Another year has come and gone. 2018 was in many respects, from an economic perspective, a carbon copy of 2017: rising employment, increasing earnings, improving consumer confidence, tightening Federal Reserve, and reduced government regulation. For three quarters of the year, the stock market rose in concert with the positive economic backdrop. Then the bottom seemed to drop out, in what will in the future will be referred to “The Powell Panic of 2018.”
What caused the panic was a confluence of exogenous events and uncertainties:
- A dogmatic FOMC which sent clear messages that interest rates would rise despite a lack of inflation and over-heating economy
- Trade disputes with China
- Failure of the UK Parliament to approve a Brexit agreement
- Closure of certain parts of the US Government
- Disappointing iPhone sales
Wrongly, market pundits declared the end of the bull market. These were the same pundits who believed that the secular bull market began in 2009. Let me set the record straight. We remain in a secular bull market. The current bull market began in 2013, once the SPX broke free of the pre-financial crisis highs. In 2018 we suffered two corrections: a mild one in February and a more severe one in the fourth quarter. That last correction in many respects, harkened back to the 1987 fourth quarter correction, which of course began with Black Monday. Black Monday was just a blip on the 1982-2000 bull market. 2018’s correction was widespread, resulting in a rare year in which all asset classes other than cash declined. 2019 will not be so kind to the bears. I continue to see no recession on the horizon. In fact, a trade agreement with China will reinvigorate the economy and may push off a recession until 2022, at the earliest.
For the first time since 1994, the SPX declined in the fourth quarter of a mid-term election year. I expect that we will make up that lost ground and some more in 2019’s first quarter.
Without further ado, in the spirit of the old Wall Street Week with Louis Rukeyser, wherein his panelists were asked at the outset of the year to make their predictions, which could not be changed thereafter, I present My Gut Feeling for 2019:
- The SPX ended 2018 at 2,506.85, which using Bloomberg’s Standard & Poor’s 500 (SPX) earnings estimates of about 146.43 implies an index price/earnings multiple (PE) of 17.11. Standard & Poor’s own analysts estimate that SPX earnings for last year should come in at 156.99 implying a year-end index PE of 15.97. Clearly, both sources use different assumptions in their calculations. Either way you look at it, corporate earnings rose handsomely in 2018. Last year I was expecting EPS of 145 with a higher PE ratio of 21. Thus, I was lower on my EPS estimate but too ebullient on the PE for the SPX. Hence, to quote Shakespeare’s Hamlet, “ay, there’s the rub.” The fourth quarter panic caused PE multiple contraction without a meaningful hit to earnings expectations. Understand that every 1 PE multiple (up or down) equates to roughly 6% in market valuation. So, I contend that the 14% decline in the SPX for last year’s fourth quarter was primarily due to PE compression. Looking forward to 2019, bottoms-up earnings as complied by Standard & Poor’s, for its SPX index, are expected to increase to 171.74. Bloomberg’s estimates call for SPX EPS of 171.58. Now both sources are back in line with one another. My belief is that 2019 earnings expectations were cut too much in last year’s fourth quarter. Considering that I expect that there will be a trade deal with China, that the FOMC will be more market friendly (see #2 below) in 2019, that tax benefits from the Tax Cuts and Jobs Acts of 2017 would last beyond 2018, energy earnings hit cyclical troughs and, expecting a softer US Dollar in 2019; my EPS estimate for 2019 is a bit higher at 175.00. The key question is what multiple to apply to my estimates. Clearly, a forward PE of 14.32 (2,506.85 / 175) is too cheap and is just a manifestation of The Powell Panic of 2018. Markets don’t peak until they have traded at around 21 – 22 times earnings for a fair amount of time. I am going to play it safe and use a PE ratio of 17, arriving at a year-end SPX price target of 2,975, an all-time high. Along the way the SPX will hit a low of 2,450 and high of 3,100.
- The Federal Reserve Open Market Committee (FOMC) raised Fed Funds target by ¼% four times in 2018. One positive development of The Powell Panic of 2018 is that Fed Chairman Jerome Powell has gotten religion and sees the errors of his ways. He will not be as dogmatic in 2019, rather, Powell will learn a lesson from his predecessors and become more data dependent. Quantitative Tightening, that is contracting the Fed’s balance sheet, will be enough to achieve monetary goals in 2019. The Fed Funds rate ended 2018 at a target range of 2.25% to 2.50%. Expectations per the Dot Plot indicate two tightening rounds each of ¼%. Fed Funds futures are pricing in no rate changes in 2019. I expect one ¼% tightening to take place in the June or July meeting. The FOMC will not be a Grinch in 2019 as it was in 2018.
- That insatiable appetite for US Treasury securities I have been writing about for years will keep going like the Energizer Bunny with pension managers and foreign investors gobbling up Treasury auctions and secondary paper in 2019. Such appetite is so rampant that it is spreading to mortgage bonds such as FNMAs. Furthermore, this continued credit boom will fuel further corporate buybacks, acquisitions and dividends. As to the slope of the curve, it will remain much the same in 2019 as it did at the end of 2018. However, I do expect a parallel shift in the yield curve across all maturities, such that by the end of 2019, the US Treasury market will yield as follows: 5-year 2.75%; 10-year 3.00%; and, 30-year 3.25%.
- We are still in a growth-oriented market. It is just that growth stocks became value stocks during The Powell Panic of 2018. While we remain in an investment mode which favors large cap stocks, there should be a reemergence of opportunity and hence demand for small cap stocks. So, it may be time to add exposure to the Russell 2000 (RUT) which has some catching up to do.
- On a micro basis, you got a gift from the market panic which created deep discounts in the technology sector. There is no reason to abandon growth tech, though you may want to overweight software and underweight or abandon social networking and internet stocks. I am going to favor medical devices, especially in the diabetic sector. Energy will have a dead cat bounce while financials will remain in Missouri as they need to show me some compelling reason to devote capital to that sector
- The US economy did reach escape velocity in 2018, while the fourth quarter may have felt some weakness from the US/Sino tariff dispute. Those clouds will lift in the first quarter and should benefit GDP the rest of the year. Continuing job growth, benefits from the 2017 tax law, strong consumer confidence and resurgence in the economies of emerging markets will benefit the US Economy. I expect GDP in the US to grow by: 2.7% in 1q; 3.5% in 2q; 3.7% in 3q; and 3.8% in 4q.
- Cyclical lows for Crude Oil below $50/bbl., will be left behind, as the economy continues to grow, and the US Dollar weakens a bit. Crude oil prices will trade between $50 and $65 for most of the year as global overproduction and gluts of liquid gold diminishes. There will be no place to hide in energy, unless, like in LakeView Asset Management’s Dividend Value Portfolios you want to own a little Exxon Mobil (XOM) for the yield. Otherwise, just underweight the sector.
- 2019 will, once again, be an interesting year in politics. So what else is new? There are no noteworthy elections, but the entertainment value will remain high in Washington, D.C. To begin with, the government shutdown will cease and we can once again enjoy the Panda Cam. President Trump will begin construction on the wall (or whatever structure you want to call it) along the nation’s southern border. It will come in under budget and on time. Nancy Pelosi will step down as her (yet undisclosed) battle with Parkinson’s disease no longer allows her to function on a full-time basis. Joe Biden will declare his candidacy for POTUS as he will be considered the Obi Wan Kenobi “you are my only hope” for the Democratic Party in 2020. An assassination attempt on President Trump will be foiled by the FBI and/or secret service.
- Facebook (FB) will go into a tailspin in more than one way. The stock will fall below 2018 lows. Cheryl Sandberg will be forced out, but to save face she will voluntarily step down. A conga line of executives will follow her out the door. Apple (AAPL) announces a surprise acquisition / merger. Possible targets: Netflix (NFLX), IBM (IBM) Salesforce.com (CRM), Take-Two Interactive (TTWO) and, Roku (ROKU). Another possibility is that AAPL buys a large stake in Vudu partnering up with Walmart (WMT). Apple needs to get into the cloud and/or expand its entertainment service revenue in a big way. Tim Cook will achieve that goal via the M&A route.
- In a partial repeat of a 2018 prediction, Ruth Bader Ginsburg will pass away or be forced to retire because of failing health and be replaced by Amy Coney Barrett. This time around, there will be no three-ring circus nomination process as there was with Brett Kavanaugh.
Best wishes for a Happy and Healthy 2019. As always, please contact me if I can help you with your investment needs or for media appearances. Also, feel free to post your comments / questions to My Gut Feeling and pass it on to relatives, friends and colleagues throughout the year.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long AAPL, CRM, IBM, NFLX, ROKU, IWM, UWM, SPY, SSO, SPXL & XOM; although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, a registered investment advisor specializing in high net worth private wealth management. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
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