Eye on the Markets - 2019


New Year off to a Mixed Start for Investors

By Ketu Desai

To sum up the month of January, the fundamental data that we got was mixed; however, central bank policy is now more favorable for investors, which improved sentiment and loosened financial conditions, driving equities and risk assets upward.

The domestic economy is the star of the global economy, led by its labor market. Jobless claims hit the lowest level since 1969. The January jobs report was over 300k. The strong employment backdrop is driving the domestic economy, albeit at a slower pace. The data out of foreign economies has not been as encouraging. European PMIs have been disappointing, and are bordering on indicating a contraction. Similarly, most of the data out of China has been weak, and growth appears to be tracking towards the low-6 percent range. As the global economic picture appears weaker, the tone from central banks and policy makers has notably changed in recent weeks. Take for instance late last year, the Fed was expecting multiple rate hikes for 2019, and the balance sheet wind-down was on ÔÇťautopilot".

The Fed's latest statement now points to the Fed pausing rate hikes for the now. Further, the Fed is considering maintaining a larger balance sheet than they previously expected, which would bring us closer to the end of the runoff. Similarly in the Eurozone, it is unlikely the ECB will raise rates until 2020, and may even consider new stimulus measures. In China, authorities have taken a raft of pro-growth measures in the form of cuts to the levels of cash banks must hold as reserves to spur lending, tax cuts, and efforts to accelerate infrastructure spending. In short, in late 2018 it appeared that central banks, most notably the Fed, were your enemy, now they are not quite your friend yet but an acquaintance.

As the tone from central banks has changed, the mood and the sentiment of the market have been better. In December, selling would intensify throughout the day, we would frequently end the day at the lows, good or bad news was a reason to sell, and fear drove investment decisions. That has all changed in 2019. For instance, earnings have been underwhelming, yet we have been able to sustain a rally. We have had the lowest beat ratio since 2014, while a fifth of the companies that have reported have reported earnings declines, and a fourth have had negative surprises, nearly double that of the previous quarter. We have had some notable misses or guide downs including names such as Apple, JP Morgan, McDonald's, Caterpillar, Nvidia, Macy's, Verizon, Pfizer, Lockheed Martin, Intel, Delta, Ford, AT&T, AMD, Tiffany, Netflix, and Morgan Stanley.

Despite such results and forward guidance, companies aren't getting severely punished for poor performance, and are getting nicely rewarded for strong performance. Bank of America estimates that the shares of companies posting stronger-than-expected earnings and sales results have outperformed by 2.8 percent the next day, the biggest reward since mid-2012, while those that have missed estimates on both metrics have lagged by 1.3 percent, well below the historical average. Behind the rally has been multiple expansion, as financial conditions have loosened we have already expanded by about a turn this year. An additional tailwind for stocks this year has been corporate activity. We have already had multiple mega-deals, particularly in healthcare, which indicates corporate confidence. Further, JP Morgan estimates that S&P 500 companies will execute $800 billion in buybacks and return an additional $500 billion through dividends in 2019.

With an improved backdrop, investors have favored cyclical over defensive, as energy, semiconductors, emerging markets, and industrials have outperformed utilities and consumer staples. Investors have been encouraged by lower rates, stable inflation, rallying oil prices, and the stable dollar. Credit markets have also opened up this year, after December did not witness a high-yield deal, we have had about $12 billion in high-yield issued, and spreads are approximately 100 basis points tighter.

Looking forward, we will see if the recent action is simply an oversold bounce or something more sustainable. The market will continue to focus on trade, the Fed, earnings, and macro data.

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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