The markets continue to recover in the wake of what has been an uneventful week in terms of news, or more specifically the lack of bad news. As mentioned in our prior weekly market overview article, we’ve come back to a more normal “bullish environment”, which implies reduced volatility and lower trading volumes.
The pullback in equities towards the end of 2018 is still
fresh on the minds of various investors and traders alike. However, broad
market corrections of 10-20% are fairly common and tend to happen every year or
every other year. The prior stock market correction troughed on February 5th,
2016 with the S&P 500 finding a base at $1,880. Following the correction,
the S&P 500 advanced to $2,990 by August 31st, 2018. This
implies that if anyone had sold shares at $1,880 the same investors would have
missed index returns of 59% over a two-year timeframe.
The key take-away? Staying invested in equities following a market correction works way more effectively (historically), hence we continue to maintain the same optimistic stance. Staying on the sidelines rarely pays dividends following a market correction, and absent of economic headwinds, stocks will continue to trade on fundamentals as opposed to market-themed headwinds or tailwinds.
Where can investors
find alpha (returns above market)?
In general, when dealing with individual equities, the stock
that are likely to outperform will be less correlated to the broad market and
will deliver returns based on their long-term earnings/cashflow growth, and the
ability to return capital to shareholders via share buybacks.
In this environment, growth stocks that are anticipated to
grow sales and earnings at a quicker rate than the S&P 500 will outperform
the market with more predictability than say a counter-cyclical trade where
you’re investing into defensive stocks that have great dividend payouts and
stable business outlook, but mediocre growth metrics.
Diminished volatility, and volume penalizes defensive stocks and tends to favor growth stocks that are more volatile. With volatility diminishing across all equities, the volatile growth stocks tend to skew more favorably in terms of daily gains/losses, hence those with more risk appetite will find more opportunities to generate returns in companies that generate revenue/earnings growth in excess of 15%-20% annually. The downside to growth stocks is how poorly they perform when the market itself is performing poorly or they miss on sales/earnings estimates. So, implicit in my assumption is the continuation of the up-trend for the S&P 500.
When will we test
I anticipate that we will re-test the prior all-time-high at
$2,930 (which was set on September 20th, 2018) within the next
several weeks, if not the next couple months.
I’m anticipating the market to struggle with breaking past this level with some consolidation, but I don’t anticipate the market to not break past the all-time-high, either. In other words, we could be testing the 2,900 to 3,000 levels on the S&P 500 for several weeks before we eventually break past on low volume, and capital inflows into the equity markets.
When entering into “uncharted territory” technical
indicators become less effective, and most of the gains are attributed to
collective business fundamentals, or the number of companies among the S&P
500 that were able to report sales/earnings beats as opposed to market
commentary from the federal reserve or treasury for that matter. Since Q1’19
earnings will be reported from the week of April 15th, which is just
1-month away there’s reasonable runway to the current market rally, and we
should anticipate a re-test of market all-time-highs over the course of Q1’19
Economic news of the
week and what to expect next week
The CPI (consumer price index), which measures inflation
fell by 0.1% month-on-month. This drop-in inflation was perceived to be “good
economic news.” Hence, CPI came in at 2.1% versus 2.2% for the month prior.
The lack of inflation diminishes the willingness of the
Federal Reserve to raise interest rates, which in turn keeps investors
optimistic, because higher interest rates are heavily correlated with the end
of an economic cycle. Basically, the higher the interest rate, the less likely
the economy will continue to exhibit money multiplier as consumers and lenders
lend/borrow less until the interest rate falls for both prime and subprime
Because inflation has remained relatively steady at 2%
there’s little incentive for the Federal Reserve to raise interest rates, which
has kept economists optimistic on a dovish Federal Reserve across consensus
macroeconomists on Wall Street. The lack of inflation paired with GDP growth in
a tight 2-3% range keeps expectations to a single rate hike from the Federal
Reserve in 2019.
Furthermore, 2020 outlook suggests some deceleration in
real-GDP growth, which may keep the Federal Reserve side-lined during the
political election cycle year. Some economists anticipate that the Federal
Reserve may not even raise interest rates in 2020, which could be helpful given
the bumpiness in the current political environment, and on-going gridlock in
Congress/Senate when passing bills or amassing political capital for pro-fiscal
Also, the Federal Reserve or FOMC (Federal Open Market Committee) is expected to meet next week on March 20t, 2019. Economists expect the interest rate to remain unchanged with diminished growth outlook from the Federal Reserve next week.
soak-up headlines on economics but nothing will likely come of it
We’re likely to witness another round of gridlock when
congress/senate votes on budget measures in 2020, but those risks aren’t so
substantial that it would derail on-going economic expansion (as we had
witnessed in 2019). Expect a lot of headline activity from both political
parties with regards to political promises and campaign trail commentary along
with economic promises as we move through 2019 in anticipation of the 2020
presidential election cycle.
But, despite the uptick in political commentary (as is
customary in election years) incumbent presidencies tend to win around 70% of
the time historically, so on the political front, we’re likely to witness the
same status-quo of the Trump presidency since 2016, which implies the same
stance on taxation, and fiscal policy, which have been pro-growth or
inflationary in nature.
For those who don’t like the current President, the
percentage odds don’t favor you, but then again, a raving billionaire has produced
some green shoots for the economy. Pro-economic policies or an aversion towards
higher taxation, or various other policies for the following 4-year term until
2024 could diminish political themed risks with most of the attention geared
towards congressional/senate elections as opposed to the presidential primary.
This also means a continuation of the usual tweet storms from Donald Trump, and
on-going political hysteria from mainstream news outlets for the following
presidential term as well. Basically, a continuation of the past four-years
seems to be in the cards, but that might not necessarily be a bad thing.
tensions have eased in the past couple weeks
In an interview on CNBC, March 14t, 2019 Treasury Secretary, Steve Mnuchin mentioned that neither President Xi or President Trump will meet at the end of this month to make a formal agreement on trade. This was followed-up with positive commentary on progress with regards to the trade agreement, and on-going efforts to improve upon the agreement before making any formal attempts to bring either president onboard to sign a trade deal.
It seems like progress has continued on this front, but
there’s unlikely to be any newsworthy developments over the month of March, as
there’s a lot of “work involved.” The Trump presidency has made numerous
attempts in the past couple months to highlight the trade imbalance, and any
positive developments here could get us over the hump and move past the Chinese
versus U.S. headlines once and for all.
While improvements in trade could positively impact certain
U.S. companies (dependent on sector) the absence of noise pertaining to U.S.
trade talks following an agreement (if made within the next couple months)
would be a positive catalyst in and of itself. We’ll continue to monitor the
Chinese versus U.S. trade discussions but expect very little headway for the
duration of March.
points on money flows
U.S. equity inflows and U.S. bond inflows ticked
considerably higher according to Bank of America Merrill Lynch, with equities
inflows totaling $14.2 billion this week, and bond inflows totaling $9.2
billion. Investors have re-entered a risk-on phase, and with limited negative
commentary on both economic/political fronts there’s a build-up of anticipation
for corporate earnings season.
In terms of Forex Exchange flows, the USD experienced a modest net inflow of 1.8% over the past week, and a 4-week inflow of 0.5%, according to UBS (March 14t, 2019). The modest dollar inflows mostly reflected some of the divergence in investment activity among global investors whereby U.S. equities had a surge of cash. In comparison, Emerging Markets and Eurozone logged a net equity outflow of $2.8 billion and $4.6 billion respectively according to BofAML (likely due to Eurozone growth forecast reductions which were outlined in our prior market commentary).
The inflows into the USD didn’t trigger a rally in the U.S.
dollar index (surprisingly), as the dollar index peaked at $97.61 and is now
trading at $96.49 (month of March). Investors monitor the U.S. dollar index to anticipate
currency adjustments on foreign sales and earnings. However, the tight range of
$95-$98 of the dollar index diminishes the impact from currency adjustments.
Historically, flat currencies have been supportive of
revenue and earnings for multinational companies among the S&P 500 who
report FX adjustments to reflect actual revenue. In this case, investors should
anticipate a currency neutral earnings season, as the trading range for the
dollar index has stayed within the $95-$98 range since October of 2018.
Therefore, the likelihood of a revenue miss due to currencies has diminished,
which should add some optimism heading into April earnings season.
In terms of equity inflows, the biggest buyer of equities
has been corporates. More specifically share buybacks, as the net corporate buybacks
among S&P 500 stocks have increased to $286 billion versus $197 billion
(prior year). The impact from share buybacks helps explain the improvement in
stock performance to start the year despite year-to-date outflows of $46
billion in U.S. equities according to BofAML. This paired with U.S. index
option open interest trending considerably higher ($544 billion), and positive
retail investor flows of $13.2 billion year-to-date.
The next leg of the rally might be driven by institutions, as
buying from institutions lagged in comparison to retail investors and
corporates year-to-date. This paints a fairly bullish picture over the
Furthermore, the on-going buyback craze could continue, as
companies tend to update shareholders on their buyback plans over the course of
corporate earnings season with some notable announcements coming predominantly
from tech giants which have massive amounts of cash sitting on their balance
sheets. Companies like Apple, Alphabet, Microsoft, Facebook, Qualcomm, Intel
and so forth tend to make updates on their corporate buyback plans, and it
would not be surprising to see the usual cash rich tech cohort make additions
to their buyback plans during this time of the year.
Equity investors are back on the offensive again, and
bullishness is returning. Despite all the concerns over the economy, or how
long the cycle has lasted there’s a lot of good to anticipate in the coming
weeks. Very little to anticipate on the political front, which is good. It
means investors can direct most of their attention on how well individual
stocks are performing as opposed to political theater.
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