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October 8, 2018

The Growing List of Market Negatives

I currently live in Maryland but I originally hail from New England. I’m writing this dispatch right now from a table with an ocean view at Flo’s Clam Shack near Newport, Rhode Island. (Try their “lobstah” roll; it’s the best on the East Coast.)
I mention all this because I’ve been scouring Rhode Island, trying to find workmen to make repairs on a home that I still own in the Ocean State. Carpenters, masons, painters — they’re all booked solid and they’ve been jacking up their prices because of higher materials costs and a tightening supply of workers amid booming demand.
Ladies and gentlemen, I’ve just described in microcosm not just my dilemma, but also the dilemma of the U.S. economy. Growth is becoming too much of a good thing, pushing up wages and prices.
Robust jobs data today underscored inflation fears, driving bond yields higher and tanking stocks for the second day in a row. The CBOE Volatility Index (VIX) jumped 5.91%.
The U.S. Labor Department reported Friday that nonfarm payrolls increased by 134,000 jobs in September, the fewest in a year, but the decline was likely due to the temporary effects of Hurricane Florence. Data for July and August were revised to show 87,000 more jobs added than previously reported.
The unemployment rate fell to 3.7%, near a 49-year low. The drop in unemployment suggested greater competition in the job market and upward pressure on wages.
As the equity markets wobble in the fourth quarter, how should you recalibrate your portfolio? Let’s review the positives and negatives in the world economy.
For the world’s growth engine of China, positives include the government’s new stimulus measures to boost growth, such as lowering interest rates, accelerating public spending on infrastructure, loosening access to bank loans for consumers and businesses, and a weaker yuan that could pave the way for a resurgence in export orders.
In the U.S., gross domestic product (GDP) growth has maintained its momentum, corporate earnings are projected to post another double-digit quarterly performance, and joblessness keeps falling.
The growing list of negatives
On the negative side of the ledger, emerging markets are embroiled in currency crises, rising oil prices are stoking inflation, Britain is facing the very real prospect of a “hard” Brexit, the trade war between China and the U.S. is escalating, and Italy is an economic basket case.
Britain’s negotiations to leave the European Union have descended into a quagmire, with little hope that the two parties can reach resolution before the self-imposed deadline in March 2019. This protracted uncertainty is starting to weigh on European growth.
Even the big positive listed above — greater Chinese growth stemming from stimulus — comes with a heavy price, namely debt.
The following chart shows China’s national debt from 2012 to 2023 in relation to GDP (asterisks denote estimates):

Source: Bloomberg
A debt crisis in China could trigger global contagion.
Rising oil prices are another wild card. The rebound of the energy patch has initially cheered investors, who’ve seen it as a sign of fundamental economic health, but pricier crude is a double-edged sword.
More expensive fuel could dampen consumer spending during the forthcoming holiday shopping season; it’s also adding pressure on emerging markets that are struggling to pay for oil with an ever-stronger U.S. dollar.
Rising interest rates pose another threat. Growth typically suffers and stocks stumble when rates are on the rise, as they are now.
Financial stocks tend to benefit from rising yields, as it becomes easier for banks to make profits from lending. But investments such as utility stocks and real estate investment trusts (REITs), from which income investors seek dividends and yield, are among the asset categories that suffer the worst from the competition of rising Treasury yields.
Then there are the U.S. midterm elections. Historically, stocks have tended to fall in the weeks before the midterms, as investors grapple with greater political uncertainty. This year’s elections are, to say the least, especially crucial and will dictate the fate of not only President Trump’s pro-business agenda but of the president’s tenure itself.
If Democrats take back at least the House, as pundits widely predict, you can expect more rancor as the two parties go after each other like Siamese fighting fish.
Weighing these pros and cons, what can you expect in the fourth quarter? Trying to time the market is a rookie mistake. But you should rebalance your portfolio to accommodate higher inflation, rising interest rates, slowing growth, and worsening political risks at home and abroad.
If you’re looking for a smart sector move now, consider the stocks of money center banks, which as a whole appear undervalued. Shy away from overvalued mega-cap story stocks, especially those in the tech sector.
Some analysts are predicting an imminent correction of at least 10%. As my Rhode Island friend Flo would say, that’s a lot of clams.
Courtesy of John Persino, Investing Daily (More from Investing Daily Here
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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