After the pre-Christmas carnage and the post-Christmas monster rally, the market started off 2019 in a slump, led by Apple’s pre-earnings guidance indicating that the economic slowdown in China, partly caused by the US-China trade war, was having a negative impact on its sales and revenue figures.
The market re-focused on the impacts of tariffs and the implications of slowing global growth, but this fear was quickly put aside upon
the news that the current round of US-China negotiations were productive, proving hopes of resolution. Furthermore, the end of the first week of the year ushered in more commentary from the Fed chief, Jerome Powell, who alluded to the Fed’s willingness to be more patient in its path of normalization (raising rates) and to take greater consideration of the pace of its balance sheet reduction (selling bonds).
As discussed in the December Market Pulse , the easing of two themes of concern that underpinned the market declines during the fourth quarter could very well cause the market to go higher. And higher it went, almost continuously through the month, ending on a high note and recovering almost all of December’s declines with the Dow, S&P, and Nasdaq closing out the month with gains of 7.2%, 7.9% and 9.7% respectively. The bond market index (AGG) closed the month with close to a 1% gain as well, reflecting the Fed’s likelihood of slowing the pace of raising rates.
During the January 30th Fed meeting, Chairman Powell once again reiterated willingness to pause on increasing rates, and further dovish talk on easing the balance sheet reduction helped the equity markets end the month at their highest levels since December 4th. As we surmised early in the year, easing the fears of the three drivers of market volatility (highlighted in the October Market Pulse) could spark a rally, which is playing out before our eyes.
The third driver of volatility was peak earnings. January ended during the heaviest day of earnings announcements, but while future guidance has been cautionary, earnings have not dropped off a cliff as the market would otherwise have indicated from last quarter’s decline. Earnings have been coming in better than analysts had forecast, and on pace to indicate 10% earnings growth. Granted, this is far from the 20% earnings growth seen in 2018, but equally far off from an earnings recession.
We believe that the market is realizing that the pessimism from last quarter was overdone and had priced in a worst-case scenario. As these concerns have eased, the market is finding its footing and again re-pricing, but this time based on a less pessimistic, yet cautionary outlook. The market usually overdoes moves both to the upside and the downside, and rarely, if ever, goes straight up without some retracement. Annualizing the January returns would imply 2019 would end with gains between 85% and 116%, which is highly unlikely. As a result, it is probable that the market will have a period of basing at best, or declines, at worst. Market corrections can come as a function of price OR time. If the market trends sideways the rest of the year, then the annual returns would be in the 7-10% range. Or, we could experience more volatility with sharper ups and downs that what we observed in January.
As a result of the moves higher in January we have used some, but not all, of the cash we accumulated during December to add to our core US equity exposure. We have also layered in QUAL as part of our core holdings to complement the US total stock market index position and USMV, our low volatility factor position. QUAL screens for high quality, large US companies that have attributes of low debt to equity, stable earnings growth and high return on equity relative to peers in each sector. USMV and QUAL should allow us to participate in market advances while buffering volatility and drawdown and lowering standard deviation. We are optimistic that 2019 will provide gains to portfolios, and remain steadfast in managing the risks that come with the possibly of entering the late stages of the current economic expansionary cycle. Contact us with questions anytime. We welcome questions and feedback.
Because of the information on this blog are based on my personal opinions and experience, it should not be considered professional financial investment advice. No financial decisions should be made based off this article without consulting with your financial advisor first.
