytime soon. To do so, the Fed communicated its plans to keep rates near zero “at least through mid-2015.”1 This combination of emphatic forward guidance on low rates and a third wave of QE acted like a defibrillator, and validated the Fed’s credibility.
Take the market and economic reaction as proof: The S&P 500 would go on to post a total return of +32% in 2013 (its best calendar year performance of the decade, although 2019 is giving that record a run for its money). That rally continues today, with the index’s total return amounting to more than +150% through the end of November. The economy recovered too, of course, as demonstrated by the steady decline in the unemployment rate and pickup in business investment in the years that followed. The experimental and robust treatment ordered by the Fed was a hallmark of the decade, and we trust that monetary policy methods will continue to evolve in order to treat what ails the economy in the future.
1 Source: Federal Reserve. “Transcript of Chairman Bernanke’s Press Conference” (September 13, 2012).
September 22, 2014: Alibaba breaks the IPO record
By Elyse Ausenbaugh
When the New York Stock Exchange closing bell rang on September 22, 2014, Chinese technology giant Alibaba’s initial public offering (IPO) officially became the largest in history at the time1. The company raised $25 billion, easily surpassing the previous $22.1 billion record set by Agricultural Bank of China. Since then, Alibaba has evolved from a simple online market place to an ecosystem encompassing most anything an online business needs to function: marketing, sales, financial services, logistics, manufacturing, search functions, cloud computing, and so on. It’s a data-enabled super merchant, and it has become one of the major players in the global retail landscape.
In its fiscal year ended in March 2019, the company generated approximately $56.1 billion in revenue.2 Relative to a U.S. e-commerce behemoth like Amazon, which had revenues of almost $233 billion in 2018,3 Alibaba’s scale may seem small. But consider things in a different context: Some estimates suggest that Alibaba could capture more than 55% of all of China’s e-commerce sales this year, while Amazon’s grip on U.S. online sales is expected to be closer to 38%.4
Such a market share is striking in its own right, and its economic context makes it even more so. Over the past 10 years, China’s development has continued to progress and improve the living standards of its population of over one billion people. The country’s GDP per capita, which can be used as a proxy to assess the wealth of the average citizen, is still far below that of more developed economies like the United States and Korea, but it’s risen rapidly throughout the decade. If China is able to continue on this sort of upward growth trajectory (and avoid the so-called “middle-income” trap that’s plagued countries like Brazil), it could create hundreds of millions more middle-class consumers with money to spend. Point being, Alibaba has already achieved success in an economy that may still be in the infancy of its development.
Now that Alibaba trades publicly in the United States, it is required to release quarterly results. And because it’s so entwined in the Chinese consumer landscape, we can potentially use it as a litmus test of China’s ongoing evolution. The intention isn’t to overstate one company’s importance in the overall success of an entire country, but rather to use it as an example of what the country hopes to achieve. The size and sophistication of Alibaba’s platform seem more characteristic of a company in a technological hub like Silicon Valley than they do of a company in a still-developing country. China has a vision of becoming a high-tech economic juggernaut to rival the United States, and the success of an internet company like Alibaba seems to fit in well with that dream.
1The Saudi Aramco IPO, priced on December 5, 2019, at a level that would raise $25.6 billion, is now expected to be the world’s biggest IPO.
2 Source: Alibaba Group. FY 2018 Annual Report.
3 Source: Amazon.com, Inc. FY 2018 Annual Report.
4 Source: eMarketer. “China ecommerce 2019” (June 27, 2019).
November 27, 2014: OPEC swings for the fences
By Jake Manoukian and Steve Berry
On November 27, 2014, OPEC tried to put U.S. shale oil producers out of business. OPEC (a global consortium of oil producers that tries to maneuver supply and influence global prices) committed to maintain an output of 30 million barrels per day of crude oil in the face of falling prices and an oversupplied global marketplace. In the wake of the announcement, Brent crude fell -5% on the day, accelerating a decline that saw oil prices tumble from $114 in June 2014 to $28 by January 2015. Letting oil prices collapse seems like a misguided decision for actors in the business of selling oil, so why did OPEC do it?
After the global financial crisis, crude prices were consistently over $100 per barrel and OPEC was humming along. Outside of OPEC, high prices incentivized innovation such as horizontal drilling and hydraulic fracturing (fracking). These technological advancements saw non-OPEC oil output (especially from the United States) rise dramatically. Initially, the changes in global output went unnoticed due to civil unrest in Libya, war in Iraq, and sanctions on Iran. These conflicts, paired with a growing oil demand from China, masked an emerging problem: Global oil production was set to significantly outpace global oil consumption. In other words, oil supply looked ready to outweigh oil demand. With this growing problem becoming painfully obvious, OPEC was faced with a decision: Cut oil production to support prices or maintain the status quo in an effort to drive the new shale producers out of business.
It chose to maintain the status quo and fight for market share. The glaring issue with the plan was that many OPEC members needed high oil prices to support government spending programs. This weakness strained OPEC to the point that the cartel had to fundamentally change to stay relevant. Now, OPEC more commonly operates as OPEC+, which includes an additional 10 countries (notably Russia and Mexico) to the original 14-country organization. In the fallout of its decision, OPEC saw its relevance in the global oil markets weaken.
The plan to squeeze U.S. oil production and exploration companies out of the market proved unsuccessful, and today the United States produces the most oil of any country. But the U.S. shale industry wasn’t unscathed. Oil and gas investment weakened substantially as producers tightened their belts, which had an impact on broad economic activity. Financial markets were also strained. High yield bond debt spreads (a measure of default risk) rose drastically in the United States as investors worried about indebted oil producer cash flows. While it only challenged the larger expansion, OPEC’s decision fundamentally changed the global energy landscape.
February 11, 2016: A rally is born
By Jake Manoukian
The beginning of 2016 was a scary time for investors. The Fed’s third round of bond purchases had ended, manufacturing activity around the world had stalled, oil prices still had not found a bottom after their epic slide from over $100 per barrel, and China had spent almost $1 trillion of its foreign currency reserves in an effort to defend the yuan against capital flight.
Market performance reflected the fear. The S&P 500 was struggling to tread water, developed markets outside the United States had fallen by over -20% from 2015 highs, while emerging market equities had dropped by -35% from 2015 highs. High yield bond spreads (a measure of risk perceived by investors) soared to 900 basis points over Treasuries. For reference, high yield spreads barely reached 600 during the Christmas Eve panic of 2018. U.S. 10-year Treasury yields had fallen to 1.66% (close to all-time lows). The banking sector seemed to be the root of the problem, and stock prices of banks in the United States had fallen by -30% over the same time period.
This backdrop made the news that broke on February 11, 2016, all the more stunning: “Dimon buys more than $25M in JPM stock.”1 Coincidentally (we think), February 11 marked the bottom for the banking sector, and global equity markets in general. From then until the end of 2016, bank stocks in the United States rallied by over +60%, and global equities appreciated by +20%.
What flipped the script for markets? For one, the fundamental backdrop stabilized shortly after Mr. Dimon’s purchase (China was able to control capital flight, oil prices found a floor, and global central banks continued to support economic activity), and then a massive round of housing infrastructure stimulus in China and the election of Donald Trump in the United States later in 2016 injected a new verve into the global economy and markets.
For most long-term investors, attempting to time the market can have adverse impacts on a goals-based strategy. Indeed, one of our favorite sayings is that market timing can be a dangerous habit. However, in this case, our CEO did adhere to a principle that a different well-known investor espouses: being greedy when others are fearful.2 Of course, not every investor can be Warren Buffet or Jamie Dimon. The lesson for the rest of us: Stick to a plan, even when things seem scary. And if you have the courage to buy when others are selling, you can reap the benefits over the long run.
1 Source: CNBC. “Dimon buys more than $25M in JPM stock: Source” (February 11, 2016).
2 Source: CNBC. “Warren Buffet’s big bank score proves his saying true once again: ‘Be greedy when others are fearful’” (June 30, 2017).
June 23, 2016: The Brexit referendum
By David Stubbs
The United Kingdom’s vote to leave the European Union (EU) on June 23, 2016, marked a pivotal moment in the political journey of Europe. Since WWII, Europe’s economic and political integration had only deepened. Now, for the first time, a country had declared its desire to leave a club of nations that many other countries only aspired to join.
The tension between forces in the United Kingdom and Europe had been building for some time. Under the surface, some factions of the Conservative Party, the dominant party of power in the United Kingdom in recent decades, had long loathed the “ever-closer union” toward which the European idealists strove. For decades, the European issue divided the party. Enter the Brexit referendum, and policymakers had a catalyst to settle the issue once and for all.
The backdrop for the vote could hardly have been worse for those advocating continued membership in the EU. Eight years had passed since the global financial crisis, and much of the population had not felt the modest recovery in the economy. Real incomes had fallen, livelihoods were fragile, and sentiment was frayed. This made it all the easier for those in favor of a U.K. withdrawal to blame the EU for their problems—whether it be European regulations, the money the United Kingdom paid into the EU system, or the immigrants who had arrived in the United Kingdom to work.
In addition, around the time of the vote, the failings of many European policies were clear for all to see. Unemployment remained very high in parts of the Eurozone years after the double-dip recession had supposedly ended, and millions of refugees had flooded into Eastern Europe from the Middle East. These migrants revealed a lack of border organization and institutional capacity on the fringes of a Union that had abolished restrictions on movement decades earlier.
The 2016 referendum also illustrated the shift in power and attention from regular established media channels toward social media. It was arguably the time of the greatest combination of scale and trust in the leading social media platforms. Misinformation was rife, foreign influence was significant, and bad blood, which would poison the aftermath of the vote, built up inside the consciousness of the country.
At the time of writing, we do not know the end of the Brexit saga. We do know the forces that drove the Brexit decision are neither isolated to the United Kingdom, nor unique in history. After sustained periods of economic distress, it is all too common for societies to turn inward, challenge existing norms, and focus on short-term, narrow self-interest at the expense of long-built institutions and relationships. Many countries are still stirring for change. Italy has clashed with the European institutions. Countries in the East openly flout supposed inter-member solidarity, even as they receive billions in funds from the Union’s center. Even Germany, traditionally the most enthusiastic on integration, has seen some far-right political forces start to question whether the country should be footing the bill for the European experiment.
It remains to be seen whether today’s politicians will ultimately follow the playbook of their predecessors, who, after arguing and exhausting all other avenues, eventually concluded that more, not less, Europe is the answer. A sustained period of economic expansion, rising incomes and healing balance sheets would help shore up support. But another recession might strain the bonds that bind a breaking point.
December 18, 2017: When the bitcoin bubble burst
By Elyse Ausenbaugh
Bitcoin was created in 2008, but it truly entered the millennial zeitgeist in the past decade. It’s been often described as the aspirational currency of the future: Think of it as digital money that’s unfettered from the control of institutions like central banks. When stored correctly, it’s supposedly unable to be stolen or seized by a third party. It’s been used as an alternative form of payment for certain goods and services since its debut, and by 2017 it seemed like the hot new investment that everyone—the college kid, the 60-year-old uncle, the typical stock-and-bond investor—wanted in on.
Before 2017, the price of bitcoin never broke above $1,000. By December 17, 2017, it had skyrocketed to its peak price around $20,000—a gain of nearly +2,000%. The hype was real.
Blink and you missed it. The first leg of bitcoin’s crash happened over the course of less than a week when the cryptocurrency plummeted more than -40% in the middle of December 2017. As it turns out, that was only the start. By the time it troughed at $3,191 the following December, the losses in bitcoin doubled to -80%.
Bitcoin’s crash (from peak to pit) wiped out an estimated $250–$300 billion of value. A number of investors around the world certainly felt pain when the bubble burst. That said, it’s always important to have some perspective—crashes like the dot-com bubble in the early 2000s destroyed trillions of dollars of wealth.
Why did it happen? A handful of factors may help explain bitcoin’s freefall, but we’ll focus on just a few we think seem plausible:
Regulatory crackdown: It wasn’t hard for governments to justify regulations on bitcoin and other cryptocurrencies—they could be used for illegal transactions on the dark web and money laundering, their surrounding speculative frenzy seemed like something that wouldn’t end well, exchanges were prone to hacks, bitcoin “mining” consumes vast amounts of electricity, and so on. In the first few months of 2018, numerous countries (from Korea to China, to the United States) began to impose different forms of restrictions on cryptocurrency exchanges, mining, “initial coin offerings,” investment vehicles and the like. Uncertainty and fear around even tighter regulations undoubtedly dampened sentiment.
Futures market bets: For every investor bulled up on a trade, there tends to be another who is skeptical or even bearish. That’s what makes a market, after all. As hordes of investors continued to buy bitcoin, the desire to short it inevitably grew. Once the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) made bitcoin futures available to trade in December 2017, that became a possibility. It’s possible that as bitcoin futures contracts started to mature (reminder—futures are contracts to buy a certain security at a specified price and specified date in the future), investors with short futures positions may have sold bitcoin holdings in order to drive the price down so that they could profit. Critics of this theory point out that it was the entire crypto market that crashed, not just bitcoin, and that crypto exchange trade volumes far exceeded the value of the futures contracts. Nonetheless, this dynamic may have played a role in spooking the masses into selling.
Flying too close to the sun: Or the “what goes up, must come down” theory. As discussed above, the pace of bitcoin’s rise was astonishing and predictably unsustainable (although hindsight is 20/20). Throughout 2017, trading volumes of bitcoin surged by nearly 9,000%—that signals a lot of speculation and irrational exuberance. It’s not unreasonable to say that the cryptocurrency was due for a correction.
Today, speculative investing in Bitcoin and other cryptocurrencies is alive, well, and volatile as ever. The bursting of the Bitcoin bubble isn’t likely to soon be forgotten, but it may eventually be overshadowed by the significance of its underlying building blocks: blockchain. It has potential applications that reach far beyond decentralized currencies, ranging from legal contracts to file storage to governance. As we enter the next decade, we’ll see how blockchain may revolutionize processes and industries around the world.
January 11, 2018: The dawn of the trade war
By Alex Wolf
Following a rancorous 2016 U.S. presidential election campaign filled with promises of tariffs and protectionism, many investors thought the harsh rhetoric was just as empty as past campaign promises. They weren’t wrong to assume that Trump would follow the path of many previous presidents. After all, many past presidential candidates promised to protect American industries, but once in office, those promises fell short. Regardless of party, most presidents tended toward free trade.
However, President Trump has proven to be different. Not only has he followed through on campaign promises to confront the trade deficit with China, but he has spared no country, whether friend or foe. The first tariffs imposed in January 2018 on solar panels and washing machines marked both a shift in White House strategy away from business-friendly policies and timed with the peak in global manufacturing activity. It’s hard to blame current global manufacturing woes entirely on the trade war, as high inventory levels and China’s deleveraging contributed. However, the onset of tariffs between the United States and China, in addition to near-constant trade frictions with many of America’s top trading partners, have ushered in a new era of uncertainty over the future of globalization.
Not since the 1930s have we seen such a reversal in views toward global trade. As the United States questions the merits of free trade, the lack of a “champion” for globalization has opened the door for other countries to use trade as a foreign policy weapon. For example, while it doesn’t make as many headlines in the United States, the ongoing Korea-Japan trade war continues to cause economic damage.
We are just beginning to understand the economic impact of rising protectionism. Supply chains are being redirected and trade flows are changing in many unanticipated ways. While China and the United States are both seeing a negative growth impact, shifting flows of goods and capital are creating winners and losers. With no clear end in sight, investors will need to understand how the trade map is changing, and how these shifts will create investment opportunities and pitfalls.
January 3, 2019: Powell’s pivot
By Jake Manoukian
Imagine you’re upset about something a friend or coworker did, and you confront them about it. It goes something like this:
“I don’t appreciate how you acted, and it upset me. I wish you’d stop, or even better, do the exact opposite.”
Which response would make you feel better?
“I don’t understand why you’re upset, and I’m just going to keep doing what I’m doing.”
“I am listening sensitively to your concerns, and I’ll do everything I can to get us back on track.”
The second option, right? After all, everyone likes a good listener.
Well, on January 4, 2019, at the annual American Economic Association meeting, Jerome Powell said the words that markets desperately wanted to hear: “We’re listening sensitively…to the message that markets are sending.”1 This one statement set off a powerful rally in stocks, bonds and everything in between, and led to the best year for standard 60% stock/40% bond portfolios since 1998.2
Markets, if you remember, were very upset about the Fed’s behavior by January 4, 2019. Just two weeks earlier, the Fed raised the federal funds rate by 25 basis points to 2.5%. This was its fourth hike of the year, and ninth since 2015. Remember, the point of higher interest rates is to make borrowing more restrictive and slow the economy down. If rates rise too much, too fast, earnings growth can slow along with the economy as a whole, and equities can lose value if previous expectations were too optimistic. More immediately, higher current interest rates reduce the value of any cash flow that an investor receives in the future, which also makes equities less valuable.
Even before that last hike, equity markets had made their stance known. The S&P 500 was trading -14% below its September peak (which was an all-time high at that point), then fell another -6% by Christmas Eve. The Fed got the message—it needed to shift gears. Instead of hiking two or three more times (like it had been planning on doing), the Fed hinted at a pause, and actually completely reversed course in an effort to keep the expansion on track. In other words, the Fed did the “exact opposite” from what it had done in 2018. From January 4 through August, both two-year and 10-year Treasury yields fell by over -90 basis points. This drop in interest rates catalyzed a wave of refinancing and breathed new life into the housing market (which had been under stress in 2018). It also supported equity valuations. From January 4 to today, the S&P 500’s price-to-earnings multiple has expanded by over 20%.
By the end of 2018, markets were in turmoil and recession fears were well founded. Powell’s pivot changed that, and it started with just a simple statement: “I am listening sensitively.”
1 Source: Wall Street Journal. “Transcript: Powell, Yellen and Bernanke in Conversation in Atlanta” (January 4, 2019).
2 Based on calendar year total returns of a portfolio comprising 60% S&P 500 and 40% Barclays U.S. Aggregate Bond Index holdings. For 2019, performance is measured through December 9, 2019.
All market and economic data as of December 2019 and sourced from Bloomberg and FactSet unless otherwise stated.
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