By Sonal Somaiya, Class of 2019
Markets this week continued a downward spiral spurred first by trade war concerns last month and egged on by the Federal Reserve raising rates. These strong market forces have obscured some of the fundamental growth companies may have announced in their earnings leading to an overall mixed market uncertain investing environment. Ahead, we discuss the three major factors at play.
As many of us learned in macroeconomics, the Federal Reserve has a dual mandate to manage inflation and maximize employment using the federal funds rate as a tool to control liquidity of capital throughout the monetary system. While the Fed sets the rate applicable to intra-bank lending, this trickles into the broader debt markets relatively quickly. Back in 2007 - 2008, the Fed drastically lowered rates as the recession hit in an effort to stimulate spending in the economy. They only began raising rates from nearly 0% in late 2015 and are now planning on raising rates to about 3%, a mildly restrictive level, by the second half of 2019.
A raising rate environment has drawn sharp criticism from President Trump who worries that the Fed is “raising rates too fast” despite low inflation levels. This is in line with his priorities though. Under his presidency, equity markets have boomed to record highs and higher interest rates serve to curb some of that acceleration. Higher rates also impact the housing index through skyrocketing yields and broader equities as the market anticipates higher borrowing costs slowing down the global economy.
The second big driver of market volatility over the past few weeks has been the trade war escalating between the U.S. and China. Back in September, President Trump imposed a 10% tariff on $200B worth of Chinese goods and has threatened to increase that to 25% in 2019 and add almost $257B worth of products to the list - covering nearly the entirety of Chinese imports to the U.S. The consumer discretionary, info tech and industrial sectors have been most heavily impacted by these as many inputs to their products have become more and more expensive. Big retailers like Walmart are struggling to decide whether or not to pass these tariffs on to consumers or to absorb them as costs. This will likely have an impact on holiday sales if prices are increased and will depress earnings results in the following quarter.
Negotiations remain unclear between President Xi and President Trump and have translated into choppy markets even outside of rising interest rates. Not only are we continuing to slap tariffs on eachothers’ goods, but China’s intrinsic economic growth has also slowed down to 6.5% - its lowest growth rate since 2009. These in combination have left the market bearish on China’s impact on U.S. equities.
Finally, a third force is at play in the market as companies release quarterly earnings this month and spur on a slew of buying and selling and upgrades and downgrades by equity research analysts. Earnings on the whole have been stronger than expected offsetting some of the higher yields and increased pressure on retailers given tariff troubles with China. However, these effects may be short-lived as companies are still internalizing some of the effects of the trade war.
As volatility continues to be spiky, investors and analysts remain divided on the long term trends at play in the market. Have we hit the proverbial bottom of the market or is there further to fall? Will the market rebound from its lows this month? The story of the three aforementioned threads continues to evolve day by day, so it’s certainly hard to tell.