Believe It or Not, Latest Stock Rally is Legit

As published in the Minneapolis Star Tribune 3/16/2019.

Death. Taxes. And stock market doubters.

Benjamin Franklin died in 1790, two years before the Buttonwood Agreement laid the groundwork for organized securities trading in New York City.

Had he lived long enough to see the creation of the New York Stock Exchange, Franklin may have recognized market doubters to be as inevitable as life’s other certainties.

If investors’ outlook is best judged by their actions, then the majority remain unconvinced the surge in stock prices we’ve experienced since Christmas has staying power.

In the first week of March, investors withdrew $5.3 billion from equity funds, according to data compiled by financial services firm Lipper.

Market sentiment, like the icy remains of a Minnesota winter, has yet to thaw.

Late year swoon

The negativity is largely due to a harrowing fourth quarter in which the S&P 500 fell 20 percent peak-to-trough.

Mutual-fund outflows peaked just before Christmas, with $56.2 billion in redemptions signaling the most significant week of selling since October 2008, as reported by the Investment Company Institute.

The market, of course, has reversed course since then. The S&P 500 has catapulted 20 percent from its Christmas lows, causing people to wonder which of these 20 percent swings more likely illustrates the market’s path from here.

To answer that question, let’s review some of the factors that offer a solid gauge of the current market conditions:

Earnings: Spurred higher by tax cuts that took effect in 2018, corporate earnings grew by 22 percent last year. The spike made it inevitable that growth would slow in 2019 and worry turned to panic as forward earnings estimates were revised steadily lower in the fourth quarter.

Estimates have since stabilized and now forecast roughly 5 percent growth for the year ahead.

Slower growth to be sure, but still growth nonetheless.

Valuations: The forward price-to-earnings ratio of the S&P 500 currently sits just above 16. That’s not exactly cheap by historical standards, but it is below the S&P’s average P/E of the last five years.

For context, the forward P/E rose as high as 19.5 in January 2018.

As of the Christmas lows, it was 13.7. In those terms, current valuations for the S&P 500 seem somewhat neutral and entirely fair.

Fed policy: Four interest-rate increases by the Federal Reserve last year led some to wonder at what point higher rates would stifle economic growth.

Since its December hike, however, the Fed has made clear that patience would be its preferred policy looking forward.

The pivot helps alleviate recession concerns.

Less-favorable economic data may be more easily digested, since negative news may be balanced by friendlier Fed policy.

It’s unlikely we get more than one interest-rate hike in 2019. Zero remains a real possibility.

And Fed Chairman Jerome Powell has already suggested a rate cut would be considered, if economic conditions warrant it.

Sentiment: As a general gauge of the investing public, sentiment tends to have a negative correlation to market performance.

In other words, the herd mentality is usually wrong. As we discussed above, pessimism and equity outflows remain relatively high.

The aggregate numbers in January and February show investors are on pace to sell stocks at an annualized pace of $113 billion.

The clichéd “wall of worry” remains intact. And that suggests additional fuel available to sustain the current rally in equities.

Rally justified

Considered through these lenses, market conditions may not scream “buying opportunity,” but they do justify the strong rally to start 2019.

In our view, stocks may still struggle to set new all-time highs in the months ahead, but a retest of the Christmas lows is unlikely.

It’s true that the length of our current economic expansion, on track to become the longest in history this summer, has contributed to the current skepticism. Powell addressed that point in an interview with CBS’ “60 Minutes” last week.

“Eventually expansions come to an end,” Powell said. “But there’s no reason why this economy cannot continue to expand.”

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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