Stocks scale Wall of Worry to start 2020
Bottom line After rising 28.9% in 2019 and posting its best full-year performance in six years, the S&P 500 picked right up where it left off to start the New Year. Despite several investor concerns, stocks rallied 0.69% over the first five trading days of 2020—a rally that’s extended to a 3.3% gain through yesterday’s record high—triggering a positive “Early January Barometer” reading. That suggests full-year performance in this presidential election year could be solidly positive.
‘Early January Barometer’ predicts 2020 will be a good year This metric says that historically, as the first five trading days of January go, so goes the full year. Since 1950, Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that 69% of the time (48 out of 70 observations), the direction of the year—up or down—was the same as that of the first five trading days of January. But when the first five trading days of the year are positive, as they were again, the stock market finished the year in positive territory 82% of the time (37 out of 45 instances). In our view, this is not a random event. Investors make their annual retirement and college-savings contributions and their changes in asset allocation early in the New Year, reflecting their bullishness.
Solid start Over the first five trading days of calendar 2020, the S&P enjoyed a price-only gain of 0.69%, starting from 3,230 on Dec. 31, 2019 and closing at 3,253 on Jan. 8, 2020. By including dividends, the total return over this period improves slightly to a gain of 0.72%. Over the past 70 years, according to the Stock Trader’s Almanac, the S&P in each year’s first week has posted a median gain of 0.65% and an average gain of 0.30% (within a wide range of 6.2% to -6%). So this year’s first-week return of 0.69% is smack dab in the middle.
Solid full-year performance on tap? Looking at the 70-year history of the Early January Barometer (excluding this year), whenever the first week’s returns were situated in this part of the performance distribution (24 observations between breakeven and 1.4%, averaging 0.7%), there were only six down full years (positive returns 75% of the time), with an average full-year return of 11.9%. That would translate into a 3,615 target price for the S&P in 2020, slightly above Federated’s full-year target of 3,500.
Presidential election cycle positive In presidential-election years since 1950, a positive early January barometer reading was followed by a positive full year in every one of 11 instances. The average return of 1.45% in the 5-days at the start of a new year yielded an average full-year return of 12.9%, within a range of 25.8% to 1.4%. Historically, the stock market has performed much better when a sitting president is running for re-election, rather than an open election.
Fundamentals still drive the bus From the S&P’s depressed Christmas Eve trough in 2018, stocks have rebounded by a powerful 41.7% to record highs (a total return of 44.7%), as forward price/earnings (P/E) multiples have expanded from an oversold 14 times earnings then to a more appropriate 18 times today. What’s driven this powerful rally? Recession fears have faded, inflation is benign, the labor market is healthy, the Federal Reserve appears to be on hold with interest rates, and the trade and tariff war with China seemingly is behind us.
But could stocks hit a moderate 5-8% air pocket in coming months, as investors take some chips off the table and lock in some profits in the face of developing headwinds? Such potential developments would represent a healthy cleansing, in our view. It would wash out some weak hands and set the stage for the equity market’s next up-leg in the second half of this year, when economic and corporate profit growth begins to re-accelerate into the election.
Wall of Worry There are three issues which could possibly spook investors over the coming months:
- Longer delay for Boeing? The company’s recent decision to halt production of its grounded 737 MAX jet could reduce first-quarter GDP growth by about five tenths of a point. In our view, the company’s critical leadership change last year ushers in a more cooperative and conciliatory tone toward the Federal Aviation Administration (FAA). But Boeing announced this week that the MAX jet may not receive FAA approval to fly again until mid-year, rather than the current quarter. The company needs to fix software glitches and wiring problems, while developing a more comprehensive pilot retraining program on flight simulators and negotiating cash settlements with affected airlines. So has management kitchen-sinked the problem, orchestrating a subsequent positive surprise for investors by setting the bar even lower now? Or is this merely the tip of the proverbial iceberg?
- Coronavirus a pandemic? Seventeen people are now dead, with more than 600 confirmed cases in this deadly viral outbreak that started in Wuhan, China. Over the past three weeks, it has spread through human contact during the Chinese Lunar New Year (Asia’s heaviest travel season) to South Korea, Thailand, Japan, Taiwan and Washington state in the U.S. The Center for Disease Control (CDC) and the World Health Organization (WHO) are now actively involved. Will coronavirus prove to be a serious, yet temporary health scare (such as MERS, SARS and the avian flu), or will this be longer lasting and more problematic?
- Skepticism about China-U.S. trade deal? In the Phase One trade deal signed last week, China has agreed to purchase at least $200 billion of additional exports from the U.S. over the next two years, which could boost U.S. GDP by five tenths of a point 0.5% annually. About $50 billion of those annual purchases will be agricultural products (such as soybeans, corn and pork), with energy and manufactured goods rounding out the deal. Some investors think China will not fulfill its commitment, and that its leaders have simply hoodwinked the U.S. into lowering tariffs. But China, in our view, is not doing us any favors. Because of the African swine flu, China has lost more than half of its herd of pigs, which was the largest in the world, as the Chinese people eat more pork than the rest of the world combined. It desperately needs our soybeans and corn to fatten up its healthy pigs, and needs our pork to bridge its deficit and feed its people.
More to come We’ll return with Early January Barometer, Part II, in 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.