The market is wise
I travel weekly, sharing Federated’s outlook with advisors and their clients; I write this weekly, and occasionally go on TV or in the press. To be prepared, I read hundreds of research reports every day and then I’m ready. So when something “big” happens, I better scurry to see if the news will change our views. Why did House Speaker Nancy Pelosi change her tune knowing what tends to happen with impeachment? Impeachments are unpopular. They also take precious time away from campaigning for the nomination! The campaign was the topic of discussion at a women’s advisory lunch in local Grove City, near Pittsburgh, where the leader advised her fellow ladies, “Don’t go into Negative Town.” Discussing Trump’s name recognition and bad press being better than no press at all, she relayed that her then 3-year-old, during the 2016 election season, ran around saying, “Trump” and calling Hillary “the old Lady.” Could it be that Pelosi is succumbing to the more progressive part of her party, setting up Warren vs. Trump? Market observers have discussed in depth the likely negative reaction to a Warren presidency. But say Trump wins. Without concerns about re-election, might he go after China hard to secure his legacy? Trouble either way? But, that’s a discussion for another day.
The valuation spread between momentum and cyclical value stocks suggests more volatility ahead, warranting exposure to value with the understanding the past month’s strong rally could be short-lived. While the reversal in momentum was its worst since April 2009’s rebound out of the financial crisis and the 17th worst in the past 67 years, Empirical Research notes growth stocks continue to produce the highest free-cash-flow margins, reducing the likelihood of a sustained change in leadership, particularly when one considers the fairly narrow, cyclical nature of the value bet. It expects the value opportunity could be exhausted quickly and gives growth’s former leadership a better chance of returning to the driver’s seat than history alone would imply. (Historically, value stocks outperformed over the subsequent year in all 16 episodes when the spread between them and momentum stocks was above one standard deviation and when valuation delivered a 1-month pop, both the case now.) Algorithmic trading, which is more prevalent than ever, could abet such a rapid reversal, much as it did this month with value over momentum. Currently, cyclical valuations remain exceptionally depressed relative to defensive stocks, have stronger earnings growth expectations and would benefit from easing recession fears. Notably, semiconductor holdings, a decent proxy for cyclicals, continue to outperform the broader market. And although the Russell 2000 has crossed above or below its 200-day moving average 17 times this year (19 times is the record), its breadth is improving. Credit spreads have remained tight as real interest rates have been falling, a positive for equities. Strategas Research views the WeWork saga (and Peloton’s debut?) as favorable as it reflects little evidence of the “new era” thinking that so often accompanies speculative excess.
Over the past 90 years, S&P 500 volatility has increased an average 25% from August to October, with the Halloween month experiencing the biggest corrections. Goldman Sachs traces this October coincidence to both pressures managements face to meet year-end earnings expectations and usual shifts in investor sentiment this time of year. If estimates are close to correct, Q2 will mark the 10th consecutive quarter of double-digit net earnings-per-share growth, the fifth-longest streak in the last 60 years. But the future could prove more challenging. Profit margins jumped in 2018 almost entirely due to the tax cuts whose year-over-year effects are rolling off this year. The Fed, on the other hand, is supportive. Of four previous periods with earnings-per-share growth above 10% for at least 10 quarters, three included short easing cycles not associated with recessions. Political uncertainty historically tends to be bullish, notwithstanding the likely halt of any bipartisan legislation (what were the odds anyway leading into an election year?). More importantly, the market is in an uptrend—the percentage of S&P stocks with a rising 200-day moving average is the most in a year—and has shown powerful momentum over the last few weeks despite the goings-on in Washington and elsewhere. “No one is above the law!” proclaimed Pelosi as she commenced impeachment inquiries. Should we sell our stocks? Impeachment!!! At first, my blood pressure jumped. Then, I checked the market, which is wise … I wonder what the Mister is preparing for dinner.
- A housing bump Based on all the new monthly housing data (much better-than-expected existing, new and pending sales as well as single-family starts), Q3 real GDP residential investment is on track to increase at around a 5% annual rate vs. Q2’s nearly 3% annualized decline, the strongest quarter-over-quarter gain in over a year. Although less than 4% of GDP, housing’s impact on the economy and markets is significant as it confirms elevated consumer confidence, boosts employment and reduces recession odds.
- Consumers are in good shape Consumers may not be as happy (more below), but their finances appear to be in good shape. While spending slowed significantly last month after July’s jump, incomes rose, pushing the savings rate to a healthy 8.1%. As long as jobs, incomes and consumer net worth keep rising, Evercore ISI says consumers almost certainly will keep going about their lives despite all the political noise and geopolitical uncertainty. Deloitte is projecting holiday sales to increase at least 5% vs. last year and e-commerce to jump 14-18%.
- A Chinese recession has been my major concern … as it could drag the rest of the world into recession, if not the U.S. Although the data is mixed, China is showing signs of improvement. Its massive stimulus—97 moves and counting—is reflected in the rising trend in manufacturing PMI, exports and auto sales. But weak retail sales and investment should keep Beijing on the stimulus track, Cornerstone Macro says, helping it lead global monetary policy that is setting the stage for global pickup in 2020.
- Capex is struggling Second-quarter capital expenditures (capex) were revised down again, declining for the first time since Q1 2016, and core capital goods orders unexpectedly fell in August and were revised down to no gain for July. Capex has caved under the trade war uncertainty and slowdown in manufacturing, with low business confidence suggesting it may weaken further in the coming quarters and remain a drag on overall growth.
- Things don’t seem to be getting better in Europe While Citi’s measure of economic surprises in the eurozone has been trending higher since mid-August, the leading economic data have been getting worse. This week, euro area sentiment fell to a 4-year low and the euro area manufacturing PMI slid further to a 7-year low, with Germany’s flash PMI slumping to its lowest level since mid-2009. The companion euro area services PMI also dropped sharply, though it remains in expansion territory.
- Blame it on the end of summer Conference Board consumer confidence fell to a 3-month low in September and the Bloomberg Consumer Comfort Index slipped a third straight week. Still, the gauges remain elevated on an historical basis, with the bulk of worries about the outlook, not current conditions. Final Michigan sentiment for the month unexpectedly improved.
I have my theory I teased at my SRO breakout before a large group of advisors in Austin as to why Pelosi decided to move this week. But no one asked, at least not in general Q&A. No discussion of impeachment at all (!) ... perhaps they agree that the market is wise. (I’m buying lots of popcorn, for the next 13 months will be fascinating to watch unfold.)
Is Pelosi prepared to throw Biden under the bus? My Austin cab driver was playing NPR News, in which an interviewer asked why Hunter Biden would be offered the job. Answer: He had no qualifications except that he was related to someone important. A negative Biden reference on a liberal-leaning station? Popcorn!
This very well may come up in the general election debates When MSNBC recently asked Sen. Warren if she would raise taxes on the middle class, she refused to answer. In 1984, Mondale lost the election to Reagan by stating he would raise taxes. He tried to make a virtue of it by saying, “Mr. Reagan will raise taxes, and so will I. He won’t tell you, I just did.’’ Voters turned out in droves against “virtue.” At the time, the squeeze on the middle class was nowhere near what it is now. Meanwhile, Bloomberg reports a CNBC finding that big money Dem donors are warning the party, “We’ll sit out, or back Trump, if you nominate Elizabeth Warren.” Lots of popcorn!!