November made me tired. Perhaps it was the breathless mainstream news coverage of the midterm elections that in the end produced the most predictable result - a somewhat divided government. There was certainly no mandate for the left or the right.
Maybe it was the incessant coverage of the “trade war” with China that some in the news media started to call a new cold war. Of course, it is not a new cold war, and as of last night we heard news of the predictable result of the meetings between the leaders of the US and China - a 90 day cooling off period while negotiations continue.
Or, it could have been the clamor of the talking heads on CNBC claiming that Federal Reserve Chairman Powell was eager to raise short term interest rates to the sky and cause a new depression. In a speech last Thursday, Mr. Powell made clear that he was “data dependent” and that Federal Funds rates were not that far from “neutral.” Never mind!
All of this noise resulted in a lot of volatility. The Standard and Poor’s 500 ranged from a high of 2814 early in the month and a low of 2633 just before Thanksgiving. It closed at 2760, pretty much where it began the month.
However, there were some significant changes that occurred beneath the churning on the surface. First, and importantly, equity market sentiment which had been wildly bullish for most of the year, retreated back to “neutral.” Finally, there has been some fear put into investors. Investors Intelligence reports some 38% Bulls (down from over 60%) and 21% Bears (up from 11%).
The numbers are not in screaming buy territory where there are more Bears than Bulls. But at least it indicates an end to complacency. That is a good short-term sign. That, and the signal from the Federal Reserve that they may be closer to slowing their intended increase in the Federal Funds rate, should allow Santa to come for the stock market over the next three to five weeks as usual. I would be surprised, however, if the market is able to reach the September high of 2930 on the S&P 500.
Several things are pointing to slower economic growth in 2019. The economies of Germany (down 0.2%) and Japan (down 0.3%) contracted during the month. The yield on the US Treasury bond maturing in ten years declined from 3.25% early in the month to close the month below 3%. Housing has fallen off a cliff. And, the price of oil has fallen from $86 per barrel in early October to $50. All of these are early telling of slower growth next year.
Yet, earning estimates for companies have not been coming down commensurately. A few top town forecasters have cut estimates for the S&P Index. But few analysts have cut numbers on individual companies. Back in September, the consensus estimates for earnings for a unit of the S&P 500 was $180. Today, it is $178. Now that a growth slowdown is apparent, there is a good chance that earnings won’t grow much above the $160 estimated for 2018. Don’t expect the market to breakout to new highs until earnings expectations fully reflect a slower economic growth rate. That could be midyear.
Meanwhile, credit markets are tightening. Bank loan funds have been under pressure. Corporate bond spreads (the yield above US Treasuries) are widening. That is especially true for below investment grade bonds. The capital market is beginning to ration credit after years of easy money. The impact of “quantitative tightening” by the Fed as they allow bonds on their balance sheet to mature and not be replaced will be to reduce bank reserves and tighten credit. That will slow things more.
Enjoy the yearend rally in stocks. But, keep a weather eye on late January/ February. After years of buying the dips, we may well be in a new phase where we need to sell the rallies for a while.
A note from WSC and WAMI . . .
Robert C. Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.
CANEY CREEK REPORT - Santa Should Come
December 04, 2018|