August 2019

Summer Heat - July 2019 Recap

The Federal Reserve moved on the last day of July to cut rates by a quarter of one percent, the first reduction since 2008.

Concerns by investors that this cut may be a "one and done," along with another round of China tariffs the following day, hurt stock prices after a positive July +1.31% SPX.

This is only the fifth time in 25 years the Central Bank switched from raising to lowering rates, according to the Wall Street Journal.

The beleaguered Fed Chairman, Jay Powell, is trying to balance concerns about a weaker global economy and a strong domestic one. The SPX closed on July 31st at 2980, -1.1% on the day, snapping a 36-session streak of less than 1% move in either direction.

10-year US Treasury notes closed July at 2.034%, while the WSJ Dollar Index rose to 91.25 near a 12-month high. Today they trade at 1.85%.

Fed officials said they would end their runoff of the $3.8 trillion asset portfolio two months earlier than planned. In other words, they are no longer tightening monetary and credit conditions.

The U.S. unemployment rate in June was 3.7%, near a 50 year low. The U.S economy grew at 2.1% in Q2-19 seasonally adjusted. Year over year U.S. wages are rising at 3.5%, and the Savings rate is 8% according to Larry Kudlow, the Chief Economic Advisor to the President. Job growth in the U.S. has averaged more than 170,00 new jobs per month. The biggest beneficiaries of these trends are the working population.

Manufacturing is slowing. However, housing is gaining strength in many areas of the country, particularly for the entry level home buyer. Core C.P.I rose only 1.6% for the year ending in June, below the FED's 2% inflation target.

In past cycles, when there was no recession and the FED cut rates, stocks did well the following year. Small rate cuts in both 1995 and 1998, were followed by strong stock market action.

In 2007, the last time we saw the start of a rate cut cycle, FED funds were 5.25%. However, a recession and financial crisis was only a year away.

The odds of a recession going into a Presidential election year are low. Yield curves have inverted, but not at the closely watched 2-year to 10-year Treasury spread level.

With 77% of companies in the SPX reporting EPS so far the earnings decline is -1.0% for Q2-19. Revenues are up 4.1%. Materials have negative growth and Industrials have no growth. All other sectors were up, led by Communications and Health Care.

The forward 12-month P/E ratio on the SPX was 16.8 x the end of July. This P/E ratio is above the 5-year average of 16.5 x, and the 10-year average of 14.8 x, according to FactSet.

With strong gains from stocks, bonds and gold through July, some profit taking in August has already begun, and may continue as trade talks ebb and flow.

President XI seems to be waiting out President Trump's term in office. In the first half of 2019 China dropped to our number 2 trading partner, after Mexico.

Go out and enjoy the summer breeze! We still have the monetary wind at our backs. Our economic sails are at full beam reach and domestic seas are generally smooth.

Don't be surprised if we get a summer swoon in markets after a 19% jump for stocks year to date. August and September are often bumpy.

July 2019

First Half of 2019 - Review

At the end of June, the S&P 500 index stood at 2941.76, +25% from 2346 low 0n December 26, 2018 and just below the October 2018 high of 2944. The Q4-18, 20% decline is a distant memory.

The broader Russell 2000 index still remains 10% below its 1742 high made on August 31, 2018.

Yields on the 10-year U.S. Treasury dropped to 2% on June 30th, well below the nine-year high 3.24% on October 5, 2018.

U.S. GDP is slowing from the revised 3.1% Q1 level but not dramatically. Fear of a global recession permeates government bond markets, in the developed world, with negative rates on $12 Trillion of debt in Germany, Switzerland, Holland, France and Japan.

S&P 500 earnings have increased from $60.80 in 2009 to an estimate of $167 in 2019, according to Yardeni Associates. At 2973 the index sells for 17.8 times forward earnings, with a 5.6% earnings yield. This compares well to the U.S. Treasury "risk free rates" of 1.98% on 10-year notes.

Unemployment is at 3.8%, a 50 year low. Inflation is below 2%.

Mexico and Canada, our largest trading partners, have agreed on a new trade deal. China, Europe and Japan are likely to follow. The U.S. leads the world in technology, food production, energy production and total wealth with merely 5% of the global population.

We are mindful that the economy is in the 11th year of recovery. Valuations depend on earnings and interest rates, and both support current stock prices.

Our markets have outperformed foreign markets, despite values being cheaper abroad. Growth stocks have outperformed value stocks over this cycle. We acknowledge that we trade near the top end of the 10-year valuation range, however stocks remain cheap relative to bonds.

With the SPX up 17.3%, and the DJIA up 14% through June 30th, some believe the market may falter, as earnings comparisons remain difficult for the next few quarters.

The Fed is more accommodative in 2019 versus last year. The market anticipates 2 rate cuts by year-end, starting in July. Some call this market “Goldilocks,” while others the "Twilight Zone,” but it keeps on keeping on no matter what you call it.

Happy July 4th and God Bless America!

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.

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.