By David Nelson, CFA CMT
Captain Renault – “Round up the usual suspects.” – Casablanca
The usual market suspects continue to weigh on investor sentiment. Trade talks, slowing global growth, a paralyzed Washington along with an earning’s season most analysts believe will deliver a down year on year bottom-line, has forced many investors to the sidelines. Even today after a monster 21% move off the Christmas Eve low, more money has gone into fixed income Exchange Traded Funds (ETFs) than Equity.
World Markets are up double digits and the S&P 500 is less than 2% percent from an all-time high and a solid +16% year to date. If we maintained this velocity the S&P 500 would close out the year up 57%. Don’t even think about it. Ain’t gonna happen.
All of this begs the question what do stock investors see that the IMF, FED and frankly many of the world’s top strategists don’t? Investors clearly seem to be looking through the slowdown and the distinct possibility trade negotiations don’t end with a Kumbaya moment showing Trump and Xi walking off into the fog like Captain Renault and Rick in the movie classic Casablanca.
The Fed
Catalysts
First, on anyone’s list of market catalysts has to be a Federal Reserve that has turned 180 degrees reversing a policy that clearly set off a market free fall in the last quarter of 2018. Emerging markets were the first domino to fall followed by developed markets in nearly every corner of the planet. I think the change was justified as several Fed hikes in the face of little inflation took the administration’s pro-growth agenda potentially turning it into a liability despite the good news on jobs and the economy. Where I part company with Chair Powell and the FOMC is their capitulation on the balance sheet which today still stands close to $4Trillion. The announced slowdown and eventual halt to the roll off should leave us at about $3.5 Trillion nearly 7x pre-financial crisis levels.
If rates continue to stay low, than as even Warren Buffet points out, stocks remain the more attractive asset class.
Did CEOs bag the quarter?
Second catalyst: Despite a backdrop of down year on year earning’s growth, CEOs may have bagged the quarter. Last earnings season they were tripping over themselves to cut guidance and as we’ve learned from previous episodes, when CEOs have to give bad news why not throw in the kitchen sink? Analysts cut their numbers more than needed making it easier for companies step over a lowered bar during the next reporting season.
We’re about to find out if my theory is correct. JP Morgan’s (JPM) report Friday seems to point in that direction handily beating estimates that have been trickling down for the last couple of months. Nearly every line item in the report pointed to a strong global franchise with the lone exception, capital markets which appeared challenged.
China – What will victory look like?
China is the third catalyst. The entire world is counting on a trade deal between the United States and China. It dominates every financial news cycle and is the focus of every central bank and therein lies the problem.
Trump Xi?
Look, all the body language points to a deal but as I said on Morning’s with Maria Friday, “just what will victory look like?” Will there be real structural reform or will it be more likely a deal where China spends $Trillions closing the deficit but unwilling to stop the outright theft of intellectual property? As I’ve said ad nauseam, China is an adversary in every sense of the word. Trade, Foreign Policy and even militarily China confronts us each and every day. IP theft is in their DNA. Maria said it better than I. “It’s in their culture.”
For any trade deal to work both sides are going to have to be able to paint it as a win. Difficult given our opposing views. To their credit this administration has been the first in decades to hold China accountable regarding IP, cyber threats and the blatant theft of military secrets. Never the less, 2020 isn’t that far off. It may pay for Xi to drag his feet on some of these key issues hoping for a Democratic win and a chance to negotiate with an administration with a different set of priorities.
Currently, Secretary Mnuchin implies there’s been some agreement on enforcement and that’s going to be key. No matter what deal is struck you can expect this to be an ongoing issue because in the end, China will cheat.
