- The sharp rebound in U.S. stocks since the Christmas Eve 2018 low has been a welcome development for the bulls, still, we are concerned that the pendulum may have swung a bit too far.
- The fourth quarter 2018 earnings season has been healthy, although estimates for this year’s first quarter have descended into negative territory. Meanwhile, the Fed has turned more dovish; why and for how long are relevant questions.
- Trade continues to be at the center of investors’ attention—the recent positive news from talks with China may be overplayed and there are other potential trade disputes simmering.
Too much of a good thing?
Equity investors have been cheering the sharp rebound seen since the end of last year, with the S&P 500 up more than 16% since the Christmas Eve low. It didn’t take long for sentiment to move from overly pessimistic to overly optimistic according to the Ned Davis Research (NDR) Crowd Sentiment Poll; somewhat concerning given the contrarian nature of investor sentiment, especially at extremes. We believed that U.S. stocks had gotten to oversold levels and were likely pricing in too great a risk of a near-term recession—so a rebound was to be expected. Some of the declines seen toward the end of last year were justified in our minds as economic growth has been slowing, trade uncertainties remain, government dysfunction persists, and corporate sentiment is deteriorating. In short, we don’t believe we’ll revisit the lows seen late last year if a recession remains a 2020 story, while we see that a retrenchment of some of the recent gains seems likely. If a recession looks to be developing this year—and if there is no trade deal and additional tariffs kick in—those market lows could be retested (and beyond).
Economic growth slowing, while an earnings recession becomes more likely
U.S. economic growth, while remaining in positive territory, has definitely slowed courtesy of tighter financial conditions last year, weak global growth, the trade-related denting of “animal spirits,” and the effects of the government shutdown. Retail sales for December were weaker than expected, truck orders have declined, and auto sales have weakened (with inventories climbing 4% month-over-month according to Wards Auto).
On the other hand
The story is not all bad. Both the ISM manufacturing and non-manufacturing readings remain above 50, the labor market remains strong: 304,000 nonfarm payroll jobs were added in January; and wage growth is improving, with the Atlanta Fed Wage Tracker moving within striking distance of its highest level since the Great Recession.
Markets got a healthy reprieve from last year’s fourth quarter carnage as a few headwinds became tailwinds; including a more dovish Fed, some hopes on trade, strong fourth-quarter earnings growth, and an end to the government shutdown. That been said, there are lurking risks, including equities having become technically overbought and investor sentiment having moved back into the high optimism zone. We continue to recommend investors remain near their long-term equity allocation, using rebalancing during bouts of volatility and keeping portfolios diversified across asset classes.