Look out above, a melt-up may be underway
Readers of this space know we long have speculated about a market melt-up once the old 2018 highs on the S&P 500 were breached. Last week's news and market action suggests that this worst nightmare of the bears could be underway. On the fundamental side, virtually all the worries of December have faded, nearly on cue with our January “Upside surprises for 2019” roadmap. Three months later, here’s where we stand:
- By midyear, central banks will shift from synchronized tightening to synchronized stimulus. Status: that milepost is far in the rear-view mirror The Fed has moved from "hiking till we cause a recession" to "long pause" or maybe "cut," with balance-sheet shrinkage soon to be halted, to boot. China is cutting taxes and rates, sprinkling dry kindling all over the forest floor of its economy, which will light up as soon as Presidents Trump and Xi agree to the new rules of the trade game for the world's largest export economy. European Central Bank (ECB) Chief Draghi has ended his pursuit of a rate hike and hints the ECB will make another round of low-rate refinancing loans available to European banks.
- By midyear, the conversation will shift from global recession to global recovery. Status: we just passed that milepost Recent Institute of Supply Management and Markit manufacturing gauges have turned upward here and in China. Europe is bottoming, emerging markets are bouncing higher and, over the last two weeks, most strategists and economists I’ve met have raised their tone and even forecasts about the economy.
- After slowing off last year’s surge, earnings will re-accelerate higher. Status: Almost there The downward drift in full-year estimates has stopped. 2019 earnings numbers last week actually ticked higher for the first time since October. Then the big banks reported and low and behold, numbers surprised to the upside. It's likely that earnings from China-related stocks (such as industrials) will be less helpful, for sure, but everyone at this point expects this and will be more interested in post trade-deal projections.
- Oil moves from $50 to $90. Status: at about $72 on Brent, more than halfway there And for reasons we anticipated. OPEC, i.e., the Saudis, is remaining disciplined on supply constraints. Although U.S. production is higher, supply issues elsewhere are offsetting this. Meanwhile, global demand is running ahead of forecasts—and that's before the coming trade-deal induced re-acceleration in China. Remember, the U.S. is now a net oil exporter, making higher oil prices good, not bad, for our economy and for earnings.
- The U.S. and China announce a big trade deal and their relationship moves into a more constructive, honeymoon period. Status: not there yet, but enough leaks have emerged that the scary “No Deal” scenario is already off the table We expect a Big Deal (i.e., one which incorporates better–than-expected protections on intellectual property and information technology theft), which is not remotely in anyone’s numbers. But all we need, frankly, is a deal that clarifies the new rules of engagement on trade between the world’s two largest economies. That alone would ignite a nascent global economic recovery that already may be underway.
Against this dramatically improved fundamental picture, most investors and market pundits remain psychologically off sides. To quote an unnamed but well-known seer, virtually all believed, “The highs are in! Everyone knows it.’’ As the backdrop has improved, they keep hoping/convincing themselves it's all a mirage. Market moves are quoted scarily as "up 16% year-to-date and it's only April!", not more realistically as still below the level set six months ago when the economic outlook was much bleaker. Importantly, both technicians and fundamentalists believe the old S&P high at 2,930 is the new Maginot Line that cannot, will not, break.
The last time we can recall as solid a consensus around a firm market "ceiling" despite an obviously improved fundamental backdrop was the weeks ahead of the now historic breakout of this bull from its 13-year long bear market in 2013. When this many investors are off sides, with the fundamentals stacked up so tall against them and nothing but air technically above them, melt-ups happen. Look out above if earnings season continues as it has started and, "worse," if Presidents Trump and Xi finally announce their deal before the snowbirds fly north from Mar-a-Lago.