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CANEY CREEK REPORT - Year End Review and Outlook

| December 31, 2018
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Each year at this time we find it instructive to review our forecast from a year ago compared to what actually happened. It helps put things into context as we make our fearless forecast for the new year. A bit unfortunate; our last year’s forecast was pretty much on the money.

For 2018, we will grade our forecast an A. We expected GDP to grow some 3.5%. We expected corporate earnings to be great, with Standard & Poor’s 500 earnings of about $160 per unit. We thought that inflation would increase to about 2.5%, and that the Federal Reserve would raise overnight interest rates to 2.25%. We also thought that the 10-year US Treasury Bond would finally reach 3%. All that turned out about right.

We said corporate bonds would have a negative total return for the year and that municipal bonds would be the best performers in fixed income. That was correct.  Oil traded in the $50-70 range we predicted. And, gold managed to outperform both stocks and bonds as expected.

We said that the S&P 500 would trade in a range of 2400-2900 for the year. That turned out to be true. But, unfortunately, the high end happened in January and the low end in December. In our letter at the end of January 2018, we urged caution suggesting the market was “overbought” based on sentiment that was too Bullish. Stocks ended up with a down year. But, it was not terrible after such a great year in 2017.

Every new year presents some serious problems for forecasters. 2019 offers the most difficult challenge since the Great Recession. But, here you go.

In the new year, the economy will remain positive; growing on average about 3%. But, growth will slow in the second half to about 2%. Inflation will remain above 2% for the year, but start to accelerate in the second half. Fed funds will increase by 0.25% - 0.50% in the first half of the year. The 10-year Treasury will remain at a yield of plus or minus 3%.

Corporate earnings will be hurt by declining margins due to higher wage costs and a recovery in commodity costs. Oil stays in the $50-$70 range, which means it rises from the current low end of the range. Gold again outperforms stocks and bonds as the dollar weakens for the first time in years. Bonds manage a positive return for the year.

My best guess for stocks is that they remain in about the same trading range of 2400-2900 on the S&P 500. I think the earnings for the S&P companies will not grow much above this year’s $160 per unit in 2019. However, in 2020, I think earnings could start to grow again. So, unlike this year, we should be moving toward the top of the range in the second half of the year. Earnings comparisons will be difficult throughout the year. But, by summer the market will be anticipating earnings improvement in 2020.

Fortunately, market sentiment is almost the opposite of last January. There is now money on the sidelines needing reinvestment down the road. I don’t think stocks can break out to new highs in 2019, but a recovery in the S&P 500 back to the top of the range would result in a great return for the year.

Clearly, there are risks that the talking heads on CNBC point out every day - Brexit, China trade, Fed overshoot, politics, etc. Most of them will work out OK. But, I am concerned about politics. Mr. Mueller’s report will likely be out in February. With the new Congress, it could be a volatile time. The bottom of the range could be tested. That would be a buying opportunity.

Have a healthy and prosperous New Year!

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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. 

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