Threat mitigation, that’s what we’re talking here. It’s a sober-sounding and fancy cyber security term but it describes nicely what’s happening in the stock market lately.
Concerns that have dogged investor sentiment much of 2019 and even late 2018, too, have quite suddenly started to melt away. Risk-on is back.
How’s that? I see an upturn in investor economic expectations further solidifying my view that 2019 is an analog to 2009. There’s been a notable change in the character of markets (in the past few weeks) caused by a general improvement in the macro backdrop for risk assets.
Exhibits 1, 2 and 3: Not only have risks around Brexit and China-US trade spat been mitigated, but more importantly incoming economic data, such as purchasing manager indexes (PMIs), have pointed to a bottoming of industrial cycle. Combine that with potential growth catalysts and the result is marked improvement in growth expectations by investors. Our readers were alerted to this possibility in our previous reports.
● I think the 2020 economy will be better than 2019’s. The key takeaway, in my view, is that prospects for a stronger economy next year have increased. This is a contrast to the consensus view (for most of 2019) that a recession was likely to develop in 2020. In fact, those odds have dropped sharply recently.
● A recent Bank of America Merrill Lynch survey sees a flip in fund manager growth expectations. According to MarketWatch, it was FOMO or a “fear of missing out” that triggered a huge switch by fund managers from cash into stocks this month. The most recent survey of 230 managers running $700 billion of assets found cash levels dropped 0.8 percentage points to 4.2%, the biggest monthly drop since Nov. 2016 and the lowest cash balance since June 2013. The allocation to global equities climbed 20 percentage points month on month to a net 21% overweight, the highest level in one year. Growth expectations jumped 43 percentage points from -37% to net 6%, the biggest gain since the survey began in 1994.
This is a big deal. This flip is quite unusual, particularly after extended negative readings. For prospective, note that this kind of expectations change (from -35% to positive territory, or 4,300 basis points) has happened only three other times since 1994: 1998, 2002 and 2009. Notice a pattern? These inflections in growth expectations take place when markets are upturning in a sustained way, a positive and reinforcing risk-on signa.
● If global growth is improving in 2020, then S&P 500 aggregate 2020 EPS growth could reach >15%. ISM exports in October were above 50, and historically, this has signaled an upturn in EPS growth. The EPS increase over the next year averaged 18% since 1990. Hence, EPS growth could be strong. The Oct ISM Exports posted a 50.4, a sharp rebound from September’s 41.0, lowest since the Great Recession. As shown in the nearby table, each 1 point increase in ISM Exports adds 0.6% to S&P 500 EPS growth.
The recent ISM reading of 50.4 is 9.4 points higher than September. History suggests S&P 500 EPS growth should rise by 545 basis points. I believe this recovery reflects abating of oil shock, weakening U.S. dollar and generally improving conditions.
● Where is the growth coming from? Goldman Sachs says the continued strong consumer and the improvement in the housing market in the U.S. are setting stage for a capex cycle in 2020. JPMorgan points out that America’s capital goods PMI moved above 50 for the first time in a year and that in China there are signs activity has bottomed. Japan is set to push forth fiscal stimulus. Collectively, these 3 countries represent ~50% of global GDP. Hence, an improvement in these 3 regions will likely mean accelerating global growth.
What could go wrong? There remains considerable macro uncertainty, particularly in Washington and 2020 elections. Moreover, interest rates are low.
Bottom line: The recent improvement in fund manager expectations is a positive in our view. This further reinforces the credibility of the recent upside breakout in the S&P 500 (after 20 months of “markets going nowhere”). I still see about 100 points of upside for S&P 500 into YE based on PMIs, Santa Claus rally and portfolio manager positioning.
I favor a Cyclical + Quality tilt, characterized by 25 stocks. The tickers are TPR, KSS, LEN, PHM, EXPE, LMT, CAT, CMI, EMR, ROK, IBM, INTC, MXIM, QCOM, QRVO, PLD, CBRE, CCI, IRM, SBAC, CTL, DISCK, T, ATVI and VIAB. See table above.
