Covenant Weekly Market Synopsis for February 8, 2019

February 11, 2019

Last Week Today. Senators Bernie Sanders and Charles Schumer announced a plan to introduce a bill limiting corporate stock buybacks. This bill suggests that the government knows better than management teams how to allocate scarce capital in the most productive capacity. I wonder if the esteemed senators have read Ayn Rand’s Atlas Shrugged? | In the “Are they negotiating or is this real?” category, Larry Kudlow and President Trump made pointed comments on negotiations with China. Kudlow said there was a “pretty sizeable distance” in trade negotiations between the U.S. and China. Meanwhile, President Trump announced he does not intend to meet with Chinese President Xi Jinping before the March 1st deadline to reach a trade deal. The market disliked the former and was indifferent to the latter. | Former Fed Chair Janet Yellen appeared on CNBC, offering support for the Fed’s newfound monetary policy patience, “If global growth really weakens and that spills over to the United States, or if financial conditions tighten more and we see a weakening in the US economy, it’s certainly possible the move is a cut, but both outcomes are possible.”

Domestic equities eked out a small gain for the week, while slow growth in the Eurozone and talk of “technical” recessions in Germany and Italy dragged down overseas stocks. Pulling back the camera a bit, the global equity market rally since Christmas Eve has been impressive, erasing most of the December swoon as shown in the chart below of the MSCI All Country World Index. However, the rally has yet to overcome losses sustained in the first bout of Q4 volatility from October. The message here is that while equities looked attractive back in December, and have rallied nicely since then, further gains are unlikely to come as fast. Closing the gap from early October to make new highs will require some combination of positive geopolitical news, improved economic data, or better earnings outlooks, none of which occur overnight.

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Sources: Bloomberg and Covenant Investment Research.

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Reading Tea Leaves. The relatively modest gain for the S&P 500 belied the intraday moves that threatened to take the index lower. On Thursday the S&P 500 declined by 1.6% before an end-of-day rally pushed the index to close down less than 1%. On Friday, the market was in the red all day long until the final minutes pushed the index into positive territory. Friday was the seventh day in a row that the S&P 500 rallied during the last hour of the day (Bespoke Investment Group). Some see the pattern of late-day buying as a bullish indicator. They reason that trades made at the start of the day are based on emotional reactions to the overnight news and that trades later in the day are less emotionally driven. Wall Street trading-lore is filled with these types anecdotes and investors are welcome to trust their money to these ephemeral patterns. However, no trading pattern will trump fundamentals in the long-run. That is, ultimately stock prices are based on the present value of future cash flows whether you buy the stock at the end of the day or the beginning.

Speed Bumps. The European Commission lowered estimated 2019 GDP growth for the Eurozone by nearly 33% from 1.9% to 1.3%. Australia’s central bank lowered its outlook for growth. India’s central bank cut interest rates in a surprise move. Although the US economy is a relatively closed, service-oriented economy, is it any wonder that the Federal Reserve adopted a “patient” outlook given slowing growth prospects globally?

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Q4 Corporate Earnings – not too shabby. To date, approximately two-thirds of S&P 500 management teams have reported Q4 2018 results. Although investor expectations were low, either due to guidance from management or general pessimism, 47% of firms have beaten consensus Earnings per Share (EPS) estimates by at least one standard deviation, which is in line with the long-term average. Consensus estimates called for a 12% increase in EPS, but thus far companies are tracking 14% growth. Highlighting the general state of pessimism, the share prices of companies that beat profit expectations have jumped an average 2.47% on the day after reporting earnings – the highest magnitude of outperformance since Q3 2009 during the Great Financial Crisis. (Source: Goldman Sachs)

Economic Data Update. The government closure delayed fourth-quarter economic data releases, but now that government has been open for a couple of weeks, the data is beginning to flow again. During our quarterly IC meeting next week, we will discuss the recent economic data in detail and the investment implications therein. In the meantime, below is a snapshot of a handful of current economic trends and how our resident economist of Foleynomics is viewing them:

  • Housing remains in the doldrums.  Not collapsing, but certainly not a growth driver.  The best I can say is that activity levels are steady or stagnant, take your pick.
  • Factory orders have been weaker, with core orders down sequentially three out of the last four months.  However, we are coming off very robust spring and summer numbers that were boosted by pre-tariff inventory stocking.  Current limited data suggests real GDP slowing into the low-2% area. The various surveys (ISM manufacturing and non-manufacturing for example) have been ok.  It’s the global data that is concerning.
  • The all-important consumer is showing signs of spending restraint.  Credit card spending has been weak lately.  The latest consumer confidence & sentiment data did not inspire much….confidence.  Sorry, that just had to be written :).  Some of this surely reflects the shutdown, how much is unknowable for now.
  • Based on what I think I know, available data continues to suggest weaker but steady growth. Both the NY Fed and the Atlanta Fed have 4Q estimates in the mid-2% range, and both models are due for updates.  1Q estimates (guesses) are low-2% for now.  All else equal, this morning’s trade report should boost the 4Q estimates a bit even if for the wrong reasons.
  • I won’t name names, but some soothsayers are practically cheering for a recession.  Let’s stipulate that eventually all of those flag-planters will be correct.  If we do get a recession this year though, it will surely rank as one of the best advertised ever.  As for me, I’ll stick with my slower but “ok” call for the year, at least for now.

Be well,

Justin