Winter 2019 Quarterly Commentary

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.

 

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