Terrific is the only way one can describe the performance of the stock market through the first quarter of 2019. Prices rose for the third consecutive month, adding on 1.79% in March. Year-to-date, the total return to stocks, measured by the S&P 500, is 13.65%. The remarkable surge in prices nearly perfectly matches (reverses) the utter devastation stock prices faced in 4Q18 when prices fell a cumulative 13.52%. In 4Q18, stock prices fell more than 1% on 16 occasions, while in 1Q19 prices fell more than 1% only three times. This was some change.
From my perspective, I am somewhat surprised by the sudden rebound, and also suspicious that eventually some less-good news is going to let the air out of the market. As much fear as there was in investor’s eyes last December, there is a renewed sense of urgency to own stocks again. Wall Street clearly favors Washington’s policy agenda. Possibly the single largest change agent was the more dovish stance by the Federal Reserve.
The headwinds I’ve discussed in prior letters remain firmly in place. In addition, the yield curve has inverted, with short term interest rates now higher than long. This has historically been a caution sign and is highly correlated with recessions and often challenging stock markets. We’re faced with a chicken and the egg scenario. Does an inverted yield curve signal a recession? Or, does the early phase of an economic slowdown cause the yield curve to invert? This is the first time the yield curve has inverted since 2007.
The short-term economic boost from the 2017 Tax Cuts and Jobs Act has petered out. What we are left with is a $1.5B increase to the federal deficit. Contrary to the plan, there is no economic growth to spur deficit reducing tax revenue. Normally, the intention during good times is to use the excess wealth to deleverage or repay borrowings taken on during the tough times. The increases to the federal deficit are not sustainable and will ultimately have to be corrected. The self-imposed trade war is hurting domestic profits, according to recent earnings calls.
1Q19 earnings season is just about to be begin. According to FactSet Research, earnings estimates for the S&P 500 are expected to decline 3.9% for the first quarter 2019, which would be the first year over year decline in earnings since 2Q 2016. Stocks, at the moment, seem to be looking through these numbers. In fact, it’s not uncommon for the value of the index to increase while the S&P 500 earnings estimates are decreasing.
If companies miss earnings or are forced to reduce guidance, their response will be a key indicator for us. Companies that miss earnings estimates could respond by cutting spending on capital improvements and labor, further strangling economic growth and possibly igniting a stock-market selloff. Earnings misses tend to force companies to rethink their priorities.
Amidst this challenging backdrop, investors are radiant. Prices are rising like its 1999, again. That was a long time ago, but one of the most remarkable periods in stock market history. While 1999 receives all the popular acclaim, (stocks were up 19.5% in 1999), in the four preceding years, prices rose 26.6%, 31%, 20.2% and 34%. While we are clearly in the business of pursuing investment gains, I think a more humble posture is appropriate. Let’s hope we do not repeat the fear of missing out syndrome that owned Wall Street in the late ‘90s.
My take on the way forward is to buy (and sell) stocks selectively. Stocks overall are not that cheap, but individually, some are attractively priced, and others have high growth rates that are unrecognized. Patience in putting funds into the market is key. As the market saw-tooths, we want to buy the dips. We are also watching closely the emergence of new companies, new business models, that may prove to be the next transformative move in the market’s life-cycle. I’m confident that our keen eye and years of active investment experience will allow us to work through this odd hodgepodge of factors.
Please do not hesitate to give us a call if we have not spoken recently. We are happy to work closely with you to asset allocate your portfolio and answer any questions you may have as to the best way forward. All the best, and enjoy the emerging spring time.
Bruce Hotaling, CFA