Investment Commentary – November 20, 2018

Year to Date Market Indices as of Market Close November 20, 2018
Dow 24,440 (-1.16%)
S&P 2,638 (-1.25%)
NASDAQ 6,851 (-0.63%)
Gold $1,223 (-7.97%)
OIL $53.99 (-2.91)
Barclay Bond Aggregate (-1.89%)
Fed Funds Rate 2.25% (last increase was 9/26/18)

Why The Split Congress May Be The Best Stock Market Election Outcome

The Democratic takeover of the House in Tuesday’s midterm elections, as the GOP narrowly held the Senate, is likely the best outcome for Wall Street. While stock market strategists had generally opined that continued GOP control would be the best outcome for the Dow Jones industrial average, S&P 500 and Nasdaq, history suggests otherwise. So does the threat of an escalating China trade war.

First, look at historical returns for the stock market. Going back 60 years, to the election of 1958, a divided Congress has the best track record, followed by a rubber-stamp Congress run by the president’s party. The worst combination has been a unified Congress controlled by the party in opposition to the president.

Gridlock Good For Stock Market?

The historical record suggests a need for clarification of the Wall Street adage “gridlock is good,” based on the idea that markets do well when Washington doesn’t get in the way. It seems that good gridlock — coming from a divided Congress — is good, while gridlock at the hands of a hostile Congress might not be so great.

Here’s what IBD found, looking at S&P 500 returns during each two-year election cycle, from election day to election day. The best outcome, an average 18.7% two-year return, came when Congress was divided. Unified control of Congress by the same party as the president yielded an average 17.3% two-year gain. When control of Congress was unified under the opposition party, gains averaged 15.7%.

Oppenheimer View: Recent Correction May Extend Current Market Cycle

We think the market may have appropriately responded to excessive expectations for U.S. growth.

As the U.S. stock market suffers through its second official correction of the year and non-dollar assets continue to underperform, we ask the question made famous by Vince Lombardi and NFL films, “What the (heck) is going on out there?”

We think there’s not as much going on, fortunately, as the recent market action may have you thinking. We see the correction as more about adjusting the elevated and misplaced expectations for the U.S. economy rather than anything fundamental in the global economy. It’s still the same old “Goldilocks” cycle—modest growth and modest inflation—that it has been since the global financial crisis, the stimulus and strong cyclical growth notwithstanding.

It wasn’t long ago that the global economy was in the throes of a synchronized expansion. Growth was sound, inflation was modest and as a result 2017 was a benevolent, banner year for the markets. In truth, the synchronized global expansion was little more than a historical accident, the result of the early 2016 bottoming in oil prices and the massive stimulus by Chinese policymakers. By early 2018, the U.S. tax cuts were arriving just as the impact of the Chinese stimulus was fading, and the expansion became asynchronous. U.S. growth took off (look no further than last week’s 3.5% real Q3 GDP print), while the rest of the world was slowing. As always, capital flows to where growth is strongest, and dollar-denominated assets outperformed meaningfully.

The narrative, however, that the U.S. economy is poised to sustain this higher level of growth was always hyperbole. For one, the U.S. output gap had already closed. Two, there was always the inevitable downsides of late-cycle fiscal stimulus including premature tightening by the U.S. Federal Reserve, higher interest rates across the yield curve, and a stronger dollar. It’s no surprise then that U.S. financial conditions are now tightening. Make no mistake, we still believe U.S. economic growth will slow in the first half of 2019. The slowdown is already showing up in the U.S. housing and auto markets. The equity market is simply pricing the slowdown in ahead of time with the highest-valuation sectors, including the information technology sector, selling off the most.

It is, however, not the end of the cycle. This cycle will ultimately end, as all others do, with 1) a significant policy mistake in the U.S., or 2) a significant deterioration in economic activity in one of the major economic blocs of the world.

The Federal Reserve, with inflation largely under control and financial conditions already tightening, will back off their tightening stance. Rates will fall, the dollar will moderate, and credit spreads will tighten. A policy mistake could come by way of a full-blown trade war with China, but we expect greater clarity following the midterm elections, and we believe the ultimate impact of a new trade agreement on the global economy will be relatively small.

The ongoing weakness in European growth bears watching. Europe continues to suffer from unending political concerns and was disproportionately impacted by the emerging market slowdown and capital flight. We expect Europe to stabilize in 2019 as its emerging market trading partners stabilize from a relatively modest slowdown

Around the web

Shopping season: U.S. retail sales exceeded expectations in October, which could bode well for retailers heading into the holiday shopping season. Sales increased 0.8% last month compared with September’s level, topping most economists’ expectations.

Reversing course: Stocks couldn’t maintain their positive momentum of the previous two weeks as the major indexes fell around 2%. As a result, the S&P 500 Index remained close to its level at the start of November but was nearly 7% below its record high reached in September.

Tech trouble: The S&P 500 finished the week with gains on Thursday and Friday, but that wasn’t enough to offset the market’s shaky start to the week. The biggest decline came on Monday, when weakness in the technology sector weighed on the broader market. The S&P dropped 2.0% and the NASDAQ sank 2.8%.

The Markets 10 years ago vs. today
DOW 7,552/24,440
S&P 500: 752/2,638
Nazdaq: 1,316/6,851

Other Notable Indices (YTD)
Russell 2000 (small caps) -1.49
EAFE International -9.27
Emerging Markets -14.69
Shiller Annuity Index 3.73

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments.