- Q4 2018 was a rough time for markets
- Trade will remain a priority
- Iran and Brexit can move markets
- The US is a political mess, and the Fed is likely to keep markets guessing
- Risk-reward is critical over the coming months
On Monday, September 30, the third quarter of 2019 will end. The year has flown by, and it seems the older I get, the faster time passes. The many issues facing the world promise that the final three months of the year will continue to be a period where volatility in markets across all asset classes remains elevated.
Europe will face Brexit, and the ongoing saga of the trade war between the US and China is far from over. The recent attack on Saudi oilfields have Iran’s fingerprints, and the US Congress has begun a formal impeachment inquiry of President Trump. The 2020 Presidential campaign in the US is kicking into high gear with the odds of a progressive candidate challenging the incumbent rising. The news cycle will continue to cause asset prices to move from risk-off to risk-on mode.
In the current environment, approaching markets with a plan is not a luxury. A logical approach to risk-reward is what will separate winners from losers as price variance is the norm rather than the exception.
Q4 2018 was a rough time for markets
We are coming into a scary time of the year starting on Tuesday, October 1 in markets. There have been more than a few market crashes and speedbumps in October, the most recent coming last year.
As the weekly chart of the E-Mini S&P 500 futures contract highlights, starting on October 1, 2018, the index futures dropped from 2944.75 to a low at 2316.75 in late December, a decline of over 21%. Stocks fell on the back of rising interest rates in the US as the Federal Reserve increased the Fed Funds rate four times for a total of a full percentage point in 2018. The final 25 basis point increase came in December. Meanwhile, quantitative tightening continued throughout last year, pushing rates higher further out along the yield curve. Adding to the stock market woes in Q4 2018 was the increasing trade tensions between the US and China.
The weekly chart of NYMEX crude oil futures shows that that the price of the energy commodity fell from $76.90 during the first week of October to a low at $42.36 per barrel in late December. The price of oil fell by 44.9% in Q4 2018.
As we head into Q4 2019, the S&P 500 E-Mini is around 10 points above its level at the start of the final quarter last year. Meanwhile, at $55.91 on September 29, crude oil is over $20 per barrel below its October 2018 peak, even in the aftermath of the recent attack on Saudi oil fields.
Trade will remain a priority
The trade war between the US and China has escalated dramatically over the past year, which has weighed on China’s economy.
The chart of the FXI ETF which reflects the price action in the leading Chinese large-cap stocks shows that it was at a high at $43.23 in early October 2018 and was trading at $39.45 at the end of last week. Chinese stocks have underperformed US shares over the past year as tariffs and protectionism have created problems for the world’s second-leading economy.
The trade war continues to be a leading factor for markets as we head into Q4, but both sides have motivations to find a solution and strike a deal. China’s economy would benefit most from an agreement, but President Trump desperately needs a political victory with the 2020 election one year away and Congress beginning its impeachment inquiry. A pragmatic approach by both sides could lead to compromise. When it comes to the Chinese, bipartisan support for a change in the trading relationship in the US is a reason to strike a deal with the politically weakened President. For President Trump, moving the needle on trade with China would fulfill a 2016 campaign pledge and invigorate his political base. Therefore, I do not think that trade will be a roadblock for markets in Q4 as the chances of a de-escalation of the trade war are higher than further protectionist measures. While the rhetoric will continue over the coming weeks with threats from both sides, we are likely seeing positioning for an eventual compromise.
Iran and Brexit can move markets
The situation in the Middle East has grown far more strained since the drone attack that temporarily knocked out 50% of Saudi oil output, which amounts to 6% of the world’s supply. The Iranians continue to deny involvement in the attack that had its fingerprints. However, the President of Iran told the world that he is prepared for new negotiations on the nuclear nonproliferation agreement if the US lifts sanctions. The Trump administration has said they will not entertain any preconditions.
The Saudis and US have exercised restraint when it comes to any retaliation for the attacks. However, as the economic noose continues to tighten around the necks of the theocracy in Teheran, the potential for more provocative actions is likely to rise. Any further hostilities that impact oil production, refining or logistical routes in the Middle East would cause price spikes in the oil markets as well as fear and uncertainty in other markets across all asset classes over the rest of 2019.
In the UK, the deadline for Brexit is at the end of the first month of Q4. However, the Parliament has passed legislation that would require Boris Johnson to request an extension if he does not reach a deal with the EU by October 19. The Prime Minister continues to guaranty an exit by the end of October, but that does not appear to be in the cards. The most likely outcome over the coming months is a general election that will serve as a second referendum for the divorce between the UK and EU. The political wrangling and uncertainty surrounding the membership in the EU and precedent for the future will continue to hang over the markets throughout Q4 as no deal seems to be on the horizon. The Prime Minister could be in for the battle of his life during the early days of his leadership.
Brexit and Iran are two issues that will dominate the news cycle in Q4 and are likely to cause price variance in many markets.
The US is a political mess, and the Fed is likely to keep markets guessing
The United States is a politically divided nation. Aside from a contentious battle for the Presidency in 2020, the US Congress commenced an official impeachment inquiry at the end of Q3. The current charges against the President center around a telephone conversation with the leader of Ukraine and a whistleblower complaint that President Trump allegedly involved the nation in an investigation of a political rival in the US, the former Vice President Joe Biden and his son. Democrats are calling for impeachment, while most Republicans continue to stand behind the President.
Impeachment proceedings will capture the attention of the US and world news cycles. However, it is unlikely that there will be enough votes in the Senate to convict and remove the President from office. The impeachment could fortify the President’s political base going into the 2020 election.
On the other side of the political aisle, it seems that the situation with Ukraine has done damage to the front-runner as the former Vice President has slipped in the polls. Senator Elizabeth Warren has moved into the lead of the pack with more than one year to go before election day. Meanwhile, Senator Warren supports a progressive agenda that many believe is not supportive of energy production in the US. Moreover, she has been a champion of the anti-Wall Street wave that followed the 2008 financial crisis and supports much higher tax rates to fund a slew of social and environmental initiatives. The bottom line is that if President Trump survives a potential impeachment, a battle between Republicans and the progressive wing of the opposition party is likely to create more than a little division in the US. All evidence seems to point to lots of volatility in markets across all asset classes if the Senator receives the support of her party. Leon Cooperman, the hedge fund manager, recently said that a Warren victory could shave 25% off the of the value of the stock market. In Q4, the political landscape will become more evident, and markets are likely to respond.
When it comes to the US central bank, the markets are pricing in another 25-basis point rate decline by the end of the year. However, after two reductions and a 7-3 vote at the last FOMC meeting, the Fed will be watching economic data which will drive their next decision.
Risk-reward is critical over the coming months
Each year is always different, but seasonality and history tell us that the final quarter of the year is typically a volatile time.
Volatility can be an investor’s nightmare, but at the same time, it can be a paradise for nimble traders with their fingers on the pulse of moving markets. Watch those critical technical support and resistance levels, and approach markets with a clear and defined plan for risk and reward. Make sure you never risk more than you are looking to make on a trade or an investment. Moreover, the ratio should be skewed to where profit horizons exceed potential loss levels. Additionally, consider using time stops on trades as when the markets do not move in the anticipated direction for an extended timeframe, the original thesis for the position tends to change. At the same time, reevaluate the reasons for a long or short trade or investment at new price levels to make sure the original reasoning for the position is still intact.
Try not to get married to a position when it moves contrary to your expectations. One of the most significant mistakes traders and investors make is when they believe they are right, and the market is wrong. Be humble, and always remember that the market price at any time is always the correct price because it is the level where buyers and sellers reach equilibrium in a transparent environment.
The many issues facing markets in Q4 are likely to present more than a handful of trading opportunities over the coming months. With the natural gas market moving into its peak season of demand in November and the price at the $2.40 per MMBtu level, the energy commodity is one of my favorite plays. However, I am looking to call options during the winter months to limit risk and maximize reward. I continue to favor precious metals and would add to existing positions on price weakness.
The many issues facing the markets as we move into the final three months of 2019. Each year is different, but we should keep the action during the last quarter of 2018 in the back of our minds as a reason to limit risk over the coming weeks and months.