Year End Thoughts
|Shane C. Murphy||Dec 29, 2019|
2019 was a tumultuous year for US equities. The S&P 500 Index is +30% YTD and pretty much every asset class saw a positive return on the year. Whether you were invested in Bonds, Gold, Oil, Real Estate, Crypto or Stocks - you made money. We saw the Federal Reserve completely reverse their hawkish stance on interest rates, and as monetary policy shifted - stocks followed suit. The Fed cut rates 3 times in 2019 and in September began expanding their balance sheet (now totaling $4.17 trillion). I believe 2019 is the perfect example of Marty Zweig’s trading mantra “Don’t fight the Fed.” What he means is when the Federal Reserve displays a favorable stance on rates or other monetary tools - commit to the side of the Fed. They are the director of Wall Street’s melodrama - when we’re seeing rate cuts and Treasury security purchases, it’s often interpreted as expansionary and therefore good for stocks.
Economic indicators were the biggest curve ball of 2019. Many of which are still deviating from equities and causing quite the outcry from financial media and under-performing money managers. Core Capex (Manufacturing New Orders: Non-Defense Capital Goods Excluding Aircraft) is one of these indicators. In July we saw the first negative YoY reading since November 2016. Stocks do not like seeing Core Capex contracting, any YoY reading below 0% is a red flag and interpreted by “some” as a recession indicator. However, November’s reading came in at +0.5% - I find this encouraging. A hard stop to the duration of contraction invalidates the forecast and increases the likelihood of the indicator following stocks higher.
Another economic indicator which received quite a lot of buzz in recent weeks is Corporate Profits. Below is Corporate Profits as % of GDP. From Q2 2016 to Q4 2017, we saw the 2nd longest continual decline in post war history (7 consecutive quarters). Only being beat by two instances of 8 quarters of continual decline (1973-1975 and 1999-2001). Some Macro Strategists argue that current stock prices do not justify the slump in Corporate profits relative to GDP. These two indicators do not move in perfect tandem by any means, but historically when CP / GDP is rising, stocks are spitting out better than average returns. I believe Corporate Profits on a relative basis is important, but the more globalization we see from Corporations, the more this measure may be construed incorrectly. Nonetheless, it’s an important ratio to keep eye on.
The Fed’s 2% inflation target was another topic of conversation all of 2019. For the most part, as interest rates bottomed in October, we’ve seen inflation gauges begin to jolt back to life. Below is a chart of Treasury Inflation Protected Securities vs. US Treasuries. When this ratio is trending higher, it’s indicative of an inflationary economic environment. I coupled TIP vs. GOVT with the CPI year-over-year number to highlight the relationship.
It’s no secret that it wasn’t difficult to make money in 2019 - but only 3 US sectors outperformed the S&P 500. That is Technology, Communications, and Financials. The year’s biggest laggard is the Energy Sector, which some may argue is presenting itself as a huge opportunity in 2020. Crude Oil in particular is becoming a topic of conversation. I believe the 3 touches below $51 per share in 2019 qualifies as a basing pattern. We’re seeing constructive price moves above diagonal downtrend lines, which are not as important as horizontal levels of supply & demand, but still encouraging. I believe from a Value point of view, there is a lot the Energy sector is offering, but until we see price confirm these value theses it’s difficult to be overly bullish.
As always, I appreciate your support and interest in my thoughts! Enjoy the remainder of 2019 and let’s get ready for an amazing new decade. See you next year!