Big Rally. Now What?

What a difference a couple of months make. There have been 8 consecutive weekly gains. This has so far been the best start to the year for stocks since 1990. I believe it is the 6th best ever, with a 10% gain for the S&P as we reach the midpoint in February. Talks between the US and China in Beijing have reportedly been productive and will continue next week back in Washington. The current thinking has a 30-60 day extension beyond the March deadline to allow more negotiations before tariffs jump from 10% to 25%. It’s kicking that can down the road. But that’s how these things seem to roll these days. The same can be said with Brexit and the US government shutdown. Brexit is much messier and it still remains unclear where it is headed, despite being just 45 days away from the deadline. China’s economy continues to slow, as does Europe, which is feeling tremendous pressure from the global economic slowdown, the risks of Brexit and Trump’s tightening on trade. Europe is facing outright recessionary pressures, and Brexit is complicating an already ultra-complicated situation.

Back at home, earnings keep coming in with what we’ll call a less bad flavor. With over ¾ of companies reported for Q4 2018, earnings have grown 13%. If this number holds, it will mark the fifth straight quarter of double-digit earnings growth for the S&P 500. Over 70% of the S&P companies have beaten earnings estimates and 60% have reported a positive revenue surprise. This is important, but we always have to remember that it’s in the rearview mirror. What matters most is what’s ahead. 6 months ago, the Street was estimating 10% earnings growth for 2019. It was also expecting 17% growth for Q4 then too. With the December collapse, the Market began factoring in an actual earnings contraction in our estimation, so the fact that Q4 earnings didn’t fall off a cliff is encouraging. Now the Street is modeling earnings growth of less than 5% for the year.

Slowdown is the theme. The accelerated growth from 2018 was unsustainable. The question is just how fast things slow and where and when it ends. The US Economy is showing some vulnerabilities. January saw the worst retail sales numbers in 9 years. If you recall, the American Consumer accounts for 70% of US economic activity. That sort of poured cold water on the party. But just for a day. The rally resumed with an explosive Friday to head to the long weekend.

Are you wondering, was that it??? Are the lows in and the Stock Market is in rally mode for the rest of the year? We do get that question a lot. Our answer is, we don’t think so. A lot of the good stuff seems priced in already, with a lot of the bad stuff either unresolved or still ahead. The Fed probably took the re-test of the December lows off the table in January, talking back the autopilot tightening language which triggered the year-end collapse. The Fed has given the Bulls a backstop. But this explosive move higher to start the year feels pretty frothy. A snapback is way overdue. We are definitely not “pound the table bullish” at this time. Just as quickly as 2018’s gains got erased, 2019 gains have been paid forward. The thing is, overbought tends to last a lot longer than oversold. Emotions play a big role here. Fear is a much stronger sensation than greed. Gains go a long way to mask problems. We think earnings are going to be a tough sled ahead. The Trade War has taken a toll. Corporate profitability has likely peaked with low unemployment and strong demand. The cycle is maturing.

Interest rates continue to stay low with money flowing back into Bonds. The Fed cutting back on its hawkish monetary policy has certainly played a role here. But the thing is, the Bond Market has not seemed to believe this strong rally in Stocks. We would naturally expect rates to tick higher if things were improving. The 10-Year Treasury yield is back down to 2.6% after running out of speed at 3.2% last year. We think a sell-off would provide the healthy back and filling required for this Market. Another signal we have mentioned before, investor sentiment, has improved considerably with this rally. The number of Bulls were near Financial Crisis levels back in December. They have crept back toward the September highs before the correction began. It’s not a perfect science. But investor sentiment has proven to be a helpful contrarian indicator for extremes. With a lot of good stuff seemingly priced in right now, it seems ripe for a sell-the-news first, then buy-the-dip later. We think a sell-off would be very buyable.

Have a nice weekend. Our office will be closed Monday for the President’s Day holiday. We’ll be back, dark and early on Tuesday.


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