Feb. 11, 2019 Commentary

Off to a Good Start in 2019 and Finding Comfort in What We Believe Really Counts - The Data!


“Discipline, which is but mutual trust and confidence, is the key to all success in peace and war.” -General George S. Patton, Jr.

After experiencing one of the toughest fourth quarters on record and absorbing headlines such as “Worst December since 1931,” the stock market is indeed off to a good start in 2019. Specifically, the S&P 500 Index saw its biggest monthly gain since October 2015 and its best January since 1987, gaining 7.9 percent for the month. It has advanced 15 percent off the December bottom (as of Feb. 6, 2019).

As impressive as this return figure feels, the significant shift in leadership is equally encouraging. Last year’s worst performers are this year’s best performers, and cyclical areas of the market that generally do well in a solid economy, areas like Consumer Discretionary, Industrials, and cyclical areas of Technology, led in a meaningful way. And yes, finally, the Financials, also a cyclical sector, had an outstanding month.

Unlike last year, when only a handful of individual stocks did well, we saw broad participation at the sector and individual stock level in January. While we don’t usually make 30-day calls on the market, we were not surprised by all of this. Our mantra at year-end 2018 was that investors had become overly pessimistic and were anticipating both an ugly economic recession and worst-case outcomes on ALL of the wall of worry items out there—trade, Federal Reserve policy, government shutdown, etc. We saw it differently; instead of this pessimistic view, we believe the economy is in a normal transition phase. Growth is moderating in normal fashion to a still-healthy level. We also foresee better than feared outcomes in the major headline concerns. Our confidence in expecting healthy returns in 2019 is grounded in the discipline that the late General Patton alludes to in the quote above. The process of researching and focusing on the facts and the data leads us to this conclusion.

Unlike the bearish chorus we heard as 2018 came to a close, we find it rather difficult to be negative on the market when P/E multiples had fallen to roughly 14 times earnings and the 10 year Treasury hovers around 2.7 percent, while the fundamental economic and earnings data remain solid. This wasn’t a popular view to maintain around Christmas, but we believe it is supported by the data. If the data changes, we’ll adjust our view.

Catalysts for the January Gains

The drivers of the solid returns to start the year were fairly straightforward. 1) Healthy fundamental data releases and trends on the economic and earnings front, and 2) Productive news flow on the global policy front:

  1. The fundamentals data
    • Earnings picture remains healthy: During the psychological abyss back in December of 2018, consensus earnings expectations were revised downward sharply for fourth quarter 2018 and for calendar year 2019. Projected fourth quarter earnings per share (EPS) growth declined from the 15 percent level down to 10 percent, and anticipated growth in EPS for calendar year 2019 was adjusted down to virtually zero from the earlier forecast of a double-digit rise in earnings.1 As solid earnings reports have been released in January, the data is better than implied by the downward adjustments made during this panic attack.

    With more than 70 percent of companies beating estimates for fourth quarter, EPS growth for the final quarter of 2018 has been revised back up to the 15 percent level, and projected consensus S&P earnings for calendar 2019 have been adjusted back up to $173 from the $167 level, representing 7 percent growth.2

    Yes, EPS growth is moderating but down to still healthy growth levels; earnings are not collapsing as the headlines warned. We have appreciated the solid news out of the more cyclical stocks in the Consumer Discretionary, Industrials, Technology and Financial sectors. Earnings power in these economically sensitive areas supports the conclusion that the economy is NOT nearing recession. In fact, moderation in earnings growth can actually be good for equity prices based on history. Historically, either periods of very weak or excessively strong earnings growth are the times to be concerned, not when we’re just seeing a modest deceleration in earnings pace.

    • Economic data remains supportive: Similar to earnings data, some of the U.S. economic data has moderated from very strong to only solid/still healthy levels; several key economic metrics remain quite robust. Regardless of how one describes its level of strength, we believe the data is NOT signaling recession. The unemployment data falls in the robust spectrum, with more than 300,000 new jobs created in each of the last two monthly payroll reports.3 Wage growth is in that sweet spot at just over a 3 percent annual pace, the strongest progress we’ve seen in this data since the 2007/2008 recession, but well below the margin-choking level of 4 percent.

    Unemployment claims are at lows going back to 1969. The Leading Economic Indicators (LEIs) are signaling growth and have actually ticked up this last month. After a softening in the manufacturing and service activity data in December, these indices also rose in January and continue to signal growth. The yield curve steepened and credit spreads re-tightened. This just doesn’t sound like recession to us.

    In prior recessions, typically unemployment claims rise significantly, LEIs go negative as do the manufacturing and service activity indices, the yield curve inverts and credit spreads surge. This is not happening today; quite the opposite. Our modus operandi is not to predict the predictors, like many were wanting to do in December 2018, but to follow the data and look to it to guide us.

  2. Wall of worry items: We’ve seen progress here as well. Let’s focus on the big two…Federal Reserve Policy and Trade. We saw progress on these two items in January, as we expected. It doesn’t make sense to us that either the Federal Reserve or the Trump administration would want to CAUSE a recession, move forward in auto pilot fashion and ignore the data. The Federal Reserve’s mandate is to promote economic stability, not instability, and the GOP wants to get re-elected in 2020. So, pursuing policies that work against their primary missions and ambitions would not seem to be a smart base case bet to us. Hence, our judgement that less than worst case outcomes would result on these two policy fronts and that helpful policy adjustments would likely be made this year. We’re not expecting perfection, just some helpful adjustments, which is all that is required, in our view, to provide a lift to the market. 

Interestingly, one of the myths out there is that the stock market always does poorly when policy risks are elevated. The chart below shows the opposite to be the case.

Global Policy Uncertainty Index

Source: Strategas

S&P 500 Returns Following Spikes in Global Policy Uncertainty - Reading Above 200

Source: Strategas

These charts illustrate that over the past 20 years the Global Policy Uncertainty Index has been tracked (index established and maintained by academics at Northwestern, Stanford, and the University of Chicago), the S&P 500 performs quite well following periods when policy risk surges to higher levels. The reason for this isn’t entirely clear; perhaps the angst associated with higher levels of policy uncertainty forces policy-makers to become more focused and rational and to make prudent adjustments on a go-forward basis. Regardless, we seem to be seeing progress on the policy front:

  • Federal Reserve Policy: Chairman Powell appears to have completely changed the late 2018 narrative that the Fed is far away from wrapping up rate hikes and that unwinding the Fed’s monthly bond purchases is on “auto pilot.” These comments frightened investors. He walked it back in 2019. In the press conference following the January Fed meeting, he said, “The case for raising rates has weakened somewhat,” and he highlighted the fact that U.S. growth is moderating and global risks remain. He also expressed willingness to slow the pace of reduction in the Fed’s bond portfolio if the U.S. economy weakens. This is the more patient, dovish message investors needed to hear, and it sets the stage for a Fed pause in hiking rates.
  • Trade Negotiations: There has been significant progress here, too, in January. The Chinese delegation met with trade representatives and President Trump in Washington D.C the week of January 28. While still not nirvana, the tenor is far better for a deal. It was confirmed that China committed to purchasing significant agricultural products from the United States as part of the goal to shrink the trade gap. While structural issues still need to be resolved, even the curmudgeon-oriented lead U.S. trade representative and well-known China-skeptic, Robert Lighthizer, said after these discussions, “We made substantial progress.” This sets the stage for high-level negotiations in China in mid-February and a face-to-face meeting between Trump and Xinping in China in late February.

Investment Myths—the Seeds of Over-Pessimism

Before closing, we believe it’s important to once again call out what we believe to be misinformation that, unfortunately, can inspire investor fear and over-reactions to the downside, like we saw in fourth quarter 2018. We’ve already discussed the comments by many that volatility in late 2018 was at unprecedented levels. This is not true...volatility did spike at year-end from very low levels, but it was roughly average at that time. Volatility levels were far higher in such periods as 2011 and 2007-2008, so this was far from unprecedented.4

Another myth out there was that this past government shutdown was unprecedented in its economic harm. In reality, it should shave only 0.02 percent off of GDP growth in 2019 when all is said and done.5 For perspective, the 1996 shutdown was a 21-day shutdown, but it was a 100 percent shutdown of the government. The most recent episode was a 25 percent shutdown; this one would have had to last 84 days for it to have equaled the same 21 day impact of the 1996 shutdown.6

One of the more significant myths circulating is the assertion that fiscal stimulus in the United States should fade in 2019 as we anniversary the tax cuts and that without such stimulus it will be hard for the economy to grow. It’s debatable if stimulus is needed to continue to grow the economy, but one point that is clear… fiscal stimulus is NOT less this year than in 2018.  As the chart below shows, tax cuts enacted in 2019 increased to $274 billion from $205 billion last year. These points matter when making judgements on the economy and markets.

Fiscal Stimulus From Tax Cuts NOT Fading in 2019

Source: Strategas

$ in billions


The bottom line is that we’re looking for solid returns in stocks this year, supported by the good fundamental data, less than worst-case outcomes on headline items, attractive valuation, and the improving technical price trends and leadership we are seeing in the early goings. This perspective was not embraced by many late last year, but that’s how we see it. As always, stay tuned!


1Factset and JP Morgan Research

2(Bureau of Labor Statistics) Monthly Payroll Report

3St. Louis Federal Reserve

4Factset: CBOE Volatility Index

5CBO.gov, “The Effects of the Partial Shutdown Ending January 2019”

6Source: Strategas

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