The market is an argument staged every day about the value of tomorrow. And right now, to an unusual degree, the market itself is giving each side of the the bull-bear debate sheaves of evidence supporting its case.
The bright-side view is right there on the surface:
“How can you not like a market that’s on track to deliver a 12 percent gain this year in the S&P 500 on top of 20 percent last year? The new record high in recent weeks proves the uptrend is secure, more stocks are rising than are falling on a running basis. When the S&P is up more than 5 percent year to date into September, history shows the year finishes strong most of the time.
“Earnings are about to rise 20 percent for the third straight quarter, fully supporting the equity market — and making valuations look perfectly acceptable given tame interest rates. Stocks have absorbed Fed rate hikes, including two more this year. No recession is within view based on the leading indicators. Trade-war worries have been a positive by keeping bond yields well-behaved and moderating investor sentiment. Credit markets are firm. It’s too early to worry much about the market.”
The cautious view grants all of the above but takes issue with the interpretation:
“What does it say that it’s taken so much great fundamental news to muscle the market higher by 8.6 percent as of mid-September? A huge tax cut pouring hundreds of billions into the private sector, record-high profit margins and forced repatriation of corporate are not annual blessings.
“If things are so great, why are housing and auto-related stocks reeling and the modern-day industrial bellwether semiconductor sector rolling over? Defensive sectors such as utilities and health care have outperformed for the past three months. Bank stocks have done nothing all year. Global equity indexes are almost all down double digits from their highs. Sure, most U.S. stocks are higher, but the four biggest tech stocks have produced an outsized proportion of the indexes’ appreciation this year. The market is telling you it’s time to start worrying.”
The steady trend of rising share prices and lack of financial stress or noteworthy recession signals leave the benefit of the doubt with the bulls. The fact that third-quarter GDP is still tracking above 3 percent and forward S&P 500 earnings estimates are holding up well could mean time is running out for the fundamentals to fall apart in time to pressure the market much this year.
Bespoke Investment Group has compiled a useful ledger of “pros and cons” for the market, updated through last week — with a few more positive than negative signals. One of the counterintuitive positives: In past instances of stark outperformance of U.S. stocks against overseas markets, “the trend of US outperformance typically continues through year end when the disparity has been this wide entering the final quarter.”
Jurrien Timmer, Fidelity’s director of global macro, also noted that bouts of severe underperformance by emerging markets in the past have usually been resolved by EM recovering back toward the U.S. and not the U.S. buckling.
Defensive stocks outperforming
But the complicating factors cited by the skeptics show a lot is riding on the degree to which the economy slows and earnings-growth narrows in 2019.
The caution within the stock market is evident in the outperformance of the ETF tracking defensive “low-volatility” stocks over the one containing more aggressive “high-beta” names
Are the signs of a defensive rotation in stocks a suggestion that the market cycle is aging and preparing for tougher conditions? Or is it simply a bull market’s way of sustaining itself for a phase as overheated cyclical sectors pull back and investors wait for global indexes to bottom?
Jeff deGraaf of Renaissance Macro Advisors has been tracking this ebb and flow for months. He chooses to view it as simply a feature of a relatively late-cycle market environment — a signal of how to position portfolios but not an indication of imminent market-wide danger.
A central preoccupation of the market this year has been how much to pay up for the unusual surge in profits nine years into an economic expansion — driven by the tax cut, global industrial rebound, an oil-price surge and the stunning growth of winner-take-most mega-cap tech companies.
Yes, the forward 12-month P/E on the S&P 500 has moderated from 18.5 in late January about 16.3 now. But it’s a bit backward to say stocks are therefore inexpensive “for earnings growing at 20 percent.” More accurate to say, a wildly fortuitous confluence of forces generated a 20 percent profit boost that rescued the market from what could have become a dangerously overvalued state.
Market seems comfortable
Valuation today, at 16.3-times the next four quarters’ forecast results, is not at all extreme given solid credit conditions and assuming incremental growth next year. Still, equities are again testing the high end of the valuation range against Treasurys that has prevailed since 2007.
Stocks were far more expensive compared with bonds in the ’90s and early-2000s bull markets, but this decade, investors have not tolerated a slimmer equity-valuation cushion — at least not yet.
What we can say for sure right now: The market seems comfortable hovering near its recent highs, September has not lived up to its fearsome reputation for treacherous trading, volatility indicators are well contained, the corporate sector is thriving and so the bulls can still claim the more persuasive argument.
Yes, ambiguities abound. They almost always do in markets, and ambiguities are where the long-term returns come from, in a way. When it all seems easy is when it’s usually about to become a lot harder.
