December Markets: Stocks Slide as Fed Hikes Rates, Tariff Tensions Continue

Key Takeaways

Stocks plummet into the holiday season as Fed hints at more hikes

S&P 500, Dow, Nasdaq on track for annual losses

FAANGS among major stocks hit hard during the month

December might be remembered as the month when the retreat turned into a rout.

Weakness on Wall Street swept into town in October and continued to weigh in November, but the downward move mostly seemed methodical and orderly with little sign of panic. That started to change after the December Fed meeting, as stocks lost their footing and hit new lows for the year. By late in the month, it appeared the market was headed for its first yearly losses since 2015 and its poorest overall showing since 2008.

December shaped up as one of the worst months in recent memory for all of the major indices, as markets got rocked by continued concerns about lack of progress on trade with China, the prospects of more Fed rate hikes, and possible slower growth in economies around the world. That includes the U.S., where the Fed reduced its gross domestic product (GDP) estimates for 2018 and 2019.

Equity markets saw surging volatility over the last few sessions of the year, as lighter volumes, which are typical around the holidays, seemed to exacerbate every move.

A Christmas Eve selloff of about 3% for the Dow Jones Industrial Average was followed by the largest one-day point gain ever. The following day, the Dow again retreated, then saw a massive late-day rally that put it back in the green. This is one example of the kind of volatility the markets saw in December.

All told, it appeared that investors would face a month of declines, with the S&P 500 Index (SPX) and the Dow Jones Industrial Average ($DJI) both down more than 9% for the month by the Friday after the Fed’s Dec. 19 meeting, and with the SPX trading below 2500 after peaking in late September above 2940.

Fed’s Rate Hike Adds to Turmoil in Markets

As December came to a close, debate grew around how much of this sell-off was the Fed’s fault.

At its late-December meeting, the Federal Open Market Committee (FOMC) raised the Fed funds rate by 25 basis points to a range of 2.25% to 2.5%, an increase the market had been expecting. However, stocks took a dive, in part on the less dovish tone that came out of the meeting and the press conference that followed it.

Fed Chair Jerome Powell suggested 2019 may see two more interest rate increases and no change in the Fed’s plan to keep winding down its balance sheet, a move that began last year and could increase borrowing costs. None of this sounded like the pause that Wall Street had arguably been looking for.

If people had been waiting for the Fed to say specifically that this was a “one and done” rate increase, they didn’t get that message, which was likely one reason that stocks tumbled after the news hit. Within two days of the Fed’s decision, all the major U.S. indices had lost more than 4% that week alone, and the Dow Jones Industrial Average ($DJI) and S&P 500 (SPX) were on track for their worst December since 1931, down 9% for the month.

For the Fed, however, December’s rate decision might have been a no-win situation because if it didn’t raise rates, the market might have dropped due to worries about possible unknown economic weaknesses. A rate hike, on the other hand, would risk getting people concerned about rising borrowing costs in an economy that seems to be slowing. The Fed expects 2.3% GDP growth next year, revised down from the previous 2.5%.

Seeing the Fed lower its growth projections even as it raises rates and continues to trim its balance sheet might have increased some worries about the economy’s vitality. The sell-off that followed sent the S&P 500 (SPX) down to new lows for the year and off more than 14% from its 2018 closing high posted less than three months ago. As media headlines pointed out after the news, about 60% of SPX stocks were already in bear market territory by late December, meaning they had dropped 20% or more from their highs. Energy, materials, and financials all were in bear markets, and almost every other sector had experienced a 10% correction.

The Nasdaq Comp (COMP) and the S&P 500 briefly dipped into bear territory in late December, and small-cap stocks continued to take a beating as the Russell 2000 Index (RUT) fell more than 20% from its highs.

FAANGs Continue Slide From All-Time Highs

By early December, all five of the “FAANGs” had descended more than 20% from their all-time highs, helping to put what had been one of the biggest sources of upward momentum into a bear market while contributing to a spike in negative sentiment that flowed beyond just the info tech, consumer discretionary, and communication services sectors where they reside.

Among the FAANGs heading into the end of the year as of Dec. 20, Facebook (FB) was down 24% year to date and Apple (AAPL) shares were down 7.7%. Amazon (AMZN) was up 25% for the year, but down 12% the past six months, and Netflix (NFLX) was still up 33% for the year, but down 35% the past six months. Google parent Alphabet (GOOGL) was down about 6% the past six months, and about flat year to date.

High-momentum FAANGs had once seemed to some investors like a place to potentially hide from the negativity hitting Wall Street earlier this year, but sentiment seems to be changing. It appears that some investors might be getting more selective and as the market continued to slide in December, FAANGs seemed to lose their place as a shield from news elsewhere in the market.

Major Earnings Set Mixed Tone

Earnings season technically kicks off in January, but December saw a few major companies report ahead of the rest. In a bright spot among the market turmoil, Nike (NKE) rallied 7% after it beat its earnings and revenue estimates thanks in part to strong online sales. The athletic apparel company said it saw growth in all categories, with footwear drawing double-digit growth worldwide. Even in China, sales were up 40% over last year, breaking records and showing that the U.S.-China tariff tensions have so far had little impact on their business.

In other December earnings, both Walgreens Boots Alliance (WBA) and Accenture (ACN) beat Wall Street analysts’ earnings per share estimates and issued solid outlooks. However, WBA slid 3% as it reported softer sales in Britain, one of its key markets, and it announced it would make $1 billion in cost cuts in the next three years.

And FedEx (FDX) shares fell 6% after it said it would not achieve its goal of seeing $1.5 billion in operating revenue by 2020 as global trade has slowed and shows signs of ongoing deceleration. Finally, Conagra Foods (CAG), which recently acquired Pinnacle Foods, fell 17% to a new 52-week low after it missed revenue estimates and said it expects Pinnacle to weigh on its bottom line into fiscal 2020.

A fresh wave of earnings in January could shed more light on how companies are managing in this fairly strong economy. On the one hand, the past year brought better-than-expected results from companies across all sectors. On the other hand, many analysts noted softer guidance for 2019, so investors appear to be braced for any signs of that. Additionally, many analysts have said they expect earnings growth to slow overall for the S&P 500 in 2019, but few if any see signs of earnings actually going negative.

To stay on top of the most widely-traded companies during earnings season, visit The Ticker Tape’s Earnings Page.

Crude Oil Prices Flounder

After the Fed rate hike in late December, U.S. West Texas Intermediate (WTI) crude prices fell to near $46 per barrel, their lowest level in more than a year, on concerns about oversupply. WTI is on track to end the year off about 25% since Jan. 1.

Weaker demand from foreign economies, record production in the U.S., and a surprise U.S. decision not to immediately implement sanctions on Iranian oil all combined to help send crude down more than 30% in late fall. November turned into one of the worst months for crude since late 2008, and by the end of the year, despite an agreement between OPEC and Russia to cut production by 1.2 million barrels a day, crude broke below $50 a barrel.

Any crude rally in January might be viewed as positive, potentially reflecting the demand that’s often seen amid a healthy world economy. On the other hand, U.S. production keeps rising, so that might help keep a lid on any rally.

Other commodities also didn’t appear to incur much buying interest in December. Copper, gold, and other commodities seemed to reflect fears of a slowing economy. Somewhat surprisingly, gold also didn’t find much in the way of buyers despite ongoing economic concerns. A strong U.S. dollar might explain some of the weakness in gold, which seemed stuck between $1,200 and $1,300 an ounce for most of the year, ending December near $1,275.

Meanwhile, the Fed hike had an unusual effect on Treasury yields. The benchmark 10-year yield, already down about 30 basis points from its fall highs, dropped further after the Fed move. By late December, the yield was below 2.8% for the first time since May, apparently a signal that more investors could be embracing “defensive” assets like Treasuries as volatility continues to weigh on stocks.

Resurgence in Volatility Appears to be Here For Awhile

Speaking of volatility, the market’s most closely-watched “fear index,” the Cboe Volatility Index (VIX), appeared to reflect all of the China trade jitters, lack of progress on Brexit negotiations, Fed worries, and pullback in FAANGs over the course of December. The VIX fell to historic lows below 10 during parts of 2017, shot up to 50 in early February of 2018 on a payrolls report and spiked again as markets tumbled in October, remaining above 20 much of the rest of the year. By late December it hovered near the 30 mark, and at its highest since February.

Higher volatility can, in and of itself, help weigh on the markets. By raising investor fears of impending dramatic changes in prices, it may send some back toward the sidelines or looking for less volatile places to put their money. That might in part explain the rally in fixed income we’ve seen at the end of the year.

Still, it’s important to keep things in perspective. Volatility has indeed been elevated this year compared to the last couple of years, but in historical terms it spent much of December at just above normal levels before the big upswing late in the month.

One thing to note is the orderly selling that characterized October and November continued into early December, but changed tone after the Fed meeting. On the day after the meeting ended, panic appeared to hit Wall Street. When things get panicked, it can sometimes indicate chances of a sell-off losing steam. That’s not to say there’s been a bottom, only that the market did come back pretty strongly late in the month in a sharp reversal.

Looking Ahead: Tariffs, Brexit Shakeouts on Watch

The uncertainty over the U.S.-China tariff situation continued to hang over the market in December. As long as that remains unresolved, investors are likely to have a hard time getting too excited about stocks. No one knows what path the trade negotiations with China could take over the next two months before the president’s 90-day deadline approaches (about March 1), which was set in November on a handshake agreement. That being said, tariffs are likely to remain one of the primary stories heading into 2019.

If there’s a secondary story brewing, consider the fact there’s still no deal on Brexit with the new year on the horizon. This could start gaining more significance as the late March deadline gets closer and many economists are worried about how the British economy might respond, as well as the potential impacts on the entire European economy.

The handshake deal between U.S. President Trump and Chinese President Xi might have helped to give the market a slight boost in mid-December, but with just two months to resolve decades worth of disputes, the tariff conversation could keep things volatile as January begins. Certain stocks that sometimes serve as bellwethers reflecting the ups and downs of negotiations—including Boeing (BA) and Caterpillar (CAT)—might be ones to consider watching for possible hints about how the market as a whole sees the talks progressing as January rolls along.

Good Trading,

JJ
@TDAJJKinahan

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