Well it’s official. As of Friday’s close (a close that was likely influenced by the quad-witching event and a handful of S&P index rebalances), the S&P 500 is now up +20.05% from the 12/24/18 panic low. Wow talk about a joyride to the upside!
Along with the market’s surge higher, which, for the record, has NOT experienced the typical “retest” phase, comes a healthy dose of “seller’s remorse” (you know, where anyone silly enough to think that December’s dance to the downside was anything more than a brief bout of “algos gone wild,” is now regretting their decision to manage the risk of the environment), S&P “envy” (be honest, how many advisors out there have taken calls recently about “keeping up with the S&P?”), and a little something called FOMO (fear of missing out). And from my seat, all of the above have combined to produce the relentless march higher.
The headlines touted last week’s action (which at +2.9% was the best gain since November) as a resumption of the trend. A breakout. And a reason to celebrate.
In speaking with fellow financial pros last week, the takeaway was that the investing public has been quick to simply brush aside the -19.8% decline that occurred between September 26 and Christmas eve. And since the Fed is apparently (key word) on hold and the trade deal (the deal that technically has not yet been reached) is expected to rejuvenate the global economy, investors appear to be most concerned about not missing the upside from here.
It seems that everything looks great now and once the trade deal gets inked, both economic and earnings growth are sure to surge, right?
As a result, last fall’s fear of policy mistakes and #GrowthSlowing has been replaced with performance anxiety. Buy the dips is the new battle cry. Risk-on is the only appropriate position. It’s up, up and away from here. Party on, Wayne!
Is It Though?
Although I am a card-carrying member of the-glass-is-at-least-half-full club and I recognize that the recent run for the roses is likely a “correction of the correction” given the Fed “pivot” and the expected trade deal, I am struggling a bit with the current pedal-to-the-metal mentality.
First and foremost, on my list of concerns is the issue of #GrowthSlowing. To be clear, this isn’t something that is expected to happen, it is happening. Now. Everywhere. Economic growth estimates are falling around the world. And frankly, I don’t have a lot of faith that even a “tremendous” trade deal will cause this trend to turn on a dime.
And yes fans, I am fully aware of the fact that Ms. Market looks “ahead” and not at what is happening now. My problem is that investors seem to be looking only at the bright side here. As in, a trade deal might not happen this month, this quarter, or even this year. Oh, and just because a trade deal gets done doesn’t mean the global economy is going to suddenly reverse course.
Then there is another pesky little problem: earnings. Sure, analysts have been busy cutting their estimates. The bulls say the new expectations present a “low bar” for companies to hop over in the coming quarter. But remember, analysts are traditionally too optimistic, not too pessimistic.
And with a lot of folks looking for EPS to go red in Q1, too much optimism could present a problem.
Out of Bullets?
Next there is the issue I’ll call “course correction firepower.” Or in this case, a lack thereof.
If we look back, history shows that when the economy slows, there are two ways to fight back: stimulus on the fiscal and monetary fronts. In short, fiscal policy is controlled by the federal government and usually entails spending programs. Monetary policy comes from the Fed and involves rate cuts and more recently, quantitative easing (QE), which is where the Fed prints money to buy a bunch of stuff.
But here’s the rub. Both stimulative parties appear to be either low on, or completely out of ammo to fight a slowdown – especially if it occurs in the next year or two.
On the fiscal side, the calendar (and my news feed) reminds us that there is a pretty big election coming up next year. And since the federal government is clearly divided down party lines and neither party has the numbers to get anything done, the chances of any sort of stimulus being approved by Congress prior to 2021 look to be: slim and none.
The bottom line here is the fiscal side is clearly out of bullets for the near future.
As far as Fed Policy is concerned, the good news is that the Fed was able get the Fed Funds Rate up to 2.5%. And since cutting rates is one of the FOMC’s primary weapons to battle a slowdown, they do have some ammo stored up. (Yay!)
The bad news is that according to Guggenheim Partners, the Federal Reserve has cut rates by an average of 5.5% when they are trying to stimulate economic growth. So, with only 2.5% of cuts available before they hit zero again, the Fed appears to be a little light on ammunition.
Sure, the Fed could announce another round or two of QE. The only problem is the current Fed “balance sheet” (the amount of bonds they hold on their books) is still pushing $4 trillion. And Guggenheim estimates it would take another $4 trillion of QE to create the proximate effect of cutting rates by 5.5%.
If you recall, the Fed’s balance sheet was less than $1 trillion before the Financial Crisis. So, I’m wondering if there will be the political will to take the Fed’s balance sheet above $8 trillion. Hmmm…
Where’s The Green?
Next up on the list of things causing me a modest degree of indigestion is my “Primary Cycle” indicator board shown below. In case you aren’t familiar, this is a group of my favorite, big-picture market models I use to try and keep me in tune with the overall environment.
To review, each week I show the current “signal” and “rating” of each model and then what the S&P’s historical return has been when the model is in its current mode (historical return data courtesy of Ned Davis Research).
This board includes a model of Leading Indicators (indicators that have historically “led” big moves in the stock market), my Intermediate-Term Trading Model (a model-of-models focused on trend/momentum built to trade the intermediate- to longer-term market cycles), a Risk/Reward Model (a model-of-models designed to illustrate the risk/reward environment), my Desert Island Model (a model-of-models designed to be the “one model to rule them all”), a Global Risk Model (a Risk-On/Off model based on global markets), and an Fundamental Factors Model (a model-of-models covering the state of interest rates, the economy, inflation, earnings, and valuations).
It will suffice to say there’s a lot of stuff covered here. In developing this board, my goal was to create a robust set of indicators/models covering all facets of market analysis to provide the state of the prevailing market environment.
One glance at the board tells the whole story here. In short, the question is, where’s all the green one would expect in a strong stock market environment?
Stocks are rockin’ and everybody is excited about the potential gains. Nobody wants to miss out. Advisors are clamoring for “more return.” But my Primary Cycle board appears to be, well, less than enthused.
There are six models-of-models on this board. Two are on a buy signals. Only one indicator rating is positive. Three models are on sell signals. And the reading of my “Desert Island” model is outright negative. What the heck is going on here?
Frankly, this just doesn’t happen. The Primary Cycle board usually confirms the “primary” trend – that’s its job! And since stocks are ripping, I again wonder, why aren’t more indicators green?
Maybe the models have it wrong and are simply out of sync – all at the same time. It could happen, right?
The bottom line here is something appears to be out of whack. Maybe the models are in a funk. Perhaps the models will perk up in the coming weeks as stocks move to new highs. Or… Maybe, just maybe, things aren’t quite as robust as the recent price action has folks believing. It has happened before.
In any event, this indicator board continues to give me pause. This indicator board causes me to scratch my head, raise an eyebrow, and furrow my brow. And this indicator board tells me to keep a little (key word) powder dry – you know, just in case. And while being a little (there’s that word again) concerned doesn’t seem to be a popular stance right now, staying in tune with “conditions” is the way I like to operate.
What if I’m wrong, you ask? What if the market ignores the models and simply powers higher from here? In short, this would likely produce new momentum buy signals, which would force me respect the price action and to put that small amount of dry powder I’m keeping in reserve to work. But for now, I’m hailing from Missouri and I need this market – and the indicators – to “show me” a little something more.
Thought For The Day:
The man who does not read good books has no advantage over the man who can’t read them. – Mark Twain
All the best, David D. Moenning Chief Investment Officer
At the time of publication, Mr. Moenning and/or Redwood Wealth Management, LLC held long positions in the following securities mentioned: None
Note that positions may change at any time.
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