U.S. manufacturing plunged in December, causing equity markets to sell off and bond prices to rise.
Apple reported big drop in revenues. The company makes up roughly 3% of the S&P 500.
We remain cautiously optimistic, as labor markets and the service sector of the economy remains on solid footing.
The Institute for Supply Management (ISM) released a report showing U.S. manufacturing slowed in December to its slowest pace since 2016. While the overall economy grew for the 114th consecutive month, consumer demand softened and manufacturers reported a drop in new orders. This report is perhaps even more important because there is less data to sift through to gauge the state of the economy, since the government isn’t releasing some reports, like new home sales, due to the partial shutdown. The worry is that the slowdown in global growth is now impacting the United States.
While growth is slowing, borrowing costs are rising. The Federal Reserve spooked markets at the end of 2018 by raising interest rates even though growth was slowing and inflation remained below their own target. The Fed statement at the press release was also less dovish than investors were hoping. Currently, investors doubt the Fed and their future guidance and Fed Funds futures contracts are pricing in around a 40% chance that rates will be lower at the end of 2019. There is currently a zero probability they will be higher based on the latest odds from the CME Group’s FedWatch.
Coupled with slower growth and increased borrowing costs, Apple slashed its first quarter revenue forecasts, sending its shares down the most since 2013. Apple CEO, Tim Cook, blamed declining revenues in Asia as the main culprit, but analysts have been skeptical of the company’s projected revenue growth for some time. Apple’s announcement also follows a Chinese manufacturing report released on Wednesday, raising concerns. Manufacturing activity weakened and domestic demand slowed. Tariffs and trade tensions between the United States and China may be starting to have an impact on the two largest economies in the world.
With manufacturing around the world slowing, interest costs rising and large companies missing revenue forecasts, proceeding with caution is appropriate. However, there are still a lot of positives in the economy. The manufacturing sector in the United States is much smaller than the service sector, which makes up about two thirds of the economy. The Non-Manufacturing PMI, a gauge for services activity in the U.S., posted its fourth highest reading in 20 years in November. The December report is being released on Monday. In addition, the labor market remains very robust. Unemployment rates remain near 50-year lows and labor market growth accelerated in 2018. The bad news coming from the manufacturing sector and the market reaction to it also could have a silver lining. The Federal Reserve is paying attention to this and may even ease rates in 2019. Investors are increasingly anticipating this scenario. Additionally, President Trump and Chinese President Xi are watching the impacts of trade to their economies and are incentivized to come to an agreement if economies continue to decline. A Fed pause in rate hikes, or even a cut, and a trade agreement between the United States and China would be an upside surprise for markets.
Overall, we remain cautiously optimistic. Equities have fallen, so valuations such as price to earnings ratios are more attractive. Global equities are now at their lowest valuations since 2013. Investors are not paying as much for future growth prospects. There is an increasing number of uncertainties in the market, but this could also provide opportunities. Labor markets and the service sector of the economy remain on solid footing. While corporate borrowing costs are going up, most companies have extended their debt to many years into the future. We are cautious for more downside surprises, though we are optimistic we could see surprises to the upside around trade and especially Federal Reserve policy. We expect the increasing volatility in equity markets to continue, making it even more important to diversify risk factors in portfolios and staying focused on long-term risk and return objectives.
This report is created by Cetera Investment Management LLC
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