Markets in Minutes
April 1, 2019
S&P 500 10 Year Treasury Gold World Ex-US US Dollar Commodities
Markets in Minutes is intended to give our client partners and subscribers a quick and easy understanding of current market conditions. This update covers January 1 – March 31, 2019
Investor Learning: “A year is far too short a period to form any kind of an opinion as to investment performance, and measurements based on six months become even more unreliable. One factor that has caused some reluctance on my part to write semi-annual letters is the fear that partners may begin to think in terms of short-term performance which can be most misleading. My own thinking is much more geared to five-year performance, preferably with tests of relative results in both strong and weak markets.” — Warren Buffett
Manager’s Note: Once again, Wow. What a quarter. The speed of this bounce back from the aggressive sell off in Q4 was something to see. Investors figured out the world wasn’t ending in January despite media assertions to the contrary and bid the market up almost as aggressively as it fell last quarter.
After a 21% run up from the December 24 low the market was due some corrective action and we recently experienced a -3.3% pullback. However, there are some catalysts on the horizon that may limit the near-term strength of the rally from the early March pullback.
Q1 earnings will likely be weak due to the Gov shutdown, severe weather effects, and the seasonal holiday hangover. Spending seems likely to pick up post shutdown, and weather damage will mitigate. This will form a tailwind for Q2 earnings.
Combine weaker Q1 earnings with expected stronger Q2 earnings, an accommodative Fed, a still growing economy (albeit slower growing) with the possibility (or not) of a trade deal and the table is set for a lot of indecision on the part of both bears and bulls.
In my view, that translates to prices moving within a range until we get more visibility on Q2 or the China deal.
For investors getting new cash to work in the market, holding some cash back to buy dips can be an effective approach. It’s also important to get some money to work, as Peter Lynch, record setting manager of the Magellan Fund, rightfully observed “FAR more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”
So that will be the strategy for new cash until the market breaks out to new highs or the Recession Probability Indicator sounds an alarm: Get some to work via dollar cost averaging in case the -3.3% correction is all we get, but keep some back for the dips that Q1 earnings may cause.
S&P 500 (SPY): +13.5% for the period, +13.5% 2019. Big run off the December low, with a vanilla -3.3% correction in March. Longer term fundamentals are still sound, but near-term headline risk is present, as always.
Bonds (TNX): -10.1% for period, -10.1% for 2019. Ten-year bond yields began to fall aggressively in mid-November and are now down over -22% since then. Yields are becoming even less attractive, while principal risk seems elevated unless the US moves into recession. Treasury bonds are now in a zone of uselessness from an investment standpoint. Corporates, many muni’s and others bond types offer higher yields, but also higher correlations with stock markets but considerably less growth opportunity. Not a great space for investment dollars now. There are interesting opportunities in MLPs and Fixed Index products right now that make better bond alternatives.
Gold (IAU): +0.7% for the period, +0.7% for 2019. Gold once again is failing to fulfil the promise of its pundits. As before, expect it to benefit from any bouts of serious volatility due to it’s liquidity and the current inverse correlation with equity markets (which may or may not last).
World Ex-US (SPDW): +10.4% for the period, +10.4% for 2019. It seems analysts can’t get enough of pushing the invest-outside-the-US theme. In the meantime, markets outside the US suffered far more during last year’s correction and to-date lag the US recovery. Economies in Europe and elsewhere are measurably weaker (and weakening faster) than the US economy, and as I’ve said before, when the US economy catches a serious cold, the developed world catches the flu, and emerging markets sometimes catch Ebola. Time may prove this one wrong, but I still favor US markets over all others.
US Dollar: +0.6% for period, +0.6% for 2019. The dollar hit a new high for the year in mid-December before softening slightly into year end. From a technical standpoint, it still looks like the dollar could go up or down from here. Continued dollar strength above 95 is likely to negatively impact the earnings of US multi-nationals and the balance of trade, as we saw last quarter.
Commodities: Oil +31.4% for period, +31.4% in 2018. A big rally off the Q4 implosion in oil. Venezuela’s economy and ability to pump oil has basically reached a standstill, and US restrictions on Iranian oil are hitting supply. These factors have combined to support the current rally. In the meantime, the Saudi’s are planning to reduce output by 1% in 2019 to support oil prices, but all non-OPEC producers are going to pump what they can and will be ramping as prices rise. Balanced against that is the greater efficiency in American oil and the targeted rising domestic production. My expectation is this dichotomy will hold oil in a range from $45 – $65 with spikes above and possibly below. Below $60 is a tailwind to the American economy. Below $70 is neutral to the American economy and above $70 becomes a bit of a headwind, although it benefits the sector.
Copper futures up +10.9% and +10.9% for 2019. This is probably driven by optimism that a US China trade deal will materialize rather than reflecting the continued industrial expansion in the US. If a China/US trade deal occurs, the rally seems likely to steepen.
Consumer Prices were flat in December and January, followed by a small gain 0.2% in February. Ex-energy and food, inflation was stable for the period, running just over Fed targets at 2.1% but down including food & energy. The FED recently announced the planned path of rising rates has been put on the backburner in the near term and sees a slower growth economy with potential event risks.
Industrial production is still in expansion mode, with activity rising from the December low to finish with a reading of 55.3. Order backlog appears to be growing, and inventories appear low. The trend of slowing growth has slowed. Low inventories and backlogged orders are signs of impending growth.
The Non-Manufacturing Index remains robust and near cycle highs at 59.7. 70% of the US economy is services, so this continues to be a bright spot in the US economy.
Official Unemployment was stable at 3.8% in February, near multi-decade lows. The U6, which better reflects the situation, is at 7.7%, down from January’s 8.8% but still above the November reading of 7.2%. As before, there is little slack in the job market, and this will impact wage inflation at some point. This is a net positive for the economy, provided wage inflation doesn’t increase too rapidly. Decembers reading of 2.9% annual wage inflation suggests wage inflation is still moderate.
Recent market behavior and media rhetoric aside, the US is still in the Goldilocks zone: moderate inflation, solid employment, historically low real interest rates, rising GDP and corporate earnings (with the expectation of a poor Q1 earnings report due to factors discussed above).
Earnings: Despite the Gov shutdown and weather effects, earnings expectations for 2019 remain positive, and are still expected to grow in the 5% – 8% zone, which is supportive of a continued bull market and puts a fundamental floor under current valuations.
Market Valuation: Based on the closing price on March 29, on an equal weighted earnings basis, the market is trading approximately 3.7% above fair value. Prior the the December lows, the market hasn’t been this inexpensive since October 2015, excluding the corrective action we just came through in December 2018. Given the likelihood earnings growth will restart in Q2 this is not a bad entry point for long term investment.
Recession Probability Indicator: The most recent reading on the RPI is 17. The RPI is still indicating we are not currently in recession and the investment environment is stable, despite volatility. The uptick from the last reading of 12 is likely a result of the Gov shutdown/weather/tariffs, at least 2/3 of which are temporary. CLICK HERE to learn more about the RPI. Update coming soon.
A brief note on headline risks as we move deeper into 2019. Italy continues to be a risk, as does Brexit, but the real mover is the US/China spat. As expected, Democratic control of the House has resulted in headline after headline that rattles investors as criticism of the President and his policies ratchet up and demands for more regulation and taxes increase. There may still be an attempt to impeach, which the market is not likely to appreciate. The trade deficit is still the stuff of nightmare, which probably has the President holding the line on what the US must have out of a deal. At some point, China must ink a deal. Ideally, the are smart enough to do it before their economy implodes.
This is WHAT IF stuff. History has shown that WHAT IF is not important until it’s WHAT IS.
WHAT IS: My expectation of a dovish Fed vs. the media calls to the contrary last quarter has been confirmed. American markets remain the most stable and liquid in the world, with a positive investment backdrop – low interest rates and a supportive Central Bank, low inflation, rising annual if not quarterly earnings (earnings rising at 5% rather than 20% are still rising), & a growing economy. America has never imported a recession. Stay tuned….
S&P Technical Picture: The S&P experienced a strong rally off the December low, and appears to have resumed the previous intermediate uptrend, subject to upcoming earnings reactions. At approximately 4% below all time highs with the probability of weaker Q1 earnings, I would expect bears to assert themselves when we approach 2930 and bulls to do the same at 2750 to 2800. The area in between is a short term no man’s land until we get visibility in Q2 earnings or a China deal quashes the bears.
The primary trend (and the previous intermediate uptrend) are identified by the red arrows below the green lines, Fair Value by the thick blue line. With the market only slightly above Fair Value, there is little reason for long term investors to be concerned about entry.
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As always, get in touch with questions or concerns. If the prospect of additional volatility in 2019 alarms you, let’s talk about ways to shift your portfolio so you can live without worry.
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