Investment Management

Barn Burner…

Investor spirits might have been low at year end 2018 – but certainly that desultory sentiment has dissipated over the first three months of the new year, as markets around the world have climbed almost uninterruptedly. Concurrently, American consumer sentiment has turned a “sharp corner” in 2019 as evidenced by Bloomberg’s weekly Consumer Comfort chart (see below) which at 61 is near an all-time high of 66, set in 1999 during the Clinton administration.

Chart 1

Source: Bloomberg

A sense of optimism in the American consumer is a necessary, if not sufficient, condition for a growing economy and rising financial markets. Further, U.S. Real GDP growth for all of last year was +3.1% – a strong result and one that continues a pattern of progress.

Chart 2

Finally, from an economic view, inflation in 2018 notched a 2% rate of growth as measured by the GDP deflator – a very wide measure of inflation – continuing an economic story now told for years of well controlled inflationary forces.

Chart 3

This translated into market presumptions that the Federal Reserve Bank will be very “patient” with regard to hiking interest rates in the near future. Essentially, the markets were predicting that the Fed is “on hold.”

Chart 4

Source: Bespoke

Let’s “shift gears” to look specifically at two equity markets – the U.S. and the Chinese. These stock markets represent the two leading economies of the world. Their success or lack of is a focus of their respective governments, because this is where investors from around the world “cast their ballots” on government economic policy. Market crashes, as happened late last year, unsettled bureaucrats because ordinary citizens, whether investors or not, took market downdrafts as a sign that economies were coming “off the rails” and were unsettled by the crashes. Many markets were within a “hair’s breadth” of a so-called “Bear Market” – i.e. -20% from a recent top. Further, these setbacks happened within the space of a few weeks. It was jarring! So quickly, government functionaries “got into gear” assuring everyone that economies were in good shape. The Federal Reserve actually reversed course with their language – now suggesting that they would be “patient” in tightening monetary policy vs an earlier proclamation that the Fed would continue to “march” down a path of tightening monetary conditions. Also, corporate reports came out during Q1 2019, which again highlighted the strength of company sales, earnings and cash flow. People calmed (see Chart 1 above), investors calmed and markets advanced.

Chart 5

Source: Bespoke

In the U.S., as seen above, look at the blue line representing the S&P 500. It has climbed sharply since last December. More importantly, look at the red line which represents the cumulative number of stocks advancing vs the number declining (A/D line). This line pictorially shows the reader market breadth. If the line is going up, that means that there are more stocks going up than down and vice versa. Market technicians (i.e. market analysts who predict market direction based upon market price observations) would point out that it is a necessary and sufficient condition in a bull market to have strong market breadth. Note in Chart 5 that the A/D line has advanced more quickly than the S&P 500, which suggests that the U.S. market is underpinned by strong market breadth – a bullish sign. Chart 6 below would suggest the same conclusion for an investor in China.

Chart 6

Source: Bespoke

While technically strong, is there “value” in the American and Chinese markets? There is certainly less today than there was at year end 2018. Nevertheless, company earnings are slated to grow in America and China in 2019. The rate of growth will slow dramatically this year from last (24% to 4%) due to trade tariffs, government shutdowns, Brexit and resulting corporate indecision and the growth will happen more in the second half of this year. But with a prospective P/E ratio of approximately 16 for 2019 in the U.S. and a P/E of 12 in China, markets are still not overpriced.

An Investor should never be complacent. One should always challenge a foregone conclusion or a trite truism. Nevertheless, one should hold fast to the facts, not the emotions. Rely on what one knows – not what one feels. Doing so would have forced an investor to stick with the markets in late 2018, enduring the “pain” but enjoying the rebound in 2019.


PREDICTIONS FOR 2019

  1. U.S. inflation, using the Fed’s favorite measure, will “remain around” 2%, giving the Fed some “room” to pause interest rate increases. Yes – the Fed has decided to not raise interest rates in 2019 and to stop liquidating its bond holdings as of September.
  2. U.S. GDP growth 2%-3%; rest of world range 1% (think Eurozone) – 7% (think India) Yes – Growth will be closer to 2% than 3% in the U.S.
  3. U.S. unemployment will stay low. Yes
  4. U.S. corporate profits =6%-9% Yes/No – Could be a little high. Let’s see Q1 reports.
  5. West Texas Intermediate crude oil will recover to a range of $60-$70/barrel. Yes
  6. The dollar will drift lower. Yes – Interest rates may have peaked for the year taking away this source of dollar support.
  7. U.S. Consumer sentiment will stay strong. Yes – See Chart 1
  8. Corporate chiefs will become more timid spending money; state governments will spend more. Yes.
  9. The U.S. and China will do a trade deal. Yes – The “tea leaves” suggest a deal because both parties need a deal.
  10. Equity markets will do well. Yes – so far..

A FINAL THOUGHT

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable. However, we cannot guarantee their accuracy. Past performance does not guarantee future results.

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