We are Still in a Bull Market, Patience Required
The stock market is currently in a period of confusion. The foundation for continued growth in stock prices is intact. Catalysts for economic growth are all flashing green: low-interest rates, low oil prices, deregulation, increased deficit spending, higher employment, and higher real estate prices. Offsetting these positives are the measures of U.S. and global business and investor confidence. Confidence is declining due to policy confusion, trade wars, tariff hikes. The Administration’s erratic and personalized policy goals and foreign relations are losing allies, friends, and supporters. Unilateral trade wars have proven to be more difficult than expected, reducing confidence and inhibiting coordination with other countries. However, it is too early to give up hope; it is an election year after all, and new types of economic stimulus could easily be proposed.
As we are now entering a seasonally strong period for the market, we are willing to ride out the current period of confusion as there does not appear to be a better investment alternative. Economic surprises could be around the next corner: new tax cut proposals, favorable new investment rules and concessions regarding trade deals are all possible. Fundamentally, we are still in a bull market for stocks and patience is required.
Figure 1 – Stocks Reached a New High in July and have been Consolidating Since Then
Figure 2 – Low Inflation/Deflation Has Favored Financial Assets
When looking at the stock charts since the 1970’s it helps put perspective on where the market has been and where it is going. For example, the “Black Monday” crash of October 1987 saw the stock market crash 22% in 3 days with program and computer trading seen as the culprit. Now it is just a blip in the rear-view mirror. A 22% correction today would move the index over 5,500 points to around 20,500. We would all be traumatized, but it does and can happen. However, 40 years from now it would likely be just another blip in the rear-view mirror. I believe that the message is to stay invested for the long-term.
My bigger concern would be that we could enter a period, like 1972 through 1986, where the stock market trades sideways for over a decade. The 70’s and 80’s were characterized by rising inflation and rising interest rates. From 1972 to 1986 inflation averaged over 7% annually, and mortgage rates peaked at 14%. Real assets, not stocks and bonds, were the best assets to own. The hero of that time period was Paul Volker, Chairman of the Federal Reserve, who whipped inflation by raising interest rates to unimaginable levels.
A potential catalyst could be if/when investors lose faith in government debt. Currently, government spending far exceeds its income and nobody seems to care or really expects the government to ever pay off its debts; they just keep adding to the refinancing pile. The financial markets keep rolling it over. At some point, this shill game could end with a loss of confidence in government debt, probably including the U.S., Japan, and Europe. At that point in time, everybody would look to where money could find a safe home. Gold, bitcoin and real estate are likely candidates for future asset preservation.
Trade Wars and China Negotiations take Center Stage
China trade talks will resume in October, amid growing pessimism over a sweeping pact this winter. As reported in the press, “it’s either no deal or a piecemeal deal.” It’s possible to reach an agreement for China to buy more U.S. energy and agricultural products, in exchange for Chinese assurances to stop stealing American intellectual property. This modest pact could be accompanied by some reduction in tariffs.
That would be quite a comedown after the U.S. and China had to endure a full year of uncertainty and softening economic growth. But with President Trump in a fight for his political life, a modest package would allow him to boast that farmers and U.S. businesses would benefit — and the market could conclude that the trade war has peaked, with further agreements possible in 2020.
But make no mistake — a comprehensive deal isn’t in the cards, certainly not soon. Even a modest deal could be derailed by two huge wild cards: a looming move by Beijing to crush the insurrection in Hong Kong, and a growing suspicion that the Chinese may decide to postpone cutting a deal until after the U.S. election, when they might get a U.S. president more willing to compromise on trade terms.
Federal Reserve Policy Remains Friendly to the Market
The Federal Reserve has cut interest rates by 25bp twice over the last two months. They have cut rates not due to a weak domestic economy but as a result of inflation running well beneath expectations for so many years and an overly strong dollar. They have brought the Fed funds rate down to a 1.75%-2% range. There is a slight chance they may ease rates again at the Oct 29-30 Fed meeting.
The key issue for Fed Chairman Jay Powell is whether he has the votes in the FOMC for a rate cut later this month. Our sense is that many Fed officials are on the fence, waiting for more data — including CPI on Oct. 10th — before deciding. Donald Trump’s nagging tweets aren’t the key Fed variable; it’s the market, which could react very negatively if the Fed sends a pause signal in upcoming days. The path for interest rates is likely to be sideways between now and the election.
U.S. Economic Growth is Slow and Steady
We have seen no reason to change our expectations that the U.S. economy will slow over the next year but still grow around 2% in real terms. That is not a recession! The economy is still creating new jobs, albeit at a slower rate, as the job market reaches full employment. Auto sales are steady and home sales are growing, partially due to lower interest rates and increased demand from Millennials. The manufacturing sector has slowed significantly, primarily due to the trade wars. Exports have also slowed due to a stronger dollar and the trade wars. Overall, we remain consumer-centric in our investment choices and are trying to stay focused on the economic data, not the political noise.
Figure 3 – Index of Leading Indicators – Slowing but not Contracting
Global Growth Continues to Slow
We remain concerned about growth outside the U.S., including a sharp slowdown in China. The World Trade Organization (WTO) lowered its forecast for global trade again last week to only 1.2% in 2019, down from its forecast of 2.6% in April. We believe that their prediction of a pickup in growth in 2020 to 2.7% is too high without any trade deals, fiscal stimuli and regulatory reforms. We continue to avoid investing in countries where exports/manufacturing are the keys to growth. However, we will look at the consumer, healthcare and services sectors where there are earnings growth and substantial dividends. The global consumer seems to be doing fine.
Tax Cut Proposals are in the Cards
Treasury Secretary Mnuchin mentioned that tax cuts are still very much on the table for 2020. We’re hearing that Larry Kudlow and other Trump Administration insiders are scrambling to come up with policies to combat an economic slowdown — and with third-quarter GDP possibly below 2%, their planning has a sense of urgency. Expect to see more trial balloons by Winter on what could be in a tax cut package.
The Gold Market Breaks Out
As depicted in Figure 4 below, the gold market has broken out to a 5-year high based on low-interest rates and international concerns. Whether this is the beginning of a new trend or a result of global tensions is to be determined. We believe this investment choice should be added to portfolios going forward.
Figure 4 – There is New Life in the Gold Market
Economic ebbs and flows are normal. Fear of market heights is prevalent today but is just another brick in the bull market’s proverbial wall of worry. One hallmark of this long, grinding bull market is its seemingly endless wall of worry. Negative headlines today about oil, Iran, tariffs, Brexit, the inverted US yield curve, a seemingly weak global economy and more, abound in the financial press. In our view, all are either too old, small or misunderstood to derail the bull market. My favorite unofficial indicator is the crane index – how many construction cranes do I see in a 30-minute drive. In a recent drive through Morris County, NJ, I counted 16 cranes in 15 minutes, a bullish indicator. Consistent moderate growth seems to be the plan for the balance for the year.
We remain optimistic that U.S. economic growth will average greater than 2% for the rest of this year and into 2020. Low unemployment and growing consumer spending should be the primary catalyst. It is very hard to see much of a slowdown with well over 2 million jobs created over the last year combined with meaningful real wage gains. We continue to believe that Trump will do all in his power to bolster economic growth at least through the Presidential election in 2020.
Investment Themes for 2019 and Beyond
We remain fully invested in the stock market. We have shifted more towards consumer stocks both in the U.S. and foreign markets. While we are concerned that a correction could occur at any time, we believe that the economic fundamentals would constrain it to a 5%-10% correction. We remain overweight in U.S. exposure versus the rest of the world.
Our fixed income exposure remains benign. We are taking less credit risk and have added to higher-yielding mortgage ETF’s and high-quality corporate debt. Our average maturity remains short in the 2-3 year range. In our opinion, the size of the potential federal budget deficit and corporate refinancing needs necessitates keeping maturities short and waiting for higher interest rates.
Overall, I believe that we are in a choppy market for the Fall as the recent gains are digested and a base is built for a broader rally later in the year. We are data-dependent and looking for interesting income opportunities. ____________________________________________________________________________________ Scott P. Noyes, CFA CFP®, is the President of Noyes Capital Management®, LLC, an independent fee-only wealth management firm based in New Vernon, New Jersey. Please visit our website at www.noyescapital.com
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