Weaker Economic Data and More Central Bank Support

By Ketu Desai

In 2018, earnings grew by more than 20 percent, sentiment and positioning were bullish (for most of year), rates rose, and the economic data was encouraging, however, Fed policy was against you, financial conditions tightened, and multiples contracted, causing a weak equity market. This year is almost exactly the opposite so far. Earnings are expected to contract for the first quarter, and grow marginally for the second and third quarter. Sentiment and positioning are cautious, rates have fallen quite significantly from the 2018 highs, and the macro data is weak. The good news is that weak economic data means more central bank support.

Central bank support increases liquidity, lowers rates, allows investors to pay higher multiples, and drives investors out on the risk curve, all positive for risk assets. The shift in policy has been global, which adds to the magnitude of the support. The Reserve Bank of India cut rates during the month, and there is talk of a more substantial rate cut in the coming months, according to the RBI minutes. China continues to stimulate, and there are reports that they are on the cusp of even more aggressive measures, such as a cut to the benchmark rate, aggressive fiscal policy, and targeted capital injections. It appears likely that the ECB will restart its TLTRO program, providing ultracheap loans to its banks, as soon as March. The latest Fed minutes state that they are ready to stop the runoff of its balance sheet later this year. While for the near-term this is all positive for equities, the key risk is that the weaker economic data is more than a pause, and a precursor to a recession that central banks could have less ammunition to combat.

The breadth and the leadership of this rally have been impressive. In previous years, rallies were often concentrated around secular growth tech, the current rally is led by high-beta and cyclical growth sectors such as industrials, energy, and semiconductors. The rally is broad, global, and across asset classes. Many emerging markets and commodities have been on a tear in recent weeks. Certain technical indicators also illustrate the breadth of this rally. In particular, the NYSE advance-decline line, a popular indicator of market breadth that tracks the number of stocks rising minus the number falling each day, has hit new highs. Meanwhile, 90 percent of S&P 500 stocks are trading above their 50-day moving average. Valuation has also improved from rallies in recent years, the S&P is approximately 2 turns cheaper than early last year, and equity earnings yield nearly 3.5 percent more than the 10-year.

The other market driver of late has been trade discussions with China. We appear to be heading toward a solution, with a meeting between the respective leaders in the works. The open question for the market is now that we are moving closer to some solution on trade, and we have supportive central bank policy, is that sufficient to drive the next phase of the bull market. I suspect that the markets will consolidate within a range until we receive confirmation on a trade deal and that the recent economic weakness is a pause. Looking forward the markets will continue to focus on economic data, trade, and earnings.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com