January was the best start to the year for stocks in 3 decades. What a difference from December, which was its worst finish since the Great Depression. The sectors that got beaten down the most to end last year have been leading on the way up in the new year. Earnings have been say, solid. More accurate is to say they have been less bad. Expectations sank in December, fearing the worst. The worst has not come to pass. But the accelerated growth rate of last year has. This is the dilemma for investors in 2019. The outlook is very spotty with slower growth at home and recessionary pressures overseas. Politics and Geopolitics are heavy weights on economic shoulders with low probabilities of positive outcomes anytime soon. That is namely the Trade War, Brexit, Washington politics, Iran and North Korea. That’s quite a list.
Trade talks this week in Washington seem to be moving to a more positive place. Both President Trump and Xi are in need of a win, and they know it. But a comprehensive deal which includes protection of intellectual property has close to zero chance, we think. The Fed seems to have been absorbing all of these issues and risks, leading to its 180-degree turn on policy. Tightening has basically taken a pause and “patience” is the word of the day, and seemingly for days and weeks ahead. The Fed is now providing cover, a big change from a month ago. In addition to the strength in stocks, it was the best January for Oil in 36 years. Considering this sluggish global environment, higher Oil prices stands out to us. It tells us that recession is not imminent. $55 crude is a nice balance.
Sentiment has done a complete 180 too. The extreme pessimism in December, the lowest investor sentiment measured since the Financial Crisis, has eroded with growing enthusiasm chasing the rally. There seems to be a fear of missing out in play. That generally leads to near-term tops, something we think could be in place for now with some healthy back and filling ahead. We play the long game.
Earnings Season brings the quarterly scorecard for the Stock Market. When it comes to earnings, the actual numbers aren’t the critical element. It’s all about expectations. It’s like a point spread in football, which is an equalizer. Winning the game isn’t enough, the team needs to beat expectations by covering the spread. Wall Street works the same way as expectations get built into stock prices. This is why so often stocks sell the news. The key is to buy low before expectations rise along with the stock price.
Expectations were really high for Corporate America. Back in September, the Street was modeling 10% earnings growth for 2019. In the heart of the sell-off, analysts scrambled to lower their earnings growth rate, which was down to 6% just 2 weeks ago. With roughly half of the S&P 500 companies reported, Q4 earnings have grown 12% year after year. This is better than expected. But, as mentioned, Earnings Season is only halfway done and the trend for lower for the rest of the year should continue. But importantly, at the extreme lows in December, the Market seemed to begin pricing in no growth at all for 2019. The snapback in January has come with the realization that things are not nearly as bad as feared. The Fed has gone a long way to cool those fears. Interestingly, and perhaps not surprising, the Street is still modeling 11% growth for 2020. We think that’s too high and those expectations will ratchet lower over the course of this year.
Here are some real examples of this Earning Season set-up. Bank of America crushed expectations with a strong double beat on revenues and profits when investors were fearing the worst. The stock responded favorably. Apple reported its first holiday quarter decline in both revenue and profit for the first time in over a decade. But we knew it was coming. The stock sell-off already priced that in. Apple issued a report that was not worse than already expected. In this case, less bad equals good, and the stock jumped on the news. Amazon reported a double beat as well, which came as no surprise. But the company lowered its outlook for the rest of the year, which sent the stock lower. The Stock Market is a discounting mechanism, and it continues to price in expectations real-time.
Back to the strong start to the year. The last time the DOW was up this much in January, the Niners had just won their 3rd title, with a comeback for the ages driven by Joe Montana’s fantastic finish in Miami. Billy Joel performed the Star Spangled Banner. The year was 1989. The last time the S&P 500 had this strong of a start was 1987. The New York Football Giants beat the Broncos at the Rose Bowl in Pasadena. Neil Diamond sang the National Anthem.
The result of the Super Bowl has historically been an indicator for the Stock Market for the remainder of the year. Stocks on average end positive for the calendar year if an original National Football League team (like the Rams) wins the Super Bowl. But the S&P has declined on average on the year if the winner is from the original American Football League (like the Patriots). Not so insignificant of late, after a strong run of success, the Super Bowl Indicator has misfired for 3 straight years. It now has been accurate after 40 of the 52 Super Bowls, or a 77% rate. That’s still not too shabby. In case you were wondering, Gladys Knight will be singing the Star Spangled Banner on Sunday.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
