Weekly Update

One Less Worry

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Published March 22, 2019


Below, we reprint a nice summary of the current market from Delta Investment:

When it comes to investing your money in the stock market, it may seem like there is a lot to worry about. The big worry is that you will lose your money. This big worry is nourished and amplified by a steady stream of disturbing information broadcast in headline media.

This week, the Federal Reserve gave us one less thing to worry about. The Fed says they are not going to raise interest rates in 2019. They communicate their forward interest rate expectations with a graph called the “dot plot.” The Fed dot plot graph implies no rate increases, compared with their December dot plot which indicated two increases this year. The chart below shows how Fed Funds future contracts are all now pricing in no change to the Fed Funds rate.

Rates on Fed Funds Futures Contracts (daily)

When it comes to stock investing, the big three worries are 1) earnings, 2) interest rates and 3) the risk appetite of stock buyers. Having one of the big three worries become a non-worry is a significant improvement in the investment landscape.

We live in a world of instant information. World events are broadcast in real-time and then “priced-into” stock valuations almost instantaneously. How does the market do it? How does the stock market “know” whether to go up or down based on this nearly constant flow of disparate information?

The world’s information flows through a filter or sorting mechanism that is used to determine if stocks should go up or down. The filter is:

1. Will the new information cause earnings to rise or fall?
2. Will the new information cause interest rates to rise or fall?
3. Will the new information cause investors to become more greedy or fearful?
4. Some combination of the above?

No change in interest rates for 2019 reduces uncertainty/investor anxiety which tends to make them more willing to buy stocks – less discounting of future earnings. No change in interest rates when interest rates are low makes stocks relatively attractive compared to fixed income investments. No change in interest rates means future earnings in today’s dollars have more value. All good.

Next Up, Earnings

Consensus earnings estimates for the S&P 500 for the first quarter of 2019 are -3.6%. If earnings are down on a year-over-year basis in the first quarter, this will be the first time this has happened since the second quarter of 2016. At the end of 2018, the consensus earnings estimate for the first quarter was up 2.8%. The consensus earnings estimate for the S&P 500 for the calendar year 2019 was roughly $174 six months ago. Today, it is roughly $168. The S&P 500 earnings outlook is deteriorating and it is not clear when and where the deterioration will end.

In about three weeks, earnings season will begin which should provide some clarification as to the direction of earnings. With the interest rate question off the table for now, the earnings question rises in importance.

This week, the Leading Economic Index was updated for February with a month over month change of +0.2%. This was the strongest percent month/month change since last September. For now, recession risk in the next six months is not a major worry. Employment trends remain positive and the stock market is willing to give the earnings question a pass for now.

Market Update

Stocks appeared to continue their bounce back, with a one-week dip the only pause in a v-shaped market recovery from the Christmas Eve lows. Monday offered a +0.4% follow-through on the prior week’s buying spree with little new information. Tuesday’s market ran in place as investors awaited a mid-week Federal Reserve statement. However, semiconductors, a positive market influencer, outperformed to keep the bulls encouraged. An earnings warning from FedEx (FDX) sent stocks lower early Wednesday. The company expressed concerns about slowing global growth. The Fed statement came out in the afternoon. The announcement sent interest rates lower as the Fed now expects zero rate increases in 2019. Stocks remained lower by -0.3% on the day as investors weighed the Fed’s easy money stance with the underlying rationale for the move, that being a tepid economic outlook. Thursday brought a different response with investors embracing the lower interest rate environment while an upgrade in Apple (AAPL) accelerated the recent rally in that market heavyweight. The tech sector flew higher by +2.5% as a result. But all was undone Friday on weak European data which refocused investor attention on the global economic slowdown theme. For the day, stocks slid -1.9% with cyclical commodity-oriented sectors the biggest losers.

A poor Friday performance pushed stocks lower on the week. Nevertheless, the S&P 500 (SPY) was only down -0.70% for the week. The Nasdaq 100 (QQQ), solidly up most of the week, ended at a +0.30% tally. Small-caps (IWM) continued to reflect the cautious domestic economic outlook, with resistance still intact and a -2.12% loss on the week.

Warm wishes and until next week.