Major US indexes added to already impressive gains last week with the Dow, S&P500 and Nasdaq each adding between +2.4% – 3.0%. Just eight trading weeks into the new year, the Dow and S&P500 are up roughly +11% from where they entered; and higher-beta corners of the market (such as small-caps and cyclical transportation stocks) are enjoying even stronger recoveries in the neighborhood of +15%. The numbers are even more impressive if one begins their count from the Christmas Eve low. Interestingly, as equities have improved back to, and even through, the most obvious levels of technical resistance the pace does not seem to be slowing despite what remains a quite lengthy list of items that need to “go right” for the US economy to manage a soft economic landing.
A soft economic landing is a condition believed requisite for the current bull market to advance beyond its late-3Q high. For that to develop, we need to see the consumption-led and monetary-fueled recovery transition to a capex and investment-driven backdrop. From a fundamentals perspective, there are reasons to believe this transition is not only possible, but probable: unemployment is likely to be very near to as low as it can get this economic cycle and wage growth is beginning to restrain further corporate profitability. Interest rates, despite 4 hikes in 2018, are still far from restrictive in a historical context; meaning the interest rate the US economy can take is realistically higher than the interest rate financial markets are comfortable with. But investment in new technology will need to drive productivity gains from here if corporate profits are not to contract. Tax reform benefitted the bottom line of corporations in 2018, but according to the mainstream media that windfall is not being used productively. It reportedly instead continues to be funneled back to shareholders and/or hoarded. That bears watching, and most important is that business confidence can log recovery following the tremendous uncertainties that were created during 4Q which would tend to slow long-term investment. What can refresh business confidence?
For starters, business and investors alike need to witness additional clarity on a number of fronts. The US government needs to remain “open” following the shutdown standoff; the US needs to settle trade differences with China and other key partners; monetary policy must remain flexible and not perceived as needlessly tightening; and oil prices must be stable to avoid an effective tightening of corporate credit conditions. On the international front, Brexit needs to reach a conclusion one way or the other (just 6 weeks to go!); and China needs to pursue effective economic stimulus that can put a stop on the slowing its economy appears to be experiencing. We would not be surprised to see other foreign economic leaders also pursue stimulative fiscal policies to improve competitiveness following US tax reform a year ago, and a synchronized global improvement could ensue.
In the short-run, we find the YTD rally impressive, but too good to continue at pace. This is not to suggest we are in any way negative on the outlook for 2019; in fact history supports that when years begin as strong as the current, that rest-of-year performance is stronger than average. But “V-shaped” recoveries are rare, and at this point is also abnormally strong. Of course, 4Q and December were extraordinarily sharp and weak, but a slowing (not contracting) economy suggests the market’s might be getting a bit ahead of itself.