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In 2020 It's All About SPX's EPS Growth; We See a 10% Rise

Through 2020 and into 2021, it’s all about earnings per share growth for the Standard & Poor’s 500 index and potential U.S. equity returns. As noted last week, I see 10% plus EPS growth and that should translate into another double-digit equity return next year as investors begin to discount EPS of 2021 some12 months from now. Of course, it’s a Wall Street axiom that every year profits matter and 2020 is no different. Over the long term it’s true. However, in the short term sometimes EPS can matter less than price/earnings ratios (P/E)—and vice versa—for example. Let’s look at the big picture over the past few years. Remember, that the SPX EPS shot up over 20% in 2018 to $162 from $131, thanks mainly to a one-time Federal tax cut. Yet the result was a market that was down 6% in price. In 2019, earnings are essentially flat at $163 estimated, with a few days left, from in 2018, yet the market has soared about 30%. Clearly there were other things hampering investor sentiment in 2018, and those things generally, as I have outlined from time to time, were the Federal Reserve, which was tightening when it shouldn’t have; a global economic growth slowdown, and trade war between the U.S. and China, among other countries. All this appears to be behind us for the most part and because there was a bear market in the fall of 2018—on an intraday basis—the market has now reset, let’s say, to move on earnings from here, as it normally does. Hence, I believe that EPS will matter more in 2020, the opposite of 2018-2019. Indeed, the SPX EPS and price have roughly tracked each other since 2009, but as shown below, there are times where P/E led, and times where EPS led. Again, the last 2 years have been about P/E (de-rated in 2018, re-rated in 2019), but in 2020 and beyond, I view EPS being the key. I realize this is mere a “crude comparison” but in my view, 2018 was a proper bear market and a reset of economic and fundamental expectations. And while many date this bull market from March, 2009, I suggest that 2020 is in many ways Year 2 of a newish bull market, analogous to 2010. I stated at the start of this year that “2009 was the best analog for 2019” for U.S. equity markets, and I believe this remains correct. Thus, I see 2020 equity moves mirroring 2010’s (year 2 of that bull market), with some headwinds in the first half of the year. Where do I get my confidence that the entire year will be better? I think the Purchase Managers Indexes have bottomed and the 2020 global economy will be better than 2019’s drowsy growth. The leading indicators, such as the Economic Cycle Research Institute leading index and those global PMI indexes are all pointing to the same general picture: that the persistent economic weakness from mid-2018 through 2019 is ending and setting the stage for an improved growth outlook in 2020. The October ISM Exports posted a 50.4 print, a sharp rebound from September’s 41.0, lowest since the Great Recession. As shown on 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 the SPX EPS growth should rise by 545 basis points. I believe this recovery reflects abating of oil shock, weakening greenback and generally improving conditions. In a nutshell, I see in the next year reviving “Animal Spirits” as PMI indexes bottom, plus an accommodative Fed and potential fiscal support will equal EPS upside— and by extension an SPX rise. Bottom line: Given that, my forecast is for the SPX to reach about 3,450 (from about 3235 currently) in our base case, or a bit less than 18 times price/earnings ratio on that $178 EPS. My best case scenario is for $184 EPS, to which we apply an 18 multiple for a level of nearly 3600 on the SPX. Figure: Comparative matrix of risk/reward drivers in 2020Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Bears Fight Back and Stocks fall 5%; Rally Trend Unbroken

Nothing like a nice 5% selloff to get your attention, eh? Gets the juices flowing, makes you think. Or is it worry? Just when you thought the bear had raised the white flag and slunk back into his dark cave, there he was again bearing sharp teeth and slashing at investors last Thursday. Yes, the stock market fell sharply last week, about 5% by Friday’s end, and the drop was even deeper at its nadir, down almost 7% from a high of 3233 Monday. Oh, for the happier days of just—well a few days ago. I, and my colleagues Tom Lee, Brian Rauscher and Rob Sluymer as you’ll see in following pages—don’t view this as the beginning of the end of the rally since March 23. We look at the data, whether the coronavirus (COVID-19) stats, or corporate earnings estimate revisions, or technical analysis, and it doesn’t look like a bear market rally. It looks like a bonafide rally. A few factors seemed to have depressed the formerly more enthusiastic investor sentiments. First, the fear of coronavirus (COVID-19) returning is ever present and just below the market’s surface. The rally’s been big but sentiment remains fragile. There were some media headlines about some states experience increasing cases. However, as Tom Lee points out, beginning page 3, the headlines and the facts aren’t the same. There is no strong evidence so far of a serious “second wave” as states reopen. And secondly the Fed’s FOMC meeting finished Wednesday and its outlook was less than thrilling. The idea that the Fed will keep rates low through 2022 might seem good for stocks, but the corollary to that is, “Wait a minute, the Fed thinks the economy will need rates to stay low that low.” Cue the despair and the bear roar. For more on this, see page 12. Last week, the Standard & Poor’s 500 index finished around 3041, giving back the gains of the previous week. The market is up 4% from 12 months ago. Then of course the market had gone a long way in a few weeks; it was ripe for any excuse in my opinion. Last Thursday, the S&P 500 saw its largest single-day downside shift in the percentage of overbought stocks since at least 1990, according to Bespoke Investment Group. On Monday, the net percentage of overbought stocks (overbought minus oversold) reached as high as 89%, but that fell to 6% after Thursday’s rout. But BIG also notes that one, three, and six months later, the S&P 500 traded higher all four times. In the one-year time window, the median gain was 16% with positive returns three out of four times, ranging from a decline of 1.36% after the 2007 occurrence to a gain of 21.5% after the 1997 occurrence. I find that comforting. While we’re on the subject of technical things, you can get your fill from Rob Sluymer on the website today, where there’s a special look at some hard-hit cyclical stocks. Moreover, I will note that the market saw 90% up volume days on the previous Friday and last Monday, similar to the first rally days in March. That’s strong stuff. As Wellington Shields put it in a recent report, you just can’t expect that kind of momentum to persist three months in. The numbers are long term bullish, even if short term the market is stretched and a little frothy. This is the kind of pullback we’ve been saying to buy, if you missed the initial 40% from March 23. As Tom Lee has pointed out again and again, there remains a lot of dry powder sitting on the sidelines in the form of cash. There’s simply too much of it for this to be the sustainable return of the bear. The reopening of the US economy isn’t going to be smooth but it is going to happen. Moreover, even if there is a second wave, I doubt there will be a second shutdown, but a more balance approach of masks, hand washing and distancing. On Thursday, Labor Department data showed 1.5 million Americans applied for unemployment benefits in the week through June 6, extending a drop from a recent peak of nearly 7 million applicants in the week through March 28. The Cboe Volatility Index, or VIX (dubbed the market’s “fear gauge”) jumped to about 40 from 25 during the week with Thursday its biggest one-day increase in more than two years. Quote of the Week: From WSJ: The net worth of U.S. households saw a record decline in the first three months of this year as the coronavirus pandemic sent shock waves through the economy and caused equity prices to plummet. Household net worth fell 5.6% in the first quarter from the previous three months to a seasonally adjusted $110.79 trillion, the Federal Reserve said Thursday. That was the largest single-quarter drop in records going back to the early 1950s. Gross domestic product contracted at an annualized rate of 5% in the January-to-March period. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to

Slide Does Technical Damage But Doesn’t End Rally Mode

Last week’s market drop-off did considerable technical damage to many charts BUT there are a few silver linings we would encourage investors to consider. The Standard & Poor’s (SPX), along with many stocks, notably cyclicals, were overbought at resistance heading into the beginning of this week. The SPX has pulled back to the upper end of a very broad support band beginning at its 200-day moving average (dma) at 3013, just above two important support levels. The first is the 62% retracement at 2935 and the second at the 50% retracement, 2792. Interestingly, the rising 50-dma at 2900 is in the middle of the band and serves as a reasonable proxy for the uptrend of the market. I expect those support levels to hold. Short-term momentum indicators are still early in downturns from overbought levels reached last week. Most daily momentum indicators, tracking two-four-week directional shifts, are only a few days old. In general, a downturn from overbought level suggests two+ weeks of weak/sloppy trading, and next week is an option expiration week. Source: Fundstrat, Bloomberg Bottom line: Given the velocity of recent moves, I have to weigh the odds of whether an entirely new downside move is developing or equity markets are merely unwinding a very overbought short-term condition. I think markets will find support near the support bands highlighted above. Could a multi-month, intermediate-term correction be taking hold? Yes, that is a possibility foolish to ignore, but it is premature to draw that conclusion. I continue to favor a barbell strategy of secular and cyclical growth using pullbacks in each to further accumulate exposure. Bellwether stocks at each end of the barbell remain attractive technically for long-term investors despite recent weakness. Growth bellwethers: Despite this week’s sell-off, AMZN and NFLX remain in longer-term uptrends Cyclical bellwethers: Please consult our “epi-center” stock list on the website. This week’s collapse interestingly retraced 50-62% of their May 14-early June rebounds, which are retracement levels that often provide support in corrections. We expect these levels to hold and would use recent weakness to accumulate these stocks for those accounts with flexibility to own deep cyclicals. Investors should continue to focus on the more important technical event developing within equity markets, the rotation toward oversold/bottoming cyclicals.

Stocks Streak to Record Highs; FOMO Intensifying

I don’t think I’ve ever gone through a better Holiday season in the stock market than this one—and I go back a long way. Perhaps in 1999, and I’ll get to that in a moment. The U.S. stock market’s record setting express train appears to be gathering steam. If you’ve been too busy enjoying the holiday, I’ll let you know that markets have been celebrating too. Stocks did it again, rising sharply to new records in a holiday shortened week of light trading. It looks like the famed Santa Claus Rally is here. No lumps of coal for those who are fully invested—except for the brave (and foolhardy?) shorts. Standard & Poor’s 500 index finished around 3240, a new all-time high. Yes, you’ve heard that a few times this year, over 30 times, actually, and the SPX is set to finish 2019 up somewhere around 30%. I think we can safely say that 12 months ago few strategists saw that, except Tom Lee, our head of research, and Rob Sluymer, our technical analyst. Meanwhile, the Dow Jones Industrial Average and the Nasdaq were not to be left out, both hitting new highs as well. Indeed, the tech-heavy Nasdaq finished its 11th consecutive record high close Thursday, a feat only accomplished 20 times since 1971, according to Bespoke Investment Research. More importantly, the history following such streaks is for the Nasdaq to be higher one, three, six and 12 months later. Indeed, much was made of the fact that the Nasdaq went over 9000 for the first time. I don’t put much extra credence in such round numbers but it is a milestone and the newspaper headlines seem to like it. I do think it exudes investor confidence. The FOMO factor remains intact. When it comes to U.S. equities, Tom Lee has said in these pages 2019 is an analog to 2009 and 2020 to 2010, that is, another up year for equites. But wait a minute, it really seems like the stock and bond markets are up together. Bonds, as measured by the iShares 20+ year Treasury Bond ETF (TLT), are up about 13%. Both assets appear to be partying like it’s 1998. It could be the biggest simultaneous gains in two decades, according to The Wall Street Journal. The proximate reasons behind the markets surge this week were more evidence of a strong Christmas retail season and easing trade tensions. For example, Amazon (AMZN) said it had its best holiday season to date. The stock is up big time already but Rob Sluymer says it should be bought on pull backs. (See page 8.) The shopping spree, with unemployment at historic lows, speaks to resilience of consumer spending and the U.S. economy, even in the face of trade tension. Other ongoing support comes from a better economic outlook; the expected U.S.-China trade deal, and a Federal Reserve that is clearly on the sideline. Last year, the Fed’s hikes were roiling markets. The greenback is down against several currencies, and that is good for Dow stocks, most of whom are global giants selling all around the world. Indeed, the excitement here in American stocks is likely pulling up the rest of the world, just as the U.S. economy often stimulates the world economy. The MSCI ex-U.S. index, for example, is up nearly 19% year to date. And as I’ve noted in these pages previously, there is some evidence that, through heavy recent inflows into ETFs the individual or retail investor appears to be getting more involved, which has repercussions for the sustainability of the bull. Here’s something to chew on, from Sentiment Trader. com: The Organization of Economic Cooperation and Development recently noted that their Composite Leading Indicators for the U.S. have turned up. When after a long period of decline it has done so in the past, the SPX has returned an average of more than 24% over the next six months without any failures. Mind before you go off saying there’s irrational exuberance, Wellington Shields points out that when the popular sentiment indicator called the Citi Research Panic-Euphoria index is above 0.41 that indicates euphoria, while -0.17 or below, panic. During the week of September 7, 2018, with the S&P at 2871, the Index hit 0.44, from there it slid to -0.33 on January 4th, with the S&P at 2447. The recent level is 0.15. Hardly overexcitement. Still, our very own technician and resident Grinch Rob Sluymer warns that a near-term pullback over the next few weeks seems a reasonable expectation. Just temporary. The kind of momentum we are seeing potentially has far reaching implications and Sluymer remains bullish longer term. Quote of the Week: WSJ: “Major U.S. and international contractors involved in Afghanistan reconstruction projects allegedly paid the Taliban for protection, providing the insurgency with money that was used to attack and kill U.S. troops, according to a lawsuit filed in federal court on Friday.” Now there’s a surprise. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to

The Old Bull Has Life in It Yet; Stocks Stage Big Comeback

At the risk of repeating something we’ve been saying all year, this is a resilient bull market. Indeed, very resilient. That the bull’s been trotting along generally steady over a decade now is not a legitimate “sell by” date. Bull markets don’t die of old age. I like a recent comment by Ryan Detrick, senior market strategist at LPL Financial, who says, “Bull markets do not die of old age. They die of excess — overspending, overleverage, overconfidence.” Doesn’t to seem to be much evidence of these “overs,” is there? And others note similar sentiments: bull markets don’t die of old age, but rather they’re killed by the Federal Reserve. Clearly, there was a “near miss” (as pilots say) last fall, when the Fed kept hiking rates—finally to beyond what was necessary as it turned out, and surprising mainly the policymakers. For more on this, see pages 3 and 6. After almost choking the rally last year, now the Fed is the market’s friend. Long may it last. This bull will die. They all do. It won’t be of old age, however. As long as inflation remains low and the economic backdrop fosters corporate EPS growth, I agree with my colleague Tom Lee, that the bull should make new highs in coming weeks and months. This past week the market action was a microcosm of 2019. In the early part of the week, the market tanked on some weak U.S. data and yet another negative trade and tariff tweet from President Donald Trump, only to perk up nicely not long after. In the first half of the week, the market dropped nearly 3% after President Donald Trump suggested a U.S.-China trade deal might have to wait until after the 2020 elections. That followed news that November’s ISM PMI registered 48.1%, down a bit from 48.3% in October and below expectations of 49.2%. But as Tom Lee points out on page 3, the ISM PMI diverges in crucial ways from the Markit PMI. Yet even before Friday’s strong jobs data, the market began to crawl back. There’s that resilience. And after data emerged Friday that showed employers added 266,000 jobs in November and unemployment matched a 50-year low of 3.5%, topping expectations, it was off to the races again for stocks. So the Standard & Poor’s 500 index finished around 3146, down smidge from the all-time high 3154. It is up over 25% this year. Given these ups and downs, what would have happened had you not paid any attention at all to the market gyrations last week? Well, with the SPX within a whisker of the all-time high set the day before Thanksgiving, sometimes it pays to ignore the noise. David Rosenberg at Gluskin Sheff estimates 95% of the return in 2019 has come from P/E expansion. Well, yeah, given SPX EPS growth is nil this year at about $163, up a tad from 2018. Next year, the consensus is for $172, or about 5.5% growth. However, if—as we’ve been saying—the 2020 economy will be stronger than 2019’s there could be upside to that EPS figure. And if you think this has been a particularly volatile market year, think again. According to DataTrek, as of Dec. 4, the S&P 500 index has risen or fallen by 1% or more on a total of 38 days so far this year. That compares to the annual average of 53 over the past 60 years. Volatility is therefore running below pace in 2019. Also according to DataTrek, years that have outsized returns along with an abnormally strong January—which describes 2019 to a T—are followed, on average, by years with a 10% rally and up 60% of the time. By the way, over the last 100 years, December has been the strongest month, with the Dow Jones Industrial Average up a mean 1.44% that month, with positive returns 68% of the years. One thing of which I’m fairly certain is that this December’s stock market activity will look nothing like that of 2018. Investors who do watch the weekly volatility should next week keep an eye on US-China trade talks. It will return to the forefront of market sentiment ahead of the Dec. 15 deadline for new tariffs on consumer goods to take effect. If the phase one deal isn’t signed, look for a minor sell off again. But as Tom Lee notes below, we think these are buying opportunities broadly speaking. Quote of the Week: According to Bloomberg News, owner Michael Bloomberg has spent $59 million on advertising since entering the race, relatively late in the political season. When he was asked why he had changed his mind about running for the presidency, after saying in September that he would not, Bloomberg said the Democratic field was weak. “I watched all the candidates,” he said. “And I just thought to myself, Donald Trump would eat them up.” Uh-huh. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to

After a Meandering Summer, Resilient Market Breaks Out

Some of our readers might remember an old black and white TV commercial about a Timex watch in which the manufacturer attached the timepiece to a motorboat engine blade; shot it at a wall using a bow and arrow, and dropped it in a washing machine, among other tests of resilience. In the commercials, at least, it always passed with flying colors: “It takes a licking but keeps on ticking.” That pretty well describes the U.S. stock market. The S&P 500 index (SPX) had every reason to break to downside in the past month, as the looming litany of bearish arguments grew larger seemingly by the week—the inverted yield curve; the U.S. Treasury 10-yr note yield below 1.5%; the ISM falling below 50 (which suggests contraction); the VIX (fear index) surging, and President Donald Trumps “threats” to close the Federal Reserve Board. Instead, we are witnessing an upside breakout of S&P 500 from the August range (2,820-2,940). From conversations with clients in the past few days, it seems investors remain largely skeptical of the rally, mainly because so many spent the past few weeks getting defensive in positioning and now don’t want to be whipsawed again. The S&P 500 finally broke out of its August range on the heels of de-escalation of U.S. China trade/tariff tensions. Investors need to respect this breakout, as it comes in the face of widespread skepticism and de-risking due to the movements of the yield curve. I believe S&P 500 is poised for a year-end rally towards my 3,125 yearend target. This implies a 5% gain from current levels. Given the combination of Fed easing, likely cyclical acceleration in 2H19 (recall previous notes on the long-term yield curve) and investor de-risking, I see this as probably. Granted, the world is a scary place but S&P 500 is de-coupling from it. Skepticism isn’t surprising—this is a challenging environment for active managers given presidential tweets are a crucial macro catalyst and the terrifying message from plunging global rates. Yet the S&P 500 has indeed de-coupled from global equities—my assessment since the beginning of 2019—with U.S. continuing its relentless outperformance against the world, topping the MSCI ACWI by 6,980 basis points since 2007) and 460 bps year to date. Source: FS Insight, Bloomberg The big picture drivers continue to be the following: a strong, high-margin or high value U.S. franchises (technology, healthcare, in particular) plus the lowest share of “deep cyclicals” like industrials, energy and materials. There’s also a supportive White House/ government policy, and supportive central bank policies (easing financial conditions). The implication that is the S&P 500 isn’t “ignoring bad news” but is rather highlighting that we remain in a bull market. Nor is it the case that the S&P 500 is immune to a global slowdown. In fact, the only “real” sources of meaningful demand is the U.S. and China. According to the Credit Suisse Global Report 2018, the U.S. and Chinese consumer controls $150 trillion of wealth, ~50% of the global total, with 2/3 being the U.S. Think of it this way, Alan Greenspan’s recent comment that “the stock market will determine whether there is a recession” implies that the U.S. ultimately dictates whether the world slips into a recession—European economic weakness is secondary. This leads America to decouple. There are five structural reasons for this: (i) the U.S. five-year population growth is outpacing Europe, China and Japan by 1.5%, 1.3% and 4.4%, respectively; (ii) the U.S. has a greater share of “high-value” sectors (34%) vs Japan, Europe and China, 20%, 18%, and 10%; (iii) in the World Bank Competitive Index, America has improved to #1(or best) on regulatory burdens vs peers; (iv) the S&P 500 index’s “cash return” yield at 5.2% is higher than Europe, Japan and emerging markets, 4.4%, 4.3% and 2.8%; and (v) the U.S. equity market offers vastly greater liquidity. For example, the median S&P 500 stock is a $22 billion market cap while that is only $610 billion outside U.S. Effectively, every stock outside U.S. is, on average, a mid-cap stock and among liquidity measures, the top 10 American stocks have ten to 20 times the volume of the top ten in other countries. What could go wrong? Confidence, both business and consumer, remains key to sustainability of the expansion. The drumbeat of negativism could lead to contractionary behavior and the level of pessimism was near “hysteria” reaching recession-mania levels. Bottom line: Our base case remains a 2H19 rally into year end and to S&P 500 3,125, led by cyclicals. The following 20 stocks are worth a look based on (i) cyclical sector; (ii) dividend yield > U.S. 10-yr; and (iii) ranked in the first quintile of the Doctor Quant Model: KSS, TPR, GM, BBY, CAT, EMR, HPQ, QCOM, MXIM, LYB, EMN, NUE, HP, XOM, CVX, PBCT, KEY, MS, BLK and VIAB. Figure: Comparative matrix of risk/reward drivers in 2019 Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500 ** Performance is calculated since strategy introduction, 1/10/2019

The Fed Caves, Investor Rejoice: S&P Tops 3000

Savvy investors knew a little while back that the Federal Reserve Board had changed its stance from tightening to easing. And if you didn’t then, surely you read here. Hopefully, you bought stocks. But if there were any doubt at all, any, then it’s been resolved once and for all: the Fed has unofficially officially caved in. An end of month Fed funds rate cut is coming. Fed chairman Jerome Powell, in testimony before the Congress—ironically a venue where he is respected and could have easily asserted the Fed’s independence— simply rolled over for President Donald Trump. Yes, he told the representatives that Trump can’t fire him and that the central bank remains independent of outside political interference. But then he made it as clear as a central banker can that indeed the Fed will very likely be cutting rates at the end of this month, which is what the president has been loudly agitating for over the past few months. (See page 6.) The Fed intends to “act as appropriate to sustain the expansion,” Powell said. Catnip, folks. And investors reveled in it. The Standard & Poor’s 500 index rose 0.8% last week to finish over 3000 for the first time ever. Yes, I know 3000 is only a number, not much different from 2999, but it isn’t just that. We’re at all-time highs again. Closing above 3000, rightly or wrongly, gives some investors—particularly those who have missed out—the confidence that this rally has legs. Perhaps we should get our Dow 30,000 hats ready? The Dow Jones Industrial Average finished at 27,332. The market is now up about 20% on the year, with tech stocks scoring a blistering more than 30% rise. As an aside, please note that our own Tom Lee has been saying 2019 would be strong since the beginning of the year. (See page 3.) One week ago, the market softened on strong jobs data but just a one word from one person, Jerome Powell, and the market’s wounds are salved. We will soon be coming up on the second quarter’s earnings reporting season. A few companies have already reported but the parade of the announcements will begin Monday. As of today, the S&P 500 is expected to report a 3% EPS decline for the second quarter, according to FactSet. Nevertheless, FactSet goes on to say that given the average change in earnings growth due to companies reporting positive earnings surprises during each earnings season, it’s likely the index will report (year-over-year) growth in earnings for Q2. Over the past five years on average, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.8%. See chart nearby. Investors who listen in to the company conference calls should keep an ear tuned to comments about China and effects, if any, of tariffs. Separately, WW International (WW), formerly Weight Watchers, rose 12% to 24.50 after JPMorgan upgraded the stock to Neutral from Underweight Thursday on stabilizing trends. By the way, FS Insight posted our bullish take Wednesday: A Battered Weight Watchers’ Stock Looks Inexpensive, in the Signal From Noise column. Bottom Line: The bull trots on to yearend. Quote of the Week: VW announces the end of Beetle production. WSJ: The original Beetle became a symbol of the youth-driven counterculture and peace movement of the 1960s, despite its roots as a vehicle ordered up by Adolf Hitler in the 1930s as a cheap car for the German masses. Annual U.S. sales of the model peaked at 423,008 cars during the heyday of its popularity in 1968, the same year a Beetle named Herbie was featured in the Disney film “The Love Bug.” Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to /.

  • Signal from Noise
Jun 26, 2019

After a Strong 1H '19, Potential Is For More Gains in 2H

With the half year mark fast approaching, it’s as good a time as any to take stock of the first six months for U.S. equities, and, more importantly, to see what, if anything, that means for the market’s potential in the back end of 2019. We’ll get a jump on the sell side, which will dutifully put out its forecast reports after June 30. Where is this over ten-year old bull going? Will it trot on or begin to wobble, wheeze and fall? I remain convinced the bias is to a higher level by year end—but that doesn’t appear to be the market’s view, egged on by bad news headlines. I’ll grant you that there’s plenty of skepticism to make you believe a bear market is around the corner. Yes, this is the second oldest bull market in history. There’s the on again, off again trade talks between the U.S. and China, with the market rising and falling on every seeming movement. The global economic news isn’t so great, nor even in the U.S., too. For example, this week, blaming trade tensions, the Conference Board said its consumer confidence index dropped 9.8 points to 121.5 this month, the lowest since September 2017, from a downwardly revised 131.3 in May. And Tuesday also brought news that new home sales dropped 7.8% to a seasonally adjusted annual rate of 626,000 units in May, the lowest in five months. Jobs growth has been soft of late. In the middle of this news, and after the market’s big first half run up, it’s easy for the clouds to obscure the positive factors. As we have noted in a recent reports by Tom Lee on cyclicals, the U.S. Treasury bond 10-30 yield spread has been widening, leading to a steepening yield curve. That’s salutary for both the economy in general and cyclicals in particular. And I think that despite the red hot trade rhetoric, ultimately, cooler heads will prevail. I know I’ve said this before, but both countries need a deal, and President Donald Trump needs it badly, as the 2020 elections are a little more than a year away. It also happens to be a bull without much investor enthusiasm. Nowhere is there exuberance. That’s a contrarian point in favor of the bull trotting on. As of June 25, the Standard & Poor’s 500 index is up 16.7% for the year, and 24.1% from the lows of Dec. 24, 2018. Not bad. The market’s price/earnings (P/E) on 2019 EPS is about 17.8 times consensus of about $167 and 15.6 times the consensus of about $187. Here’s some interesting data from Bespoke Investment Group (BIG). The performances of stocks and bonds this year has bucked the typical trend of this bull market, that is, bonds and stocks generally moving in opposition. Both asset classes are up. In 2019, long-term treasuries, as measured by the Bloomberg Barclays U.S. Treasury Total Return index, have rallied around 11%. Since 1980, there have only been nine years where both asset classes were up over 5% through the end of June, according to BIG. In those instances, the S&P 500’s average second half return was 11.3%, (median: 12.40%), with positive returns in all but one period. That’s twice the average return for all second halves since 1980. Of course, past performance doesn’t guarantee the future performance, but I find it interesting. Another subtle market factor is one from our technical strategist, who’s pointed out that defensive sectors are not showing the kind of strength that would indicate that investors are truly convinced a bear market is coming. For all the defensive positioning of institutions, our technical analyst Robert Sluymer points out that utilities and staples are at price highs but they actually haven’t performed well compared to the broad market. For example, in the chart below it’s clear that when the broad market weakened by 7% or so in May and utilities rose, but the sector then made a lower relative high compared to the previous high in the December 2019 drawdown. Sluymer says the utilities weekly momentum has peaked with the relative performance in a longer term downtrend. It is continuing to negatively diverge, with lower highs underway. That suggests there isn’t a lot of conviction behind the defensive positioning in the market. The consumer staples sector, another safe haven sector, shows a similar technical pattern. Source: FS Insight, Bloomberg, Optuma Where could I be wrong? Going into May I thought that the U.S. and China would reach some sort of trade agreement. That didn’t happen and the market didn’t like that at all. Talks have resumed and both Trump and China’s Xi Jinping will meet at the upcoming G-20 meeting in Japan. In any event, a full out “trade war” alone would not bring on recession, but the serious sentiment deterioration from such a prospect could hurt stocks almost as much as an actual economic contraction itself. The Middle East remains a political powder keg that can blow at any time, but this would likely be temporary setback for stocks, though not for people involved. Bottom Line: More zig zag action into the third quarter but ultimately a higher finish.

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Illustrations by Karl Wimer.