THOUGHTS ON THE MARKET

THOUGHTS ON THE MARKET

Volatility Can Be Frightful... A Rally Would Be Delightful...

Larry Adam, Chief Investment Officer, Taylor Krystkowiak and Giampiero Fuentes, Investment Strategy Analysts

Driven largely by fears of slowing global growth, U.S. markets continued their selloff through Friday's trading session. Sparked initially by weaker than expected economic data from China, mounting concerns surrounding the sustainability of international economic growth triggered a broad-based market selloff. All three major U.S. indices ended the session lower (DJIA -2.02%; S&P 500 -1.91%; Nasdaq -2.26%). This development comes in spite of the announcement that China would formally commit to suspending additional tariffs on U.S. vehicles as well as positive U.S. economic data, including better than expected retail sales and industrial production. In short, markets continue to be pushed and pulled by competing positive and negative developments.

As noted previously, the U.S. economy continues to outperform in a global economy that has lost some steam.

December 14, 2018

The recent negative market movement highlights the continuation of deteriorating manufacturing data around the globe as measured by the Purchasing Managers' Index (PMI), which measures new orders, inventory levels, production, supplier deliveries, and employment. PMI data for developed and emerging economies peaked in January 2018 and have since declined below their January 2017 levels on a relative basis, which has weighed heavily on the overall global average (see Figure 1). While U.S. PMI data has held up better on a relative basis than other developed and emerging market economies, it too has fallen on a relative basis. The peak and subsequent decline in PMI data occurred concurrently with the initial tariff announcements by the U.S. government in early 2018. The ongoing trade tensions have continued to roil global markets, which are now poised to end the year in negative territory (see Figure 2). Uncertainty surrounding trade between the U.S. and China, the two largest economies in the world, has engendered both economic disruption and market volatility. As such, positive progress towards trade compromise is crucial to both future economic growth and market performance. Assuming a trade compromise is reached early next year, fears of a global slowdown leading

Figure 1: Purchasing Managers' Indices

105

Foreign PMIs Deteriorating at a Rapid Pace

104

103

102

101

100

99

98

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96

95 Jan-17

Apr-17

Jul-17

Oct-17

140 Figure 2: Equity Indices

135 Deterioration in Foreign PMIs Has Led to International Equity Indices Underperforming

130

125

120

115

110

105

100 Jan-17

Apr-17

Jul-17

Oct-17

MSCI EM (Emerging Markets) - Price Index

Source: FactSet as of 12/14/2018 (100 = 1 January 2017 Value)

Jan-18

JP Morgan Global PMI Manufacturing Sector - World PMI Manufacturing Sector - United States PMI Manufacturing Sector - Developed PMI Manufacturing Sector - Emerging

Apr-18

Jul-18

Oct-18

Jan-18

Apr-18

S&P 500 - Price Index

Jul-18

Oct-18

MSCI EAFE - Price Index

to a U.S. recession appear misplaced. The probability of a

Figure 3: AAII Bull and Bear Indices (Spread)

U.S. recession next year remains very low.

Extreme Bearishness May Be "Contrarian" Positive Sign

50

Competing headlines out of Europe have continued to influence investor sentiment as well. Brexit remains a primary focus for European markets. Following the postponement of a vote on her Brexit proposal in Parliament, Prime Minister Theresa May narrowly survived a vote of no confidence in her leadership. Remarks from Donald Tusk, the president of the European Council, dashed hopes of further renegotiation to May's existing Brexit proposal, which increased the prospects of a `no-deal' Brexit. On the other hand, in a move that quelled mounting investor concerns, the Italian government submitted a smaller than expected 2% fiscal deficit for approval to the European Commission earlier last week, further easing tensions between Italy and the EU. As with those in the U.S., markets in Europe continue to be pushed and pulled by competing positive and negative developments.

40

30

20

10

0

-10

-20

-30

-40

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

100 Figure 4: S&P 500 Relative Strength Index

Near Extreme Oversold Levels Another "Contrarian" Positive Sign

90

80

This heightened negative sentiment has driven record weekly outflows of $46 billion from U.S. equity investments, the highest level measured by Lipper Fund Flows since 1992. However, a variety of technical and sentiment indicators suggest we may be reaching oversold conditions and investor capitulation. As measured by the spread between the American Association of Individual Investors (AAII) Bull and Bear Indices as well as the Relative Strength Index (RSI) of the S&P 500, markets may be poised for at least a near term reversal (see Figs. 3 & 4). Additionally, the S&P 500 closed on a relatively firm support level (2,600) which was formed after previous selloffs in February and March, and has been tested twice on an intraday basis since late October (see Figure 5). Furthermore, the last two weeks of December have historically been the best performing days of the month based on an average of S&P 500 returns for the last 25 years (see Figure 6). Given the recent market volatility and concerns surrounding global growth, the Fed may also be prompted to strike a more dovish tone at its highlyanticipated FOMC meeting this Tuesday and Wednesday, when the the Fed will release its official communique and hold its press conference with Chairman Powell.

The bottom line is that it is extremely difficult to time the precise bottom of an equity market pullback, especially given the sheer number of headlines that continue to dominate the market and dictate its short-term moves. However, in our opinion, the market has now priced in many of these negative headlines. As we have noted previously, with valuations becoming more attractive (S&P 500 15.2x NTM P/E), the concurrence of continued solid U.S. fundamentals (healthy economic growth and earnings), and the emergence of `contrarian' technical indicators (which suggest oversold conditions) these market movements may provide a meaningful opportunity to rebalance portfolios for long-term investors.

Change (%)

70

60

50

40

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20

2010

2011

2012

2013

2014

2015

2016

2,950 Figure 5: S&P 500 Index (Price)

2,900 Testing Recent 2,600 Support Level

2,850

2,800

2,750

2,700

2,650

2,600

2,550 Dec-17

Feb-18

Apr-18

Jun-18

Aug-18

Figure 6: Average Cumulative S&P 500 December Performance

1.9 Historical Santa Claus Rally in the Last Two Weeks

1.4

0.9

0.4

-0.1

1 3 5 7 9 11 13 15 17 19 21 23

Source: FactSet as of 12/14/2018

Calendar Day

2017 Oct-18 25 27

2018 Dec-18

29 31

All expressions of opinion by the Investment Strategy Committee reflect the judgment of Raymond James & Associates, Inc. and are subject to change. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. No investment strategy can guarantee success. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risks including the possible loss of capital. Bond investments are subject to investment risks, including the possible loss of the principal amount invested. The market value of fixed income securities may be affected by several risks including: Interest Rate Risk, a rise in interest rates may reduce the value of your investment; Default or Credit Risk, an issuer's ability to make interest and principal payments; Liquidity Risk, the inability to promptly sell bonds in the market prior to maturity. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. The Standard & Poor's 500 Index (S&P 500) is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets (EM) countries. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges which will reduce investors' returns. It is not possible to invest directly in an index. Technical Analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Investments in the energy sector are not suitable for all investors. The process of rebalancing may result in tax consequences. Further information regarding these investments is available from your financial advisor. Material is provided for informational purposes only and does not constitute a recommendation.

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