Eye on the Markets - 2019


Equity Market Trends Continue Upwards

By Ketu Desai

The upward equity market momentum continued in November, mostly driven by global central bank policy, easing of the trade war, and a growing belief that the global economic cycle is bottoming. While the Fed may not be cutting rates in its next few meetings, Chair Powell effectively said that rates won't be going up for a while, specifically, the Fed would need to see a sustained and significant uptick in price pressures before considering future rate hikes. To give a sense of the impact of monetary policy this year, over the last three months, money supply has grown 10.4% annualized, and money market growth is up 22% from a year ago, this excess liquidity finds its way into financial markets. The Chinese also stepped up their policy response. The People's Bank of China unexpectedly trimmed a closely watched money market funding rate during the month, the first such cut in more than four years and a signal to markets that policymakers are ready to act to prop up slowing growth. These moves, combined with the ECB restarting QE, have provided the equity markets the ammunition to rally, and put a ceiling on how high rates go. TINA, there is no alternative to equities, is the mantra for investors, especially when you consider that the equity earnings yield is nearly 4% on a nominal basis, and 6% on a real basis more than Treasuries.

Many market participants are betting that the trade war will continue to ease, and that economic data, particularly, the manufacturing and industrial economy has bottomed, and is set to re-accelerate. While that may be the case, the most recent economic data is less inspiring. The New York Fed GDP Nowcast is tracking just 0.8% growth for the 4th quarter, most other estimates are also below 2%. After popping earlier in the year, the Citigroup Economic Surprise Index turned negative during the month. To be fair, some of the weaker manufacturing numbers are due to issues at GM and Boeing. We have even seen some mixed results on the consumer, including retail sales, rising initial jobless claims, and earnings weakness from names such as Home Depot, Macy's, Dollar Tree, and Kohl's. That said, the market is forward looking, and the simulative measures are just starting to hit the economy. Housing is rebounding behind lower mortgage rates. Rising new orders, falling inventories, a steepening yield-curve, and an improvement in ISM, suggest that the industrial cycle is set to turn. Fundstrat points out that, over the last 25 years, when the ISM export moves from contraction to greater than 50, this has marked inflection points in EPS growth, with the average EPS growth of 18%. It is unlikely that EPS will grow at such a level next year, but it does indicate EPS growth will be better than it was in 2019.

With the improved backdrop and outlook, investors are rotating, between asset classes and sectors. In general, investors are selling defensive, rate-sensitive, and yield-oriented, in favor of cyclical, growth, and value. This rotation has favored equities versus fixed income, copper versus gold and silver, credit versus rates and duration. New highs in recent years were largely driven by secular growth tech such as cloud, software, internet, and payments and defensive yield-oriented sectors such as REITs and utilities. The recent move has included cyclical groups such as financials, industrials, semiconductors, and materials. Even healthcare, which has been one of the worst performing sectors over the last year due to the potential for drastic changes to the system, has been on a run, behind terrific earnings, and softening of policy plans by a certain Democratic Presidential candidate. While the market is technically overbought, and may need to cool off in the short-term, the combination of low rates, relative valuations, central bank policy, and recent market rotations suggest that this break-out may have more room to run.

Looking forward the market will continue to follow the latest economic data and the trade war, especially if the December 15th tariffs are put in place.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com