June 2019

June Bounce or Trounce?

Market action in May was interesting to say the least. We started off with a record SPX high of 2964.13 on May 1, then broke through the 200-day moving average by month's end for a 7% drop. The long dated U.S. Treasury bond as measured by the TLT-Ishares ETF rose 3.8%. The 10-year Treasury note ended with a 2.16% yield, the lowest since September 2017. 30-year conventional mortgage dipped below 4%.

Deciding within the final hour to take back certain trade concessions, China was swiftly lapped with 25% tariffs on much of their U.S. imports. For good measure, President Trump proposed a 5% tariff on Mexican imports if Mexico chooses not to provide more border crossing assistance.

The Fed is now forecast to cut rates 2 times in 2019, in an attempt to offset a serious economic slowdown. The Fed Funds futures market predicts a 72% probability of a cut at the July FOMC meeting.

Oil fell to a 3-month low in May and continues lower in June, now down over 20% from the spring peak. German 10-year Bunds yield negative 0.23%. Who would accept a negative return on Euros or Yen for the next 10 years? The Japanese sovereign bonds yield is -0.13%. Swiss 10-year yield is -0.52%. The Dutch have just joined the negative club, -0.06%. Can France be far behind?

Most Western governments have 2% inflation targets, yet growth in the Eurozone hovers just above 1%. Money policy in Europe remains accommodative.

Q1 US GDP was revised to +3.1%, however, forecasters at the World Bank see 2.5% GDP for 2019, down from 2.9% last year. China, the second largest economy is slowing to 6.2% GDP versus 6.6% in 2018. World economies are drifting downwards as central banks cling to QE, as long as it takes.

Earnings are still positive, but the rate of growth has dropped considerably from last year's +23% for the SPX.

FactSet noted the following on May 31:

"On March 31, the estimated earnings decline for Q1 2019 was -4.0%. Eight sectors have higher growth rates today (compared to March 31) due to upward revisions to EPS estimates and positive EPS surprises. Earnings Guidance: For Q2 2019, 84 S&P 500 companies have issued negative EPS guidance and 26 S&P 500 companies have issued positive EPS guidance. Valuation: The forward 12-month P/E ratio for the S&P 500 is 15.9. This P/E ratio is below the 5-year average (16.5) but above the 10-year average (14.8)."

It is hard to forecast earnings with conviction, but today's P/E ratio remains in line with the 5-year average. Goldman Sachs forecasts SPX earnings at $173 for the year.

Trade negotiations and tariff increases could add 1.25% to U.S. inflation according to Goldman Sachs. A combination of slowing growth and rising inflation is not very bullish for stocks.

Consumers and employees are happy with 50 year low levels of unemployment and attractive borrowing rates. CEO confidence has waned as uncertainties rise. We are 10 years into this economic recovery and nervous investors shifted dollars out of stocks in May.

Bonds are a safe haven for now, as the environment is stable but slowing. A recession is possible, but not likely in the next 18 months without an exogenous event. President Trump wants to remain in office and a good economy is required. His Chinese counterpart, Mr. Xi needs +6% GDP to retain his power base.

It is most likely we will get a trade deal or two by year end. Continued tariffs would likely lead to weaker equities. Most investors like higher stock prices as does President Trump. An untimely drop and recession in 2020 would hurt his chances for re-election.

Sell in May and go away seems to have worked for investors in 2019. A June bounce has just begun, let's see if can last. Watch government rates for directional clues.

  

Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services. 

May 2019

The Merry Month of May

We continue to experience a "V" shaped rally in the U.S. equity and credit markets. Low inflation, low interest rates and an easy monetary policy by the Federal Reserve Bank is creating background music for rising prices. Since the "December disaster" bottom at 2347, when fear of a U.S. recession brought on irrational selling, the S&P 500 has risen by 25%, and 18% year-to-date. AGG, representing Ishares Trust Core U.S. Bond market, rose 3% year-to-date. Foreign stocks rose 13% as measured by IEFA.

On May 1st, the SPX index reached a new all time high at 2954.13, slightly exceeding last October's all time high.

The concerns over imminent recession, inverted yield curves and trade wars have abated. The Mueller probe about Trump - Russian "collusion" is now history.

The U.S. economy expanded 3.2% in Q1-2019. Unemployment is at 50-year lows. In April, non-farm payrolls rose by 263,000, far more than expected. 5 million jobs have been added to the economy in the last 2 years. Unemployment rate sits at 1969 levels of 3.6%, with adult women at 3.1%. Inflation remains below the Fed's 2% target. 10-year U.S Treasury bonds yield 2.52%. Wages continue to rise, as does investor confidence. Productivity rose at 3.6% in Q1-2019. In summary, after 10 years of economic expansion, tax cuts, deregulation, plus a business friendly administration has the U.S. economy humming.

On the earnings front, according to FactSet, we observe slowing after last years torrid pace. They recently stated:

"For the first quarter, the S&P 500 is reporting a year-over-year decline in earnings of 2.3%, but year-over-year growth in revenues of 5.1%. Given the dichotomy in growth between earnings and revenues, there are concerns in the market about net profit margins for S&P 500 companies in the first quarter. Given this concern, what is the S&P 500 reporting for a net profit margin in the first quarter?

The blended net profit margin for the S&P 500 for Q1-2019 is 10.9%. If 10.9% is the actual net profit margin for the quarter, it will mark the first year-over-year decline in the net profit margin for the index since Q4-2016. It will also mark the lowest net profit margin reported by the index since Q4-2017."

Besides China Trade War negotiations, pundits are obsessed with a possible "earnings recession" and declining corporate margins.

Sometime in May, we expect the China trade deal will finally happen. Rather than face wider tariffs, we forecast China will give in to most U.S demands. If not, global stock markets will suffer. If we do have a deal, markets around the world are expected to rally further.

We have just begun the time of the year when stocks generally rest after a strong November-April period. "Sell in May and go away," is an old Wall Street saying. While a pause for stocks is over due, the traditional "wall of worry" is still in place.

Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services. 

April 2019

Q1-2019 Review

Q1 2019 saw the S&P 500 rally 13.1%. The yield on the 10-year Treasury, used as a reference rate for mortgage and many other rates, closed at 2.42% down from the 2018 year-end of 2.684%. Expectations of negative year over year earnings during Q1 are to be reported shortly. As the chart below illustrates, this has not happened since 2016.

The economy peaked in Q3-2018, as did the market, but the recession signal given by the nearly 20% SPX drop late in 2018, proved to be a false alarm. At 2867, the SPX is only 2.5% below its September 21, 2018 high.

While global economies show few signs of robust activity, the USA is still running GDP above 2% while inflation remains well below the 2% Fed target. 

U.S. retail sales slowed to +2.2% year over year in February versus +6.6% at the July 2018 cycle peak.

U.S GDP peaked at +3.0% in Q3-2018. Headline inflation peaked at +2.9% yr./yr. in July 2018. U.S Corporate profits also peaked in Q3-2018.

Last September economic forecasters expected 3 more rate hikes.

In early January, the Fed indicated it would be "patient" raising interest rates any further. Following the March meeting, Mr. Powell made an extraordinary pronouncement of "no further hikes in 2019." That was a rare occurrence of a Fed Chairman, reacting quickly to a slowing economy.

Some countries in the developed world again have negative rates out to 10 years, including Germany -0.05%, Switzerland -0.41%, and Japan -0.08%.

In an unusual late cycle pairing stocks rallied, while bond yields fell as Fed ease trumped recession fears.

Markets now forecast rate REDUCTIONS for later this year. Larry Kudlow, economic spokesmen for the Trump team, is calling for a 50 basis point reduction which again is very unusual.

In January, the markets declared "Don't fight the FED!" Central bank actions have dominated this entire 10-year cycle from the generational March 2009 bottom of SPX-666.79. When markets plunge central bankers react with lots of stimulus.

In 1966, economist Paul Samuelson famously said, "the stock market has forecast nine of the last five recessions." In 2018, the market got the forecast wrong again as the Fed changed course.

So far this year, we see no recession on the horizon, but we are seeing some smoke from this global slowdown.

The yield curve inverted, that is to say the 3-month Treasury yield exceeded the 10-year for the first time since 2006. While this can be an early indicator of a future recession, it is unlikely this situation remains the case for long, particularly if the Fed lowers rates later in 2019.

Copper prices stayed firm as the yield curve deepened and oil rallied past $60/bbl, both indicating a stable economy. West Texas Crude rose 32% in the quarter. This does not happen just before impending downturns.

As of April 1, the 2-year Treasury yield is 2.32%, while the 10-year is 2.48% not a very steep curve, but not inverted. Again not a recessionary sign. Long term rates are normally higher than short ones.

The Fed may have gone too far with their December 2018 rate hike. Soon after spooking the markets they clearly moved to the side of a more liberal monetary policy.

At current U.S.and global debt levels, central bankers and the political powers that be, really can't afford much higher rates due to record levels of government debt.

Strong sector performances last quarter included technology, utilities, REIT's, and oil.

Financials lagged badly, as banks prefer a steep yield curve and a strong economy.

China the world's second largest economy has begun to ease domestic credit policies, lower taxes and engage in serious trade negotiations.

European stocks and their economies still lag on trade concerns, Brexit uncertainty plus a strong U.S. dollar and weak local GDP's.

History indicates we may see more stock market gains in 2019 after such a strong start and future Fed policy ease.

Trade negotiations that are reportedly going well, could derail this rally if they fail. This is our main concern.

Now we await earnings reports for future guidance. FactSet sees a Q1-2019 earnings decline of -3.9%, the first year over year drop since Q2-2016. They estimate a forward SPX 12-month P/E ratio of 16.3X, below the 5-year average of 16.4x, but above the 10-year average of 14.7x.

Finally, VIX or the volatility index is back to 13.40 above last August's 10.17, but well below the spike of 36.2 we saw late December 2018. This indicates a calmer market environment, which attracts investors to risky assets.

Happy Spring!


Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services. 

March 2019

March Madness

Today is the 10-year anniversary of the generational bottom for the S&P 500 (SPX) at 666.79. The index has rallied 308% to date according to Bloomberg, while the World Index has rallied 102%.

Stocks in January and February sprinted to their best 2-month start since 1991 after their worst December since 1931.

In 1991, we had emerged from a recession and the first Gulf War. The SPX was in the early stages of one of its longest and strongest bull runs that continued over the entire decade topping at SPX -1556 in early 2000.

In 1931, we were in the midst of the Great Depression and the stock market was down 43.8% that year.

The S&P 500 closed February up 11.8% year to date.

Recently, Q1 2019 earnings estimates have dropped by 6.5% to $37.60 from $40.21 according to FactSet. The stock market year-end drop, combined with a partially closed Federal government, had a negative effect. Weaker foreign economies also contributed.

This amounts to an above average earnings decline versus the past 20 quarters of -2.4%. However Q1 2016 saw an even worse earnings drop of 8.4%, after which the market went on to new all time highs.

Earnings rose 23% in 2018, yet stocks dropped 4.2%. Just reported, Q4 2018 earnings have posted a 13% gain and stocks are soaring.

Fear or greed determines investor sentiment, which sometimes drives prices too far in one direction or the other.

Trade wars and Fed policy both created uncertainty and have trumped earnings reports over the past 5 months.

After the latest run up, we are near resistance of 2800 on the SPX. The index is back to October 2018 price levels. Stocks drop like an elevator and rise more like an escalator.

Timing markets is clearly not easy as many factors come into play. As prices drop, investors typically stop buying, even though stock prices are getting cheaper.

Bond yields as expressed by 10-year US Treasuries have gone from 2.5% on January 3rd to 2.72% today. The Federal Reserve moved from a tightening stance in 2018 to a "patient" approach regarding further rates hikes as of January 4th. Perhaps they reacted to the stock market's 20% plunge from October - December?

Wages are rising for every level of employee, yet inflation is below 2%.

As the cycle ages, recession fears fester. An overheating economy does not yet appear to be in the cards for 2019.

According to the OECD, China is expected to grow GDP at 6.2%, the EU at just 1%, and the U.S. at 2.6%. Global economic output in 2019 is expected to increase by 3.3%, if trade does not slow materially due to tariff wars. Markets and investors anxiously await the outcomes of China-US, US-EU and Brexit-EU trade negotiations.

Tariffs are simply a tax on consumers, and if prolonged and intensified will eventually slow global economic activity. Stocks are cheap relative to bonds but earnings uncertainty is great and comparisons are getting more difficult.

After the recent “V” shaped plunge and market bounce, it is a good time to check your personal risk tolerance and investment goals.

If you found it hard to handle drops in your account balances, you likely have a lower tolerance for risk than you may have thought.

Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services. 

February 2019

What a Difference a Month Makes

After the worst December since 1931 stocks rallied for the best January since 1987. The SPX rose by 7.9% for the month.

Stock market pundits, after three horrid months October through December 24,  saw the 20.2% SPX decline as a harbinger of a coming recession.

Then the new year began and tax selling stopped. On January 4, the Federal Reserve Chairman Powell, clearly stated the march to ever higher rates was coming to a halt. Trade talks with China were back on track.

Despite a record long partial government shutdown over funding the Wall, which further highlights the political divide in our country, the stock market bounced and bounced and bounced again. Half of the prior three month swoon was erased, as fear of loss turned to fear of missing out.

Last Friday, after the January Fed meeting and reiterations by Mr. Powell of his new patient data dependent policy, a January jump of 304,000 new jobs was reported. This marked another in a long string of job gains far exceeding the pre-Trump economy, all without an inflationary basis. While the unemployment rate rose to 4%, previously sidelined workers found jobs, increasing the participation rate.

This trend in job creation led most economists to put off recession forecasts until 2020. With 2020 being an election year, the government has in past decades pulled out all the stops to keep our economy humming.

We now see a market landscape pocked with negatives namely an early stage trade war, global GDP slowdowns in China, Europe and Japan, political strife here and abroad plus, the beginning of a divisive Presidential campaign.

What is an investor to think, never mind do, with hard earned funds?

A famous market technician, Bob Farell once stated, "Excess leads to an opposite excess." Euphoria turns to despair. Then we slowly rebuild confidence.

During volatile markets, many investors review and reassess their goals and redefine a time frame for future cash needs. Risk tolerance levels are tested during sharp market declines and sometimes investors realize they cannot handle wide swings that come along with large equity allocations.

Everyone loved 2017 for its unusual above average returns and low volatility. Thus, 2018 started with high confidence, ended with big volatility and investor sentiment plunged. CEO's put capital spending plans on hold and analysts lowered earnings forecasts. A strong U.S. economy coupled with 23% earnings growth did not stop a steep market decline. In January 2019 analysts lowered Q1 earnings forecasts 4.1 %, the largest decline since the - 5.5% of Q1 -2016.

J.P. Morgan, the banker, when asked for his opinion on the market famously stated,  "stock prices will fluctuate." No one can consistently predict what the stock market  will do in the short term. What we do know is that an aggressive stock allocation requires a strong stomach and a long time frame. If you can't deal with market swings you need to reduce risk exposure in your portfolio or you might reactively sell at a very bad time.

Warren Buffet stated he'd rather a larger return with more volatility than a smaller return with less volatility. Most investors dislike falling prices but some like Mr. Buffet enjoy the buying opportunities most declines present.

Unfortunately, the days of strong bond returns with low credit risk are mostly in the past. Yields on 10 year Treasuries peaked at 14% in 1984 and bottomed at 1.32% in 2016. Long term government yields were 2.25% in 1946, 3.25% in 1956 and sit at 2.73% today.  A lot of volatility occurred during those decades. Last year bond returns did not offset or cushion the stock market slide.

The governments of China, Japan, Europe, Britain and the U.S. have tried to smooth economic cycles with both monetary and fiscal policies over time. Some attempts have met with success and others failure. Economic cycles cannot be repealed by government policy or decree.

The Fed was created as a lender of last resort and was needed in 2008 but it has also caused recessions with tight policies. Earnings growth plus Fed ease or contraction cycles push stock prices up or down. Timing is always uncertain as markets in the short run often move with emotions and headlines.

In 2018, SPX earnings grew 23% , which did not stop a 6% SPX price decline. Earnings will grow again in 2019, +4-8% with a consensus 2019 estimate of $172. GDP will likely rise about 2.5%. The rate of earnings growth this cycle has clearly peaked but value defined solely by the market P/E multiple has dropped from 18x in early 2018 to 15.7x today.

The good news is that oil prices have rallied, recession fears have abated, Fed policy has gone neutral to dovish. China trade talks are progressing against the March 1 deadline. This long expansion cycle may be extended with steady interest rates and pending trade deals.

America, according to letter writer Jim Grant, required 192 years to amass its first $1 trillion in gross public debt. Now we have a $22 trillion fiscal deficit growing by $1 trillion this year. Corporate debt has also reached new highs with 50% of that total rated BBB, only one grade above so called "junk" status.

Despite conflicting conditions, we see value in certain areas of both the stock and bond markets. Emerging market stocks are attractive relative to U.S and European stocks. The U.S market has out performed foreign markets over 1,5 and 10 year periods but growth in EM economies will likely exceed U.S growth this year. The strong U.S. dollar has given up ground year to date versus a basket of trade weighted currencies easing profit headwinds.

In the U.S. we eventually deal with economic problems even though it often takes too long and the politics surrounding issues can get very ugly. Over long periods of time stock prices climb as the economy grows.

We are now energy self sufficient, we lead the world in technical innovation and health care breakthroughs. We have a huge manufacturing base that thrives with far fewer workers. Since 1970 our GDP is up 250% making us the richest economy in the world. We have population growth and over one million immigrants per year adding their talents to our economy.

With time, patience and a proper asset allocation, depending on your personal risk profile, an equity laced portfolio will likely increase in value. Given a slowing global economy, dollar based bonds have attractive yields.

We anticipate another volatile year but with positive results.

Please let us know if you wish to talk about your account, discuss your risk tolerance or redefine your financial goals.

The year has gotten off to a strong start just like last year. We shall see if slower growth with positive earnings can lead to better price action.

Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services.