Shift in Sentiment Takes Hold

Markets continue to rise this week, sending the S&P 500 to its fourth consecutive win. The positive mood was driven by strong corporate earnings, led by Goldman Sachs which rose 9.54% on strong Q4 2018 results. Investor confidence also got a boost from progress in ongoing trade negotiations between the U.S. and China on reports the U.S. is considering easing trade tariffs to serve as goodwill to China while trying to negotiate a comprehensive trade agreement. China, for its part, offered to boost its annual import of U.S. goods by a combined value of more than $1 trillion over a six-year period. Economic news in the U.S. continued to be light due to the ongoing government shutdown which prevented the Commerce Department from releasing December’s retail sales report. That left investors to digest reports on industrial production and producer prices. Those reports, however, took a backseat to China’s own trade data. The Chinese report indicated that the combination of slowing overall global economic growth and U.S. tariffs are beginning to take their toll on the Chinese economy. Markets interpreted this as a positive, believing it will increase their incentive to reach a settlement before even higher tariffs are instated. With optimism running high on the Street, the S&P 500 ended the week up 2.87%.

China Takes Hit from Tariffs

Data from December showed that slowing global growth and U.S. tariffs are weighing on China’s economy. The country reported overall exports fell -4.40% from year ago levels, while imports fell -7.60% on weakening domestic investment and consumption. Meanwhile, exports to the U.S. fell -3.50% month-to-month in December, while imports of U.S. goods fell -36% as China stopped purchasing soybeans and other commodities. China is highly leveraged to inflections in global growth, and the added weight from tariffs is anticipated to help soften China’s resolve as both the U.S. and China seek to find a resolution to their trade differences.

U.S. Industrial Production Rises

Despite global trade tensions, U.S. factory production continued to rise in December on strong U.S. consumer demand. Industrial production, a measure of overall factory, mining, and utility output, rose 0.30% in December, driven by a 1.10% increase in factory output. The gains were broad-based with vehicle and car-parts makers, appliance, clothing, and paper manufacturers all posting gains. Year-over-year (yoy), industrial production was up 4%. Capacity utilization, which reflects how much industries are producing compared with what they could potentially produce, rose 0.10% to 78.7% in December. This was the highest reading in roughly four years. The consensus heading into this report was that things were cooling in December, but this report was particularly strong relative to expectations.

Producer Prices Drop

A key measure of U.S. producer prices fell -0.20% in December, reversing November’s 0.10% gain. The month’s decline was led by a drop in gasoline prices which fell -13.10% and followed a -14% drop in November. That more than offset a 2.60% increase in wholesale food prices. Core producer prices which exclude food, energy, and trade services remained unchanged in December after rising 0.30% in November. Year-over-year, producer prices were up 2.50%, matching November’s gain. Meanwhile, core producer prices were up 2.80% yoy, following a similar rise in November. PPI numbers are a tertiary read on inflation since increases at the producer level are not consistently passed along to consumers. As such, the 2.5% yoy rise in the index is not nearly as concerning as it would be at the consumer level, and with the Fed having signaled both this week and last that they remain data dependent with respect to rates, inflation is a distant concern for markets at the moment.

What a difference a few weeks makes. The year-end hand wringing over the Fed and rates, China and the trade war, and earnings and future guidance has all but subsided since we crossed into the new year. It has helped that we’re now seeing December’s data, and the numbers suggest the economy continues to exhibit momentum, but the greater factor in this relief rally is simply the fact that concerns were too pessimistic in the first place. It is easy to say that in retrospect of course, but given that the market is moving most strongly as of late to the dovish remarks related to policy items (i.e. Fed’s more accommodating tone and U.S./China statements of goodwill), it would suggest that Q4’s volatility was simply this in reverse — backed by a whole lot of year-end tax selling — and it was not some deeper indicator of deteriorating conditions. Earnings reports will remain a major focus for markets for the next several weeks, with particular attention paid to companies’ forward guidance. Fortunately, investors will be assessing these reports with a far more stable psyche.

The Week Ahead