Green light to start 2019 Green light to start 2019 http://www.federatedinvestors.com/static/images/fed-logo-amp.png January 18 2019

Green light to start 2019

The "January Barometer" suggests 2019 could be a strong year.
Published January 11 2019
My Content

Bottom line Toxic investor sentiment poisoned stocks to close out 2018, with a near 20% waterfall decline from Sept. 21 through Christmas Eve, while December’s sharp 9.2% decline marked the S&P 500’s single-worst month since 2001 and its worst December since 1931. But from that dramatically oversold level, stocks have staged a powerful 10% post-Christmas rally, including a 2.7% surge over the first five trading days of 2019. In fact, this powerful start to the New Year, which was the S&P’s tenth best since 1950, suggests that full-year performance could be solidly positive.

Early “January Barometer” predicts 2019 will be strong The early “January Barometer” says that historically, as the first five trading days of January go, so goes the full year. Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that since 1950, 68% of the time (47 out of 69 observations), the direction of the year (up or down) was the same as that of the first five trading days of January. But specifically when the first five trading days of the year were positive—as they are this year in 2019—the stock market finished the year in positive territory 82% of the time (36 out of 44 instances). This is not a random statistical coincidence. Investors tend to show their cards early in the new year by making their annual retirement and college-savings contributions and their changes in asset allocation, thus reflecting their bullish or bearish sentiment.

Robust start to 2019 Over the first five trading days of calendar 2019, the S&P enjoyed a price-only gain of 2.70%, starting from 2,506.85 on Dec. 31, 2018, and closing at 2,574.41 on Jan. 8, 2019. Including dividends, the total return over this period improves slightly to a gain of 2.72%. Over the past 69 years, according to the Almanac, the S&P’s first week has posted a median gain of 0.60% and an average gain of 0.26%, so this year’s powerful first-week return of 2.7% is well-above average.

Top-quartile performance In fact, looking at the 69-year history of the early “January Barometer” (excluding this year), whenever the first week’s returns were 2% or higher (which happened 17 times out of 69 years), there was only one down full year (2018’s aberrant 6.2% decline), with an average full-year return of 17.3%.

Third year of the presidential election cycle In the year before presidential elections, a positive early January barometer reading was followed by a positive full year 71% of the time (12 out of 17 observations) since 1950. The average first five days return of 1.5% yielded an average full-year return of 16.1%, within a range of a 34.1% increase to a decline of 0.7%. The third year of the 4-year presidential election cycle tends to be the best-performing for the stock markets, as presidents from both parties try to enact fiscal policies that will juice the economy and the financial markets ahead of the election the following year.

Fundamentals matter most of all During 2018’s year-end collapse in stock prices, forward price/earnings (P/E) multiples contracted from an appropriate 18 times to only 14 times, as investors were pricing in the prospect of a recession in 2019, which we do not believe will happen. Investors remain deeply concerned about sharply decelerating economic and corporate profit growth, due to several worries: the path of Federal Reserve monetary policy under Chair Powell; the status of the ongoing trade and tariff skirmish between the U.S. and China; a variety of geopolitical risk flashpoints, with Brexit most prominent; and more recently, the divided Congress and the resultant shutdown of the federal government in a dysfunctional Washington.

Retest coming? While stocks have retraced half of their lost ground by rallying 10% over the past three weeks into overhead resistance at 2,600, we can very easily envision a retest of the 2,300 level on the S&P over the next two months.

Beware the Ides of March The possible catalysts for that potential correction may be related to three critical signposts we’re watching in March:

  • March 1—China/U.S. trade deadline
  • March 20—Fed policy-setting meeting, with a new set of dot plots
  • March 29—Brexit deadline between the U.K. and European Union

So by the end of the first quarter, we believe the federal government will reopen, we’ll gauge progress on the China/U.S. trade and tariff negotiations, the Fed will demonstrate a more dovish policy path and we’ll have some clarity on the direction that the U.K. goes with its Brexit plans. At that point, it should become apparent to investors that the U.S. economy is not sliding into recession this year, and that P/E’s at 14 times are inappropriately low, given core inflation at 2% and benchmark 10-year Treasury yields at 2.7%. In our view, P/E multiples will then begin to expand back to 18 times earnings over the course of 2019, and with a modest 6% increase in earnings to $170 per share, will drive stocks about 19% higher from current levels to our full-year target of 3,100.

We’ll return to examine the January Barometer in early February, after the S&P has generated investment returns for the entire month of January, to see what potential full-year market implications we can draw, and to identify what the top-performing industry sectors may be for the full year.

Connect with Phil on LinkedIn

Tags Equity
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Federated Advisory Services Company

2036522645