What a difference three months can make! After the stock market’s weakest December since the Great Depression (a market decline of 19.4% from the highs), the first quarter of 2019 experienced the strongest bounce in over 10 years with the S&P 500 Index advancing +13.1%! The Fed’s “dovish pivot” near the end of 2018 was the primary catalyst for the market’s bull run.

As a result of Jay Powell’s change in monetary policy (dovish = lower rates / no rate hikes), 10-year U.S. Treasury rates reversed course and declined near 15-month lows to 2.34%. The decline in rates encouraged a ‘risk-on’ mentality as stock investors cheered the Fed’s pivot to flexible monetary policy. Importantly, although global economic weakness has been pervasive, we believe the U.S. can avoid a recession. If so, U.S. equity outperformance

Economic Positives

Hooray for 4% mortgages! The housing market, which peaked in 2018 with higher rates, has strengthened in recent months as 30-year fixed mortgage rates approach 4% - its lowest level since January 2018. Lower rates improve affordability and refinancing – both of which benefit consumers!

The productive worker reappears! U.S. worker productivity, a key driver of our economy, recently posted a +1.9% nine-month average growth rate – its best growth rate since 2010. This is well above the +1.3% average during our current economic expansion. Bears may begin to question their recessionary fears.

Job openings approach a 19-year high! 7.34 million jobs were available in the U.S. at year-end 2018. This exceeds the amount of people looking for work by over 1 million! The data suggest that businesses are ramping up hiring & investment due to a favorable deregulatory business climate

.spring 2019 home sales

Economic Negatives

Will the global slowdown spill over to the U.S.? The International Monetary Fund (IMF) recently cut its global growth forecast to its lowest level since the financial crisis in 2009. IMF Director Christine Lagarde noted we face a “delicate moment” and stressed monetary policy missteps must be avoided!

Is U.S. dollar strength the next headwind for investors? We are keeping a careful eye on the dollar’s strength and its potential negative impact on U.S. multinationals that have significant international sales. Our stronger relative economic growth & interest rates continue to attract foreign capital.

The slowdown in non-farm payrolls is flashing a warning sign. The three-month average of non-farm payroll gains has decelerated rather dramatically from last year’s highs to +180,000 jobs per month. Was February’s weakness (+33,000 jobs) a blip on the radar or something more serious? Time will tell.

spring 2019 payroll gains

Financial Market Negatives

Earnings estimate cuts suggest pain may be in store for equities! Wall Street is pricing in a possible recession for the U.S. economy. First and second quarter year-over-year earnings growth estimates have fallen to -3.9% and +0.1%, respectively. While the ‘bar has been set low’, how will stocks react?

The U.S. China trade deal is still unresolved. The almost-daily positive updates on trade negotiations from the administration have helped buoy the market. A compromise deal is expected and ‘priced in’ by investors. If anything less than a solid deal (or no deal) is announced, a market dip should be expected.

Valuations are lukewarm. After the market decline of late-2018, the market’s one-year forward P/E valuation reached a low near 15 – about a 10% discount to the 25-year average. We currently trade at 17 times earnings. This is a slight premium to norm but still not as high as we were in September 2018 at 18x.

Financial Market Positives

History is on our side! Looking back over 50 years of market returns, the average midterm election year correction is - 19%. We experienced that late last year. However, these corrections have averaged ‘snapback’ rallies of +31% one year later and markets have never declined the following year since 1946!

The U.S. remains a safe haven for foreign capital. Low (and positive) rates on U.S. government debt are a sign of stability and very good for stocks. Outside the U.S. there is $10 trillion of negative-yielding government debt – a sign of instability & economic uncertainty! Attracting foreign capital is bullish!

Another record year for stock buybacks? A major driver of equity performance has been corporate stock buybacks. With balance sheets strong & interest rates low, early indications suggest that 2018’s $1 trillion of buybacks will be surpassed this year! This has the potential to limit the market’s downside.

 

While the markets ended 2018 with a thud (the worst December stock market performance since the Great Depression), we believe the current environment for stocks is favorable as interest rates remain low and, one-by-one, our major market headwinds approach resolution. It is our belief that the strong returns of 2017 ‘pulled forward’ last year’s expected returns.

In essence, 2018 turned out to be a ‘show me’ year where stronger economic growth, accelerating corporate profits and stock fundamentals finally ‘caught up’ with the equity market. So, with stock valuations currently below 25-year average levels, we believe U.S. equities will most likely outperform other asset classes in 2019. Plus, history is on our side as the market has not had a negative return in the third year of a presidential cycle since the 1940s!

Economic Positives

Jobs numbers end the year with a bang! 312,000 new jobs were added in December and 2.638 million for all of 2018. This was the highest annual amount since 2015. Non-farm payroll additions remain a good barometer as to the overall health of the U.S. economy.

Consumer holiday spending was Ho-Ho-Hot! Early indications suggest that the holiday period from November 1st to Christmas Eve was better-than-expected. Overall sales were up 5% but online sales led the way with a 19% increase! Spending momentum should also remain elevated by lower gasoline prices.

Strong bank commercial lending may extend the economic expansion. Bank lending oftentimes provides the fuel for the U.S. economic engine. We are encouraged that commercial & industrial (business) loan growth accelerated from low single digit growth in January to high single digit growth in December.

Economic Negatives

Is the decline in manufacturing activity temporary or a warning shot? The drop in the ISM Manufacturing Index has the market on edge. Factory activity, while still expanding, just posted its largest drop in ten years. A favorable outcome in the U.S. – China trade negotiations would certainly help!

Several rate-sensitive industries are in the economic dog house! Housing stumbled to end the year as higher rates put a damper on home purchases and construction. The good news is that mortgage rates have since fallen to around 4.5% which should bode well for a potential rebound in early 2019.

Will the weakening global economy spread to the U.S.? The transition from quantitative easing (QE) to quantitative tightening (QT) worldwide has many economists reducing their growth forecasts for 2019. In fact, U.S. growth forecasts have dropped a half point to 2.0 – 2.5%. Central bankers beware!

Market Negatives

Is the market or The Fed right on the economy? Our domestic economy is laden with debt. Therefore, the ability to issue or refinance debt is very important to the markets. To put it simply, low rates are better for stocks & the economy. We believe the market is right that the Fed needs to stop hiking interest rates!

Post-election political rhetoric is worrisome! Markets normally discount ‘political theatre’ quickly. We think this time will be no different. However, we are concerned that a prolonged government shutdown would be detrimental to growth during a time when our economy can ill afford another headwind.

Will a trade war compromise be enough to reverse pervasive negativity? An unfavorable outcome in the U.S. – China trade negotiations remains the biggest risk to the markets in early-2019. At a minimum, stock market bulls will need to see at least a compromise deal to remain constructive on stocks.

Market Positives

Can irrational pessimism be a good thing? The market optimism experienced in 2017 was replaced by widespread pessimism in late-2018. In the meantime, economic activity and corporate profits accelerated with nothing to show for it. Our contrarian belief is that pervasive negativity sets up for a positive 2019!

The correction has made stocks inexpensive again! A year with falling prices combined with expanding profits has resulted in the market’s forward P/E ratio (valuation) dropping from near 18 to 15 today. With the 25-year average around 16.5x and with interest rates still low, stock valuations are favorable!

The ‘Big Three’ to the rescue! Current and former Fed Chairs Powell, Yellen & Bernanke recently calmed the financial markets by stressing that upcoming monetary policy is “flexible” and “data dependent”. Investors cheered the news as higher rate forecasts had been a considerable headwind for stocks.

 

The Fall can be a tumultuous time for the markets. Volatility can increase as hedge funds and mutual fund managers reposition their portfolios by selling losers and chasing winners. This year we expect amplified volatility after last year’s very strong returns, this year’s solid returns and a midterm election on the horizon.

K.I.S.S. is an acronym that stands for “Keep It Simple, Stupid”. Per Wikipedia, the KISS Principle states that simplicity should be a key goal and unnecessary complexity should be avoided. In its most simplistic sense, KISS could be applied to investing basics in coming months. Investors trying to ‘time the market’ and reposition their portfolios before midterm elections may be better off just holding tight.

spring tulips in bloom

As an active money manager, we look for opportunities when others are fearful. LaFleur & Godfrey views the volatility exhibited by the market the last few months, after years of virtually no volatility, as a blessing and not a curse. Because the markets are trading more ‘normal’ based on fundamentals (profits) and with less correlation, we are beginning to see many more opportunities to invest in great growth companies at very reasonable valuations.

winter 2018 quarterly commentary

A New Year typically brings with it a new sense of optimism. This really should be expected in 2018 coming off a very strong market last year and with the recent Tax Bill signed by the President. This keeps us constructive on the markets in the upcoming year but our exuberance has been replaced by cautious optimism for several reasons.

fall 2017 quarterly commentary

While it is human nature to be more comfortable being ‘consensus’, there is a growing belief on Wall Street and Main Street that we are living in a ‘glass half-full’ economy as opposed to the general view that we are ‘half-empty’.  As a result, we believe that the strong market performance over the past year is a reliable barometer that, if Congress does its job and passes corporate tax reform, we may just be in the early innings of an accelerating economy. 

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