So, last week I wrote my annual Market Risks for 2019. The piece practically wrote itself as we struggle daily with this volatile market. In fact, while the market is still technically in a bull market, the market is also already in Market Correction territory for many indexes. Recently, I have been accused of only highlighting the potential negatives and not representing the potential positive momentum that is out there. Taking that criticism to heart, this week I write about what could provide the positive energy to take the market up the next stair step.
This post was more challenging than last week because of the current market turmoil. We are in the ninth year of a bull market that is beginning to feel exhausted. The market needs a catalyst to get it going again. In this piece, I will sort through the usual suspects of Earnings and The Fed and throw out a couple of surprises that have potential. As always, I welcome feedback!
Where we are today:
The Bear Market may have already started. Clearly, we have taken a fair degree of pain in the market. Currently, we are in a Correction of over 10% from the recent highs. It may be hard, but it is important to understand that these corrections are not unusual. In fact, they are a healthy component of a bull market. Corrections usually happen on average more than once per year.
Let’s look at some potential drivers that could turn the current market around, and get the bull market going again.
Fed Messaging / Fed Action:
The Fed has not been good for the markets in 2018. There has been a steady drumbeat of increases to the Fed Funds rate. What is worse, the Fed has tipped more increases in the future… until recently. There has been some movement in their statements that indicate that they feel that they have injected enough negative stimulus to combat inflation fears.
The rate increases will still need to work their way through the economy. The rule of thumb is that a fed fund rate hike will take 10 or even more months to impact the economy. So there is still a lot of negative stimulus in the pipeline, but . . .
Markets are forward-looking. If they see that these hikes have ended, this brings stability to the markets, and allows them to look far into the future. If indeed, this messaging holds, this will be positive for stock market 2019.
Earnings have been outstanding this year. When Q4 earnings come in, they will be in the 20% range for 2018. Each quarter, the earnings have come in stronger than expectations. The earnings beats have been widespread and almost every sector has contributed to the strong performance. While this has been going on, prices have stagnated. The net effect of this is to bring down the aggregate price/earnings ratio of the market (see chart below).
Why is this important? In the long run, investors should have a normal amount of money that they are willing to spend for a dollar of earnings. Prior to this year, the aggregate P/E was coming close to 25 (i.e. investors would be paying $25 for each $1 of earnings)—but now it is moving down to levels that are more in line with the 5 and 10 years averages around 18. A P/E of 25 represents historic highs—so moving into historical normal ranges mean that this valuation metric could increase next year.
Estimates for stock market 2019 indicate that earnings should grow 9%, so even if this ratio does not expand, it would indicate prices would have room to go up 9%. There is still a load of stock buybacks in the pipelines. These buybacks boost Earnings per Share. So if, as was the case this year, estimates were low, and earnings outperform those estimates, you could get a double digit price increase.
Okay, I admit this is out of left field, and we typically feel that political situations, even extreme ones, don’t impact the market. So let me see if I can make you a believer.
Business hates unpredictability. They typically are playing the long game with investment decisions, growth plans and simple operating decisions. A House, Senate, and Presidency all under one party can add instability. They can make tax decisions and force them through. They can dial up new regulations. Similarly, the markets also appreciate stability.
When one of the three bodies is controlled by a different party, they get stability. Nothing that is Earth-shattering will pass through. This stagnation creates a stable environment that business and the markets love. They know what they are going to get for the next two years, and can operate more effectively. Bottom line, Wall Street loves gridlock.
Trade Wars Resolution:
Much of the market meltdown these past two weeks is due directly to the trade war between the U.S. and China. When there are even slight positive hints the market propels upward. When there are indications that the war is going to worsen and prolong, the markets tank. Right now, the markets have assumed a certain level of trade angst into stock prices. You can see this by examining the technology sector, which is one of the most heavily affected. It has been hit dramatically, and would rebound the moment that there is a resolution.
Maybe I am an optimist, but there has to be a resolution to the tariff wars. It is so painful to both countries that each country will not want to sustain the war. Most likely this resolution would come in the first half of next year, and would be a powerful catalyst to the market.
Stock Market 2019, In Summary:
Stock market 2019 will most likely be impacted by all of the above factors, as well as many that we can’t predict right now. There is more uncertainty entering this year—and the markets feel nervous.
As an investor, you will have some ups and downs in store next year. The advice I can give you is to develop a solid, repeatable investment process and stick with it. Pay no attention to sensationalist news headlines and focus on the events and news that will fundamentally alter companies, industries and markets.
Best of luck to a prosperous stock market 2019!