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inflection point

Will the ongoing battle between bulls and bears be over soon? I think the next few months of U.S. economic data could be key in deciding an inflection point in market sentiment, which—despite the record highs seemingly seen day after day—remains quite cautious, if not outright bearish. I’ve been pointing out a good part of 2019 that even though the contemporaneous economic data remains soft, there is growing evidence of the bottoming of the industrial cycle. Nevertheless, consensus still sees economic risks to the downside. My base case remains that the 2020 economy will be better than the 2019 economy, as the cumulative headwinds to global growth fade and become tailwinds, particularly in US, China and Japan. Let’s look beyond the screaming headlines at the actual data. ● Financial conditions: The Goldman Sachs Financial Conditions Index (GSUSFCI ) have improved steadily in the past 3 months, and is now at the easiest level since March 2018. This index, which uses markets-based measures to estimate financing conditions, has seen a broad story of easing financial conditions and, importantly, this is the exact opposite of 2018 where financial conditions tightened steadily in the fall of 2018. ● This accommodation is so substantial that the investment bank believes this could add 0.5% per quarter to 2020 real GDP, further reinforcing a view that economic risks are to the upside in 2020. Goldman Sachs “impulse” forecasts reflect about a 12-month lag between change in FCI and the impact on GDP. To put the 2020 lift in perspective, the 0.5% of GDP lift from easing conditions is strongest tailwind since 2017. In fact, the drag from 2018 tightening of financial conditions is estimated by Goldman Sachs to have subtracted about 0.5% to 1% per quarter from 2019 real GDP. ● Yet Street sentiment remains skewed to the downside, best evidenced by the strategist sell-side consensus: 5% downside to S&P 500 in next 7 weeks. The weekly Bloomberg strategist survey shows mean yearend target of 2,960, or about 150 points of downside. Just 2 of 21 strategists (one of which is me) see any upside for stocks into YE, further evidence, frankly, that investors are too cautious. (Bloomberg sends the analysts the survey every week.) ● Curiously, the past 6 weeks has seen a breakdown in “asset light” stocks and “growth equities,” two pillars of the bull market since 2009. The former is particularly notable as this has been virtually bulletproof since the bull market began, and thus highly popular with active managers. One reason that could explain these reversals is the potential for stronger inflation in 2020, which coincidently would be consistent with trends in “employed/population” ratio which we view as better leading indicators of wage inflation. Another factor supporting the bottoming of the industrial cycle (and hence, upside to 2020 growth) is the de-stocking of inventory. Korea and Taiwan inventories are contracting, and, while not bottoming yet, this is a sign we are further into cycle lows. Finally, there is a peculiar divergence—unemployment is at 50-yr low but the employed ratio is still at levels consistent with a 7% unemployment rate. Participation rate explains this, but also, perhaps, there is a flaw in the methodology for calculating UE. As shown in the nearby chart, the employed ratio highs seem to better describe peak employment in the past few cycles. ● What could go wrong in next 7 weeks? We continue to look for equities to rally >100 points before year-end, exceeding my 3,185 YE target. The risks to my view remain macro and hard to handicap: an eventual trade deal between the U.S. and China and the Congressional impeachment hearings. (For more on the latter see page 10.) Both are unpredictable. Bottom line: I see upside risks and am a buyer into YE. I favor our “Granny shots,” whose tickers follow: The tickers are GOOG, AAPL, AMP, BF/B, FB, TSLA, XLNX, AMGN, AMZN, AXP, BKNG, CMI, CSCO, EBAY, GRMN, MNST, NKE, NVDA, PM, PYPL and ROK. Figure: Comparative matrix of risk/reward drivers in 2019Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

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