The Party’s Over
Stocks, as measured by the S&P 500 rose a surprising 7.87% for the month of January. This was the best start to the year since 1987, according to the Wall Street Journal. January’s remarkable stock returns were a generous “bounce” that largely offset the disastrous 9.18% loss that stocks suffered in December to close out last year. Now, with 4Q18 earnings season underway, we’re faced with the difficult task of assessing stocks, with an eye toward determining which ones will do the most work for us this year.
On a macro level, the forces that had been driving stock prices have shifted. After the November 2016 election, stocks went on a manic run; 15 months of positive returns. Wall Street suddenly had a man in the White House that was going to give it just what it wanted. From November 2016 through January 2018, stocks returned 31.4%. Then things changed. Starting in February 2018 the market stumbled. Over the ensuing 12 months (through January 2019), stocks fell 1.23%. During that span of time, stocks fell in four of those months for a total of -22.1%. These sharp drops in price radically changed the tenor of the market. They reflect the market’s foreboding of change on the horizon.
Near term expectations are for more of the same. There is little prospect of Washington acting in any constructive way with respect to fiscal policy. More to the point, my hope is Washington will refrain from causing further harm. The trade war, for instance, is clearly hurting the bottom line of many US corporate and agricultural businesses, based on recent earnings reports. According to the IMF, the US led trade war with China and the related protectionist tactics may lower global GDP in 2019 by as much as 0.5%. The threat of another government shutdown looms. The 35 day shutdown that began late last year damaged the economy and will show up in lower economic growth rates. FactSet Research’s review of earnings transcripts shows 33% of the companies that reported to date have made mention of the shutdown.
The elephant in the room, as always, is earnings. More than any other factor, stock prices reflect forward earnings. At the moment, 2019 earnings expectations are being revised downward. While not uncommon, the fear of course, is that continued downward earnings revisions will potentially lead to lower stock prices. Current FactSet estimates for CY 2019 project earnings growth of 6.3%, but that may be fleeting, and some analysts are quietly suggesting 0% growth for the coming year. Whether the forecasts hold up or deteriorate further, it will be a huge deceleration from the 19.9% earnings growth in 2018.
Though it’s a stock market, from our perspective, it’s a market of stocks. In 2018 our style and technique for selecting stocks worked extremely well. Of course, every year the backdrop and the factors influencing stocks and stock prices changes unpredictably. We are stock pickers, and we do not subscribe to the suggestion that a low-cost ETF is as good as one can do. In fact, we strongly believe in the value of thoughtful analysis, tactical buying and selling, and full utilization of the vast technical and analytical tools available to us today. Our focus remains anchored on the unique potential of each of the stocks we choose to own.
Finally, the roller-coaster start to the year was so distracting I nearly missed Groundhog Day. I’m glad to report Punxsutawney Phil did not see his shadow early on February 2nd, which means we ought to expect a shortened winter. This is good news though there is some concern with the reliability of Phil’s predictions. In fact, the NOAA says that Phil is right about 40% of the time and does not have any predictive value. This all leads me to Michael Lewis’ most recent book, The Fifth Risk. In it he discusses many of the valuable aspects of the federal government, including its immense ability to collect and store various forms of data (economic, weather, census, seismic, soil temperatures, etc.). With all this information now on the cloud, and vast computing capabilities at our fingertips, one of our most challenging tasks is to thoughtfully begin to ask the right questions to which we want answers.
Please feel free to reach out if we have not spoken recently. We are happy to discuss our expectations for the coming year in more detail, or any of your life circumstances that may have changed since we last met.
Bruce Hotaling, CFA