Market Update

The focus this week remained on trade developments and the actions of the Federal Reserve. I understand that some clients might be growing weary of my emphasis on US interest rates, but as the saying goes: bull markets don't die of old age; they're usually impacted by the decisions of the US Federal Reserve. Over the past three years, the Fed has raised US interest rates eight times, bringing them to a range of 2%-2.25%. Previous indications suggested four more increases by the end of 2019, causing concerns in the equity market about potential over-tightening.
A significant risk lies in a policy error by the Fed; rapid and excessive increases in US interest rates could stifle economic growth. Higher interest rates mean elevated borrowing costs for both companies and consumers, reducing corporate profitability and consumer spending. Considering that more than two-thirds of US economic activity comes from consumer spending, this slowdown could have severe repercussions.
To my relief, on November 28, 2018, Fed Chair Jay Powell signaled a fundamental shift by stating that the current level of US interest rates was "just below" neutral, indicating a rate that supports the economy and employment without causing above-target inflation. He also emphasized that the Fed was now heavily reliant on economic data, reducing the risk of overshooting.
While it's highly probable that the Fed will increase interest rates again in December due to existing challenges (such as slowing overseas economies and fading fiscal stimulus in the US), it is likely that the Fed's trajectory for interest rate hikes in 2019 and 2020 will be much slower than previously anticipated. Hopefully, there will even be hints of a future rate cut.
The financial markets responded predictably to Powell's shift: equities rose, bond yields fell, and the US dollar weakened. In fact, the S&P 500 experienced its best day since March 2018 on that Wednesday.
Furthermore, the recent PCE data, the Fed's preferred inflation measure, provides another reason for the Fed to adopt a dovish stance. The headline reading aligned perfectly with the 2% target, while the core rate, a better indicator of underlying price trends, fell to 1.8% from 2%.
The resolution of the ongoing trade war is now essential. If Donald Trump and Chinese President Xi Jinping can make substantial progress during their working dinner on Saturday, December 1, 2018, at the G20 summit, it might pave the way for a reversal of the recent equity market weakness, given the current level of pessimism priced into the markets.
However, due to persistent Brexit uncertainty and the potential for shifts before Parliament votes on December 11, 2018, we are maintaining an overweight position in cash and a corresponding underweight to the UK. It's challenging to be proactive before the vote, and our views and your portfolio positioning remain consistent with the commentary provided in your October valuation and the Quarterly Market Outlook authored by my colleagues Peter Quayle and Jonathan Wiseman.
Regarding Brexit, while I anticipate Theresa May might lose the initial vote, the likelihood of a no-deal Brexit seems small. Politics often involves grand gestures to satisfy voters, followed by minor strategic adjustments that allow all parties to present the final agreement as a win. However, we cannot rule out the risk of a Jeremy Corbyn government if there is a snap election.
In the upcoming week, the key US economic event will be the employment data released on Friday, December 7, 2018, including non-farm payrolls, the unemployment rate, the participation rate, and average earnings. Additionally, the Fed's beige book report on Wednesday, December 5, 2018, will be closely watched.