All the dominoes fall
As we sit here with barely two full trading weeks left in the year, the bears' hope for a late Christmas gift of something going wrong have instead become a wall of dominoes dropping on them. I wish I could tell you I'm sorry, but I'm not. We've been warning the pessimists for some time that from our viewpoint, the odds were high we'd close to the north of our 3,100 year-end target on the S&P 500, and now are well above and making early ground on our 3,500 forecast for 2020. That optimistic outlook for next year, which seemed like news when I first mentioned it on national television a month ago, looks more attainable if not unremarkable today. More on 2020 later; let's summarize what's happened as four big dominoes fell this week.
- Trade truce with China Although there were many skeptics, our call has been that Presidents Xi and Trump had enough of their trade war for now. China needs a boost going into next year to get its economy back on track, and Trump has an election to win and needs continued growth at home to do it. I'm sure they'll get back to fighting about unfair Chinese government policies on intellectual property theft enforcement, cross subsidies and generally less open domestic markets … after the election. Anyway, much of this is in China's interest as well as ours, but hard for Xi to implement as a U.S.-enforced policy. Rather, they'll likely bleed out announcements as "Xi-inspired domestic reforms." And as he does, look for President Trump to find reasons to scale back the remaining tariffs. Bottom line, trade worries are receding rather than increasing, a directional shift that’s key to which way confidence and economic activity head from here. The biggest domino falls first. Bang!
- Brexit course much clearerBoris Johnson's dramatic win last night couldn't have been better for those bullish on the global and European economies and markets. When I was in London for meetings this week, most business people I met just wanted to know the direction forward but were worried Johnson's margin of victory might not give him a large enough majority in Parliament to get a sound deal done. That concern now has fallen. With his crushing victory over Labor, the prime minister can deliver on Brexit without having to pacify his Northern Irish wing and/or the hardest Brexit elements within the Tory coalition. Rather, this new Parliament, knowing it was put in place on Johnson's coattails under the “Get Brexit Done” banner, will do just that. Yes, the next step will be negotiating new, independent trade terms with key trading partners. But if Johnson can get a broad deal done with the U.S. quickly (President Trump already is hinting at this), that will help him in the tough negotiations with Europe to follow. We'll see how this goes and yes, markets don't have perfect visibility on how this gets done. But don't let that scare you. The worst is already over and given the size of Johnson's majority, markets can rest assured the prime minister has sufficient negotiating flexibility to develop a deal good for both sides of the English Channel. A second domino of global uncertainty falls, right on cue, literally within hours. Bam!
- The Fed takes itself off the table Incredibly, this domino also dropped on the entrance of the bears' cave of this same week, barely 48 hours earlier. On Wednesday, after leaving rates unchanged at its December meeting, Fed Chair Powell took any action on rates in 2020 off the table. This was no surprise to us, as we thought Powell could not credibly shift course a third time in 12 months without even his supporters wondering if he'd become unglued. Markets can now cheer that yet another potential risk, Fed tightening, is off the table. Green flag on the racetrack for risk assets. Another domino down. Bong!
- Congress signs off on the USMCA trade deal With their impeachment exercise trailing off to a weak ending (see below), Nancy Pelosi's House moved on to the revised Nafta deal negotiated months earlier by President Trump. What? Did you say they signed off? Remind me, how big of a trading partner for the U.S. are Canada and Mexico? (FYI: Year-to-date through September, Canada and Mexico were virtually tied for first place, with China coming in third). What, bigger than China? When did you say this happened? This week? You must be kidding! Run for the hills, little bear cubs! Run! Gong!
What's even worse for the bears, a whole host of other dominoes already were tottering. Now, with this week's fresh infusion of confidence for businesses and consumers alike, even the bears dare not try to advance the case. To wit:
- The U.S. consumer, faced with a bear-concocted boogeyman called "the coming recession," appears to have missed the memo. The Christmas retail season underway is looking strong, particularly on the online front, with consumer confidence—and the entire services sector—on sound footing and November’s massive jobs report adding more fuel to their Yule log fire.
- The Democratic House, which has slashed impeachment charges from "quid pro quo" then "bribery and extortion" to a vague charge of "abuse of power" and contempt of Congress (for resisting a politically motivated impeachment charge). This suggests even it has figured out impeachment is not playing well with the country and is blowing the retreat bugles as gracefully as possible.
- Along those same lines, the House, suddenly desperate to prove it’s still carrying on the typical business of government, struck a budget deal with the president (right after approving the aforementioned USMCA), killing any "hopes" the bears had for a government shutdown at year-end.
As all of this plays out, earnings forecasts continue to hold up and, with all the positives above, are more likely to move higher, not lower, from here. This comes as the manufacturing sector put in another stable, though low, ISM number last week, supporting the case that its year-old down cycle is flattening out. Cyclical stocks have been on a tear, and last night's positive trading speaks volumes of what the market thinks is coming next following dominoes 1, 2, 3 and 4 above: a confidence-driven upturn.
A more subtle but incredibly important domino that fell last night, in our view, was the risk of a radical shift left in U.S. fiscal policy. This will be one of our topics in an upcoming "Top Five Surprises of 2020" memo, but here’s a preview. While President Trump’s re-election would be most bullish for the markets, at least over the longer term, a moderate Democrat with a Republican Senate would be OK, too. It likely would represent little significant change in tax regimes, though perhaps a rebirth of regulatory overreach that could shave but not kill growth forecasts. Not so with perceived anti-capitalist, anti-free-market candidates Bernie Sanders or Elizabeth Warren. Although not currently assigned a high probability by the market, this tail risk can't be ruled out. But with Britain's working class voters having rejected soundly last night eerily similar siren calls for "attacking the rich" from Sanders' twin Jeremy Corbyn, many here will begin to believe that a Democratic socialist is similarly unelectable stateside in 2020.
So the dominoes, big and small, have fallen. Hopefully, most of the bears made it into their warm caves for the winter before these dominoes blocked their entrance. If they've been keeping up with our market memos, surely they have! The rest of us are comfortably overweight equities. Next stop: 3,500. And if you see a lonely bear or two out there, give him or her a Christmas hug. They’ve had a rough year.