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  • Signal from Noise
Dec 26, 2019

– Strong equity return years—like 2019’s near 30%—often followed by good years – Another double-digit equity return expected, fueled by improving world growth – Tech, financials, materials, energy and industrial sector stocks should benefit Raise a glass if you have one handy —get one if you don’t—with just a few trading days left in 2019, the year will likely finish up as one of the best of the decade for U.S. equity investors, with a total return near 30%, as of Dec. 24. This is all the more remarkable since the 2010-2019 decade itself has been a robust one for stocks, too, up 182%, fourth best decade since 1900, according to Bespoke Investment Group data. Source: FSInsight, Bloomberg It’s the time of year when some pull out their crystal balls, but we use data here as well as history and good old-fashioned analysis. In 2020, I’m looking for the old bull to continue its yearend move to a nice canter from a leisurely trot, with the stock market rising at least 10%, as the EPS of the companies in the Standard & Poor’s 500 index (SPX) increase about the same percentage or perhaps better. SPX EPS should finish around $163 this year and estimates are for $178 in 2020. Indeed, while in 2019 the market’s price/earnings multiple carried the bull almost entirely—rising more than 25% to 18 times from less than 15 times on little or no earnings improvement—the market will have to produce the earnings growth that is expected of it, 10%, for the bull to continue rallying in 2020. It’s possible I’m underestimating the reviving “Animal Spirits,” which my colleague Tom Lee has alluded to in his recent “2020 Strategy Outlook: Reviving Animal Spirits,” Dec. 19. He has a base case SPX target of 3,450 based—versus about 3,235 currently—with a 17.9 price/earnings (P/E) multiple on estimated EPS of $193 in 2021.  That’s a number the market will be discounting 12 months from now.  While an 18 forward multiple is  higher than the 15 long term average, it’s interesting to note that this entire bull market’s (trailing) P/E has risen 50% from 2009, not atypical for bulls.  Valuations look particularly reasonable compared to bond yields below 2%. Let’s line up the various positives that undergird my call. The house forecast is for the global economy to pick up steam in 2020 from a languid 2019, and that should help SPX earnings grow. Purchasing Manager Indexes should recover and the easing trade tensions between the U.S. and China will support stocks. Meanwhile, China itself is showing signs of economic reacceleration. Additionally, earnings growth will likely get a boost from an improving inventory cycle, at a multi-year low. The Federal Reserve, a strong headwind in 2018, turned into a tailwind in 2019 when it began to reduce the Fed funds interest rate, and it should continue that way in 2020.  Unless the economy and inflation really ramp up, unlikely I think, the Fed has said it will remain on the sidelines next year, a plus. There will be potential easing of monetary conditions in Japan and Europe and all this could add 0.5% per quarter to U.S. gross domestic product, again benefiting profits growth. Perhaps the market is already discounting this, as in Q4 stocks of companies in the SPX with the most international revenue exposure have begun to significantly outperform those companies with mostly domestic sales.  By the way, materials and technology, sectors we think should benefit in 2020, have the most overseas sales. And what about those “animal spirits”? Until recently, this was a hated bull market, which ironically helped support it.  Finally, investor confidence, both institutional and individual, appears to be gaining, though we remain a long way from love or euphoria. I think that FOMO (fear of missing out) is just beginning to take hold and momentum is rising. This can last a while.  According to a recent Bank of America Merrill Survey, there has been a pronounced flip in fund manager expectations about the economy to a net +6% from -37% a month ago. This type and size change is unusual, particularly after extended negative readings. Similar past moves have only been seen at inflection points (to positive) in equity markets, such as 1998, 2002 and 2009.  Source: FSInsight, Factset  Individual investors, who have never really bought into this bull, seem to be getting more interested. According to , there were “impressive” ETF inflows of nearly $52 billion for the week ended Thursday, Dec. 19—the largest weekly inflow on record. Much of that went to equities. The year-to-date total is $342 billion, higher than the year ago inflows ($305 billion).  How different the picture is today from 12 months ago, when the market was coming apart at the seams, hitting an intraday bear market on Dec. 24, 2018. What about earnings? The nearby chart shows what industry analysts are projecting.  The energy sector, which we favor, is expected to report the highest EPS  growth, 21%, according to FactSet.  Industrials, another sector we like, is expected to report the second highest, 14.8%.  Additionally, SPX firms with more international sales exposure are expected to report higher earnings, 13.8%, relative to those with less, 7.6%. Many stocks are underperforming, even if they are up a lot.  The average SPX stock is up 26%, less than the index. Tech is up nearly 50%, but much of it is from Microsoft (MSFT) and Apple (AAPL), and there are even tech stocks that have underperformed.  Besides energy and industrials, we are recommending financials, materials and technology, for the long term.  While the U.S. is an overweight, by style cyclical and value stocks—which are more plentiful in Europe and China—are also expected to do better in 2020. Wall Street strategist surveys, a modestly good contrarian indicator, show a mean expectation of a 4% rise in 2020. Since 1928, nearly 80% of returns were higher than 10% or worse than -4%, so you should always be asking what might trigger the next big move, in either direction, says the Dow Theory Forecasts newsletter. Meanwhile, the NYSE Advance/Decline line is also at an all-time high and this often leads the market price by four to six months. Over the years, the odds are 85% that the market will be up after a double-digit return, points out Wellington Shields.  Indeed. A Happy New Year wish to all our clients and members. Where I could be wrong:  In terms of known knowns, the impeachment politics could turn uglier, or a radical leftist Democratic presidential candidate wins the presidency next November. Or the economic data somehow doesn’t improve, contrary to our expectations, EPS doesn’t grow and the recessionary boogeyman returns. Bottom Line:  2020 should provide a strong, double-digit return for equities. Prior “Signals” Date Topic Subject / Ticker The Signal 12/18/19 Stock Ulta Beauty Ulta Beauty Shares Whacked 35%; Stock Looks Cheap 12/11/19 Market UK Stock Market Conservative Election Win Should Boost Lagging UK Stocks 12/4/19 Stock Capri Holdings (CPRI) Capri Holdings Recovery, Makeover Could Send Stock Higher 11/27/19 Style Value When a Value Stock Is a Value Trap 11/20/19 Stock Aaron’s (AAN) Roughed Up Aaron’s (AAN) Stock Looks Undervalued 11/13/19 Stock Bed Bath & Beyond (BBBY) Bed Bath & Beyond Fixable; More Best Buy Than Blockbuster 10/30/19 Stock GH Pharmaceuticals (GWPH) Undeservedly Caught Up in the Volatile Marijuana Stock Fad 10/23/19 Stock Sherwin Williams (SHW) Sherwin Williams Paints a Pretty Profile 10/16/19 Stock Eyepoint (EYPT), Sonova (SONVY) Both cater to the increasing vision, hearing needs of seniors 10/9/19 Stock Skechers U.S.A (SKX) Volatile Skechers stock could be ready to roll higher 10/2/19 Stock Arcos Dorados (ARCO) Arcos Dorados Shares Undervalued; Turnaround In Sight 9/25/19 Stock Peloton (PTON) Peloton IPO Offers Growth, Scarcity Value—For Now 9/18/19 Stock Oshkosh (OSK) For investors with a long term horizon, OSK looks cheap. 9/5/19 Market BBB bond mkt implosion overdone Don’t sweat the BBB market so long as market chugs along 8/29/19 Industry Soybean/Tariff Impact on Trump 2020 If tariff wars continue, auto – not farm – states could hurt Trump

Watch for Cyclicals bottoming for sign of new up cycle

You have to be impressed by the persuasive power of price movement on sentiment and headlines. I’m obviously just a bit biased, but the sudden reversal from bearish to bullish headlines only reinforces the importance of including technical analysis in one’s investment process. Why? Well, despite the short-term wiggles that have developed through the summer, the longer-term technical backdrop has served as a very helpful steadying perspective through all the headline noise. Pull up a monthly chart of the S&P 500 on your favorite charting software for a longerterm perspective that steps back from the near-term wiggles that dominate headlines. What you’ll see is a market index that has traded in a very narrow range following a major rebound from its secular uptrend using the 200-week (4-year) moving average. In fact, as I’ve regularly highlighted here, 2019 looks very similar to 2016 which was another period when equity markets stalled in the shadow of pending global recession… that never happened. Now, of course, I can’t state for sure there won’t be a recession, but if you believe equities are reasonably good at discounting events 6-12 months ahead, then the S&P’s chart pattern is hardly bearish, at least not yet. If you been reading this space regularly, my view remains unchanged expecting a Q4 upside acceleration by stocks into yearand well into 2020-2021. Until I see otherwise, equity markets are tracking a very normal bullish 4-year cycle acceleration. For active traders, I’m expecting one more short-term pullback from current levels given daily momentum indicators are becoming overbought. Pending pullbacks are viewed as buying opportunities in anticipation of an upside surge through Q4. The focus of the three stock charts this week reinforce the broader market cycle commentary above. JPM, ITW and JPM are good proxies for companies moving money globally, manufacture ‘stuff’, and digging and building respectively. These monthly chart profiles are broad consolidations to important technical support at their rising secular uptrends defined by 48-month (200-week) moving averages. If the economic backdrop is truly deteriorating, as many forecasters are warning, why are these global cyclicals merely in relatively shallow consolidations and beginning to bottom at major support. In the interest of keeping these charts easy to read, I didn’t include monthly momentum indicators which are is a useful way to view the longer-term cycles. If you were to add them to each of these charts, you would see they are all in the very early stages of a cycle upturn after peaking in late 2017/early 2018. If you are interested seeing these indicators added to these charts feel free to contact us and I’ll forward them. The bottom line is that these cyclical stocks appears to be have simply consolidated for 12-18 months after a strong bull cycle between 2016-2018 and are showing technical evidence of bottoming as part of a new up-cycle. As part of a diversified portfolio, I would encourage investors to add some cyclicality back to your portfolio particularly if the current positioning is heavily over-weighted in bond proxies.

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