“From the Desk of Michael Sheldon, CIO”
- The next Federal Reserve Bank meeting will take place this week on June 19. Greater attention is being placed on the central bank after Federal Reserve Bank officials recently indicated that more accommodative policy is possible this year. In recent weeks, Fed Chairman Powell stated that “we will act as appropriate to sustain the expansion.” The odds of a rate cut this month are pretty low (although not zero) but the odds of one or two rate hikes later this year starting in July are much higher and growing. With the unemployment rate at 50-year lows and equity markets just off all-time highs, it’s hard to make the case that the economy needs rate cuts from the central bank. However, due to uncertainty caused by the U.S. / China trade dispute, weak inflation data and a slowdown in corporate profits and industrial production, the outlook for the economy looks a little less certain over the next few quarters. As a result of the question marks highlighted above, we believe that the central bank can justify cutting rates somewhat and in the process, take out an insurance policy for the economy. Due to the uncertain timing (and impact) of any future rate cuts by the central bank, financial markets may experience some added market volatility over the next few months. At some point, we believe the U.S. and China are likely to resolve their trade differences which should provide a renewed tailwind for the global economy. However, until that time, rate cuts by the central bank may help provide a boost to consumer and business confidence and (hopefully) help keep the economic expansion on track.
- The U.S. consumer represents approximately two thirds of the U.S. economy and is therefore an important piece of the puzzle that needs to be monitored over time. Based on a combination of rising wages, mostly solid employment data (note: the unemployment rate is now at a 50-year low – Source: Bureau of Labor Statistics) healthy confidence levels and solid balance sheets, the U.S. consumer currently appears to be on pretty solid footing. For reference, retail sales jumped 0.5% last month with gains in 11 out of 13 categories (Source: Census Bureau). Retail sales data has been very uneven so far in 2019. However, on a 3-month annualized basis, retail sales (based on the control group which feeds into quarterly GDP) has now advanced at the fastest rate since 2006 (Source: Bureau of Economic Analysis – BEA). We realize it is important not to be overly complacent when evaluating the current state of the U.S. consumer because things can always change.
- Every week since 1987 the American Association of Individual Investors asks its members a question – Do you expect equity markets to be higher in six months? In the latest poll, 27% of investors were bullish, 39% were neutral and 34% were bearish. While bullish sentiment rose 4.3 points last week, investor optimism has remained below 30% for the fifth straight week and has also remained below the poll’s historical average of 38.5% for the 17th time this year (source: www.aaii.com). Investor optimism is not the lowest it has ever been but remains at historically low levels which is no surprise given trade / tariffs concerns, geo-political risks, questions about the length of the current expansion and uncertainty about the outlook for the economy and corporate profits. However, the fact that investor sentiment has been at low levels for much of this year indicates that a certain amount of negative sentiment might already be built into current market prices.
- Looking ahead to the remainder of June, we will be keeping an eye on the following economic reports: 1) a number of housing reports will be released including new and existing home sales, housing starts as well as the NAHB Housing Market Index. Housing has been a drag on the economy for five straight quarters but there are some modest signs that falling interest rates may provide a lift to the housing market in the months ahead; 2) we continue to keep an eye on weekly jobless claims which come out each Thursday morning at 8:30 am (note: this helps provide a timely read on the health of the job markets); 3) the Leading Economic Index (LEI) will be released on June 20th and this is always an important index to keep an eye on because it helps forecast the direction of the economy looking out over the next 2-3 quarters and finally 4) we will get the monthly Conference Board’s Consumer Confidence Index on June 25th and the final reading of the Michigan Consumer Sentiment Index on the final day of the month.
- While market fundamentals (things like sales, profits, interest rates, inflation and GDP) are the most important economic indicators that we watch, we also keep an eye on market technicals (for example the breadth of the market). One such indicator is the percent of stocks in the NYSE trading above their 200-day morning average. A higher number above 60 or 70% represents a healthy market while a lower number below 50% or so could indicate weaker market conditions. To put things in perspective, in early 2018 the percent of stocks above their 200-day moving average rose to around 80%, in late 2018 the number fell to around 10% (during the market decline) and today it sits around 50%. It’s certainly possible for the stock market to generate additional gains over time if only 50% or so of the market is trading above its 200 day moving average. However, this would likely mean a more concentrated market led by a smaller number of stocks. We would like to see the number of companies trading above their 200 day moving average rise above 60% and stay there during the second half of the year to indicate to us that underlying market conditions remain healthy.
- Last quarter profits for companies in the S & P 500 fell 0.4% on a year over year basis. This is a big change from the 20% growth companies generated in 2018 (thanks to the Trump tax cuts). The optimist might say that negative 0.4% is a lot better than the -4.0% estimate at the start of reporting season. However, to us negative EPS growth (if sustained) is a concern. Looking ahead, the current outlook is for -2.5% this quarter, 0.0% year over year EPS growth during the third quarter and +6.8% year over year growth in the fourth quarter of the year. For 2020, the outlook is forecast to brighten. As of the latest update (June 14, 2019 – source: Factset) the S & P 500 is forecast to generate 11% full year EPS growth with six out of 11 sectors (led by cyclical parts of the market like energy, industrials and basic materials) forecast to produce double digit profit growth. To us, the outlook for corporate profits will likely depend on the outlook for business confidence and 2) resolution of the U.S. / China trade dispute. We believe that investors are likely to be okay with a short period of slow or even negative corporate profit growth. However, investors need to believe that the outlook for corporate profits will get better again after a brief slowdown. Anything that changes this narrative could represent a headwind for equity markets during the second half of the year.
As always, we welcome any comments you may have.
Michael Sheldon, CFA®
Executive Director & CIO
RDM Financial Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
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All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.
This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.