In our January 10, 2019 report, “The Consensus View” we noted that there was broad agreement among strategists regarding their outlooks for 2019. Most forecasts include the concept that global and US economic activity will decelerate this year, the risk of a US recession grows for 2020, the Federal Reserve is apt to be on hold for much of the next 12 months, the dollar will remain stable, interest rates have peaked for the intermediate term, and emerging markets represent better values than US securities. We tend to be wary of strong consensus views since history suggests that they tend to be wrong. Therefore, we believe investors should be on the lookout for positive surprises in 2019.
This week the 2019 World Economic Forum in Davos is the big financial story and we remind readers that this forum is famous for misjudging the global mood and events. Last year global financial leaders and executives were brimming with optimism about the world economy and the ability of stock markets to continue to rise. This year the mood is much more subdued and is focused on the political paralysis seen in the US, UK, France and Germany, the stress on trading relationships and rising concerns about the concentration of corporate power, especially among large technology firms. Corporate leaders are eyeing global trade, the potential impact of the US government shutdown, the uncertain state of the economy and a volatile political landscape as the major risks of the current year and many are calling these risks unprecedented. However, while forum participants are downcast and glum this year’s Economic Forum is most notable for the people who did not attend. The list includes President Trump who did not attend due to the federal government shutdown, Prime Minister Theresa May did not participate due to the time pressure she faces to get a Brexit deal and Chinese President Xi Jinping was not there as China announces economic growth has decelerated to the slowest pace in decades. Clearly the consensus view among US equity strategists that we described two weeks ago is also a global view. To us, this suggests that we should be looking for what could go right in the US and global environments in 2019.
In our last weekly publication we listed the most likely positive surprises of 2019 to be a trade agreement between the US and China, a smooth Brexit, a quiet and uneventful end to the Mueller investigation and a bi-partisan US infrastructure spending bill. This list is presented in order of likelihood.
The most plausible positive surprise in 2019 is a trade agreement between the US and China. While the negotiating process has been messy and contentious it seems that President Trump is pressing China for the best possible long-term deal, including the ability for the US to monitor the agreement for compliance. Like many deals, the process can be acrimonious, yet we believe it is in the best interest of both parties to find a solution before additional tariffs are imposed in March. Prime Minister May could be facing a tougher battle to pass a Brexit proposal through Parliament; but the disruption of a hard Brexit could pressure politicians into finding a solution in coming weeks. Of all the items on our list, a bi-partisan infrastructure bill currently seems the least likely. This is a very sad commentary since both sides of the US political aisle actually agree on this concept. The absence of such a bill highlights the dysfunctional state of the US political scene and of the US Congress.
The Economic Backdrop
The current US economic backdrop has its highs and its lows. The most recent low was December’s existing-home sales which fell 6.4% from a revised November number and was down 10.3% from December 2017. This was not due to seasonal factors since both the seasonally adjusted and unadjusted sales figures were down by similar percentages. The median single-family home price in December (SA) was $261,220, down 1.2% from November but still up 3% from December 2017. December’s weakness could be temporary factors since these sales were based on contracts signed one to two months prior to December when mortgage rates were at their peak. Weather was also unseasonably cold and wet in November which hampered potential buyers and the government shutdown may have delayed some transactions which were expected at the end of the year. The good news is that interest rates have moved lower in recent weeks and this could bolster the housing market in 2019. See page 3.
The ISM manufacturing index fell from 59.3 in November to 54.1 in December and is now at its lowest level since late 2016. All components of the manufacturing survey, with the exception of imports and exports were lower in the month. The broadness of this decline depicts a clear slowdown in activity at the end of 2018; however, all components of the ISM index remain above the 50 benchmark which indicates the manufacturing expansion is continuing, albeit at a slower pace. See page 4.
One of our favorite economic surveys is the NFIB small business optimism index and it fell from 104.8 in November to 104.4 in December, the fourth consecutive monthly decline. The decline in optimism was modest and the components of the survey revealed mixed results. Plans to make capital expenditures fell decisively to 24 in December, but a net 23% of small business respondents plan to expand employment. This is better than the 22% reading seen in each of the prior two months. This stability in employment plans is encouraging for the average household. See page 5.
The highpoint of December economic releases was the jobs report which showed payrolls grew above expectations with 312,000 new jobs added during the month. Job growth was strongest in construction, leisure/hospitality and education/healthcare sectors. We were most encouraged by the fact that our favorite indicator, the year-over-year growth rates in both the household and establishment surveys, showed December’s year-over-year growth in employment was above average in both surveys for the first time since September 2016. See page 6.
The key question facing investors is whether the risks seen in 2019 have been fully discounted by December’s decline in prices. Consensus surveys for 2019 show that SP500 forecasted earnings have slumped from double-digit growth levels in October to the current 6.1% YOY growth rate in Thomson IBES data and the 8.1% YOY growth rate in S&P Dow Jones data. These consensus estimates remain above our 2018 SP500 earnings estimate of $156 but have now edged below our 2019 estimate of $172. In our view, the consensus has become too pessimistic about 2019 earnings. See pages 9-10.
Technical Indicators are Favorable
We expect the market to remain in a broad trading range until the geopolitical backdrop improves. Nonetheless, a number of technical indicators indicate that December prices represented the worst of the decline. The most important and bullish feature of breadth data were the 90% up days recorded on December 26 and January 4. These days were reversals of the 90% down days seen in early December and were signals that the decline was both stabilizing and reversing. In addition, the AAII 8-week bull/bear spread is in positive territory for the sixth consecutive week. In sum, both breadth and sentiment are suggesting the market has begun a bottoming phase.
“Overweight”: Overweight relative to S&P Index weighting
“Neutral”: Neutral relative to S&P Index weighting
“Underweight”: Underweight relative to S&P Index weighting
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