Here are some ingredients for stock-market gloom: A trade dispute between the world’s two largest economies, a Federal Reserve pushing the yield curve toward inversion, and a U.S. president under investigation by an independent counsel.
But enough about 1994.
Seriously, though, investors might want to take a look back at the events of the same year that brought the world Forrest Gump and the founding of a plucky little company called Amazon for a “possible analog” to the current stock market environment, argued Tony Dwyer, analyst at Canaccord Genuity, in a Monday note that highlights the chart below, one that looks somewhat similar to the pattern seen in 2018:
The S&P 500 index
fell 1.5% in 1994, according to FactSet, while the index is down 3.9% in the year to date in 2018.
Dwyer emphasized that the backdrops now and in 1994 aren’t exactly alike, but said there are enough similarities between the current political, macroeconomic, Fed policy and market environment to that year to potentially offer some insights.
Moreover, if 1994 and 2018 share similar backdrops, does 1995 offer a guide to 2019? Dwyer noted that after the near-doubling of short-term interest rates in 1994, the first half of 1995 saw just 0.5% annualized gross domestic product growth. The Fed, however, remained worried about inflation and hiked interest rates one more time in February. As it became clear the economy was indeed slowing sharply, the yield curve, a line that plots yields across Treasury maturities, steepened, with the spread between 2-
and 10-year yield
steepening to around 50 basis points, or half a percentage point, after having narrowed to around 7 basis points in December 1994, Dwyer noted.
Meanwhile, trade tensions between the U.S. and Japan, then the world’s second-largest economy, got worse in early 1995, with President Bill Clinton in May threatening Japan with 100% tariffs on 13 Japanese luxury cars, Dwyer recalled, signifying then the largest tariff against a trade partner in U.S. history. A trade deal was reached at the 11th hour in June.
In the end, though, it was a more dovish Fed that made the difference to investors, Dwyer said, with the S&P 500 rising 17% by the end of June.
Dwyer described himself as “a bit skeptical” the market could see similar upside in the first half of 2019, but argued that a similar environment could develop if the Fed signals a more dovish path when policy makers deliver a December rate decision on Wednesday.
Similar to the first half of 1995, “much slower economic and earnings growth in 1H/2019 could be offset by a rebound from very skeptical sentiment, improved trade relations, and valuation stabilization on the back of clarity toward Fed policy rate hikes,” Dwyer said.
Indeed, the outcome of Wednesday’s meeting is being watched carefully as investors weigh a deepening selloff that’s pushed the S&P 500, Dow Jones Industrial Average
, and Nasdaq Composite
into correction territory and nursing losses for 2018.
Some analysts have argued more pain could be ahead because investors have been too quick to pencil in a more dovish Fed in 2019 — a shift they argued wasn’t justified by strong, underlying economic fundamentals.
Read: Here’s why the Fed won’t save the stock market, despite its worst December start since 1980
Indeed, the bottom line is that, just like in 1995, it’s the Fed that will be in the driver’s seat in 2019.
“Although we are clearly further along in the economic cycle than 1994, assessing whether the current weakness in equities is a historic buying opportunity similar to 12/1994, or just a taste of things to come, will be determined by investors’ comfort that the Fed is doing everything it can to engineer a soft landing,” Dwyer wrote.
Read more from source here…