Market conditions decline as threat of government shutdown looms

December 21, 2018

Market conditions have been affected by a number of factors, including the possibility of a partial government shutdown, rising interest rates, trade tensions with China and slowing global growth.

U.S. equity markets have not provided investors with the desired “Santa Claus Rally”; instead investors are feeling as if their “investment stockings” have been filled with coal. The markets continue to be plagued by known concerns and have been exasperated by the strong possibility of a partial federal government shutdown, leading to further decline recently.

What might be affecting the markets?

Throughout 2018, markets have been worried about rising interest rates, trade tensions with China and slowing growth across the globe. On Wednesday, Dec. 19, 2018, the Federal Reserve raised interest rates by 0.25% to the target range of 2.25% - 2.50%. This represents the fourth interest rate hike this year and is arguably the most controversial. Economic data has shown tepid signs of rising inflation, prompting many economists to question the merits for the Fed to increase rates. The rate increase announcement by Federal Reserve Chairman Jerome Powell lacked clarity regarding interest rate policy in 2019. It appears the Fed anticipates moving rates two more times in 2019, but will look to evolving economic data as the determining factor for rate decisions. Unfortunately, the message by the Fed left the markets without the desired level of clarity, which in turn increased the levels of uncertainly reflected in markets this week.

Additional factors affecting the markets

We have once again come to the limit of government spending, requiring Congress to pass a spending bill that will allow the government to continue operating. The deadline for passage of a spending bill is Friday, Dec. 21, 2018, and not meeting this deadline will likely shut down various parts of the government. This narrative should sound familiar.

As a country we have been at this crossroad many times over the last several decades. Since 1976, we have faced the need to raise the spending limit on 20 occasions. Since 1990, the government has adopted the practice of shutting down nonessential services and curtailing various government agencies as an incentive for Congress and the president to pass a spending package.

President Trump’s desire for a border security “wall” was a campaign promise and represents one of the primary agendas of his administration. His ability to get the appropriations for his border security agenda have been held up in the U.S. Senate. The current spending bill is his last reasonable chance of getting the necessary funds before the House of Representatives are controlled by the Democratic Party in 2019. Consequently, President Trump is playing hardball and is willing to allow the federal government to experience a partial shutdown in hopes of pressuring Congress to negotiate with him on this issue.

Needless to say, a partial shutdown of the government increases levels of uncertainty in the equity markets and will inevitably lead to additional volatility, depending how long the government remains at an impasse over the spending bill.

The latest increase of uncertainty caused by this week’s Fed increase and the threat of a government shutdown is layered upon the existing trade tensions with China and slowing of global growth. These combined issues have led to bear market territory for several areas of the market (bear markets are defined as a 20% decrease from the market’s high) and may lead to the end of the current longest bull market in U.S. market history.

Looking back at previous market corrections

Since World War II, the U.S. equity markets have experienced seven bear markets (not including the current possible bear market), with the average duration being 14 months (Table 1). So, how should investors view these current market conditions and what action should they consider taking?

Table 1:

  Historical High Index/Security      
Equity Asset Class Date Price 12/20/2018 Price *Percentage off historical high Security
U.S. Large Cap 9/20/2018 295.76 247.45 -16.33% IVV
U.S. Mid Cap 8/29/2018 204.98 164.1 -19.94% IJH
U.S. Small Cap 8/31/2018 173.02 131.78 -23.84% IWM
Developed Country International 1/26/2018 75.25 58.53 -22.22% EFA
Emerging Country International 1/26/2018 62.69 46.84 -25.28% IEMG
Equity Indexes          
NASDAQ Composite Index 8/29/2018 8,109.69 6,528.47 -19.50%  
S&P 500 Index 9/20/2018 2,930.75 2,467.42 -15.81%  
Dow Jones Industrial Average 10/3/2018 26,828.39 22,859.6 -14.79%  

*Red shaded areas represent current bear market conditions

Of the previously discussed issues plaguing the markets, only one represents a concern: slow-down in global growth. Trade tensions with China, the impasse of Congress getting a spending bill passed and lack of clear communication from the Fed concerning future interest rate hikes are, in our belief, temporary issues which will resolve themselves with time. The slowing of global growth is real, but it does not represent zero growth. According to the International Monetary Fund (IMF), economic growth estimates for emerging and developed countries and the globe are as follows:

Table 2:

Year Emerging Countries Developed Countries World United States
2018 4.7% 2.4% 3.7% 2.9%
2019 4.7% 2.1% 3.7% 2.5%
2020 4.9% 1.7% 3.7% 1.5%
2021 4.9% 1.7% 3.6% 1.7%

IMF estimates as of October 2018

Our thoughts

We believe investors with longer time horizons should stay in the market and investors with excess cash should view this market as opportunistic. Emerging markets have been one of the more disappointing areas of the market for 2018, but continues to drive more than 50% of the world’s economic growth. We believe investors should have exposure to this area despite the higher volatility associated with the space.

Dave Isaacson is the Chief Investment Officer of Schenck Investment Solutions, LLC, a Registered Investment Adviser. Registration with the Securities and Exchange Commission does not imply any level of training or expertise. Schenck Investment Solutions, LLC is wholly owned by Schenck SC. Material presented herein is for informational and educational use only. The views, forecasts and opinions presented herein may change based on market conditions and other factors. Nothing herein should be considered to be legal, accounting or tax advice. Consult your lawyer, accountant or other advisor before making any financial, legal or investment decision. This information may not be duplicated or redistributed without prior consent of Schenck Investment Solutions, LLC and distribution or publication of this material does not represent a solicitation to complete a financial transaction with the Schenck Investment Solutions, LLC. In developing the forecasts and opinions contained herein, we have relied on data from third-party sources. Though information was prepared from sources believed reliable, Schenck Investment Solutions, LLC does not guarantee its accuracy or completeness.

Any investment advice contained in this publication is not specific to any individual, entity, or retirement plan, but rather is general in nature. Therefore, the investment advice contained herein should not be relied on for specific investment solutions. Investment decisions should be based on a number of criteria, such as individual’s risk tolerance, time horizon and personal goals. Suitability on products must be determined on an individual basis. Not all products are suitable for all investors.

Both the issuers and counterparties of fixed-income securities face inflation, credit, and default risks. Stock markets are volatile, especially markets outside the U.S. All markets may decline significantly in response to adverse developments caused by political, regulatory, issuer, or economic factors, including other markets. Bonds generally present less short-term risk and volatility than stocks. However, bonds have the risk of default and interest rate risk, or the risk that issuers will be unable to make income or principal payments. Investing involves risk. And risk includes loss. Past performance is no guarantee of future results.

Tags: Investments