Behavioral Finance, ‘Certainty’ As An Investment Style And Other Key Themes For 2019

When last we checked in on Wells Fargo’s Chris Harvey, he was riffing on Clint Eastwood classics and lamenting the fact that “Santa got mugged on the way to the rally”.

Or wait, actually that’s not true. That was the second to last time we checked in on Chris. The last time we checked in on Harvey, he was slashing his 2019 S&P target to 2665 all the way from 3079 based on what he called “a more comprehensive understanding of the Fed’s near-term philosophy and the belief that it will cause the growth deceleration to intensify.”

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Essentially, Harvey argued that the Fed’s December hike and, perhaps as importantly, the way in which that hike was communicated, might well have cemented the self-fulfilling prophecy wherein, to paraphrase Chris, lower equities lead to wider credit spreads which entail higher costs of capital leading to diminished access to capital and thereby less investment and risk taking which will eventually lead to an economic slowdown “with the cycle repeating and feeding upon itself.”

That was late last month and while we’ve seen a couple of dramatic rallies (December 26 and Friday) since then, the generalized sense of angst among market participants is still palpable and it’s by no means clear that Powell’s reasonably successful effort to calm fears during remarks delivered in Atlanta is going to be enough to turn the ship around. That goes double if the December jobs report ends up being more “last gasp of a long-in-the-tooth expansion” and less “sign that the economy is in fact more resilient than the pessimists give it credit for.”

Well, Harvey is out with a brief new note that serves as a review of the year that was, but it kicks off with his “Top 10 List for 2019” and there are couple of notables.

Harvey says that Value and Bank stocks will ultimately start to perform well sometime in H1 (with Value only becoming truly attractive “after one more negative repricing”), but the more notable bits come courtesy of his take on the prospects for the Fed and the economy. These are all written as predictions, so that accounts for the forward-looking phrasing.

“The Fed does not placate equity investors in 1Q19 and in the first half of ’19 equity markets waver”, Harvey says, before warning that management teams are likely to start sounding the alarm in the form of weaker-than-expected guidance. “The C-suite takes a more conservative stance citing uncertainty, a lack of visibility and difficult comps when providing their 12-month ahead outlook”, he then cautions.

Harvey also notes that it is “not unusual for a new Fed chair” to run into problems and he thinks Powell be no exception. In essence, Harvey thinks ol’ Jay will probably find himself face to face with a “capital markets crisis.”

He goes on to suggest that “the market will become even more discriminating with the continued tightening of monetary policy [and] as a result, markets may differentiate first across risk and then across fundamentals.” “Certainty”, Harvey says, will “become an investment style”, as market participants avoid risk in favor of dividends, lower vol. strategies and quality.

Importantly, Harvey says the following about market psychology and sensitivity to trade concerns:

This year, Behavioral Finance and Supply Chain Management are the buzzwords. Market and investor psychology plays heavily into risk pricing. The full extent of the demand pull ahead related to tariff mitigation and the management of the supply chain becomes apparent.

That speaks to two of the themes we’ve been keen on emphasizing for months, namely that i) a key determinant of where things go from here will be the extent to which investors pull forward end-of-cycle trades amid rampant concerns about growth, thereby effectively shaping their own reality, and ii) the ramifications of Trump’s efforts to force companies to rethink and otherwise shake up their supply chains will suddenly dawn on management teams as it’s no longer possible to argue that “this too shall pass”, so to speak.

As ever, Harvey isn’t wholly pessimistic, but as is clear from the above, he generally agrees with the notion that risk aversion is likely to proliferate in the new year while corporate management teams will finally be forced to accept the reality of a more uncertain outlook amid the trade war and a generalized inability to get a clean read on where things are headed now that the fiscal impulse is waning without a concurrent resolution to the myriad issues weighing on sentiment.

Take all of that for what it’s worth.


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4 thoughts on “Behavioral Finance, ‘Certainty’ As An Investment Style And Other Key Themes For 2019

  1. If he is correct on the economy/earnings value stock earnings will have more risk to the downside than growth earnings though all will see continued multiple contraction.

    This is a guy that had a 3079 target so one his precision questionable (why not 3078 or 3081) and two he did not see this coming.

    Sure he does bring up good points but there is a lot of driving looking in the rear view mirror going on.

    But i do agree mgmts will be safe to be cautious on forward guidance BUT the market has already priced some to most of it in barring a severe recession.

    I don’t mean to beat up on him, I just am not sure there is anything insightful here.

    1. “This is a guy that had a 3079 target so his precision questionable (why not 3078 or 3081)”

      i mean, they don’t just pick these numbers out of thin air.

      You could argue that ultimately, it amounts to that because in the end, it’s an exercise in futility, but you should be aware that there is a process here. And your comment also suggests that you think there’s something more “real” about round numbers. Of course that isn’t true. Why would 3,000 (for instance) be inherently more realistic than 3079?

      But the overarching point is that yes, there is a process. And here is how he gets to his numbers, both 3079 and the new target, 2665:

  2. expectations can become at least partially self fulfilling and reduce further macro data in the next following months
    logistics redesigned as management realizes that Trump is not giving up with his idea of stopping delocalization outside USA
    it follows that guidance will be prudent or somehow a bit pessimistic

    So all the above will translate into a higher premium risk (risk aversion) and PE will move/remain lower.

    Two months ago you posted a table by SG as of 26/10/2018, it was a matrix relating equity risk premium and 10Yr US yields. For a yield of 2.75% there was 2695, 2482, and 2205 for a risk premium of 3.25%, 3.50% and 3.90%.

    SG preferred scenario was 10Yr between 3.00 and 3.25% and risk premium between 2.75% and 3.25% for a min max SPX range of 2301-2949. The central value would be 2600-650, basically my idea too. With volatility around 20% (average of 2019) it can oscillate plus / minus 10% around that central value depending on waves of pessimism and exuberance.

    We saw that buybacks are not enough to support prices (they can actually be damaging in an environment of lower and lower prices, creating trading losses and decrease profits). A lot will depend on the retail investor, we have to see inflows into equity funds again. Without them the systematic flows will just keep the market volatile with accelerating momentum on both directions but no clear direction. The more the choppiness and volatility and the more the retail investor will avoid the equity market. Emphasis on investor, I’m not writing about e-traders that want to ride the intraday volatility (but 80% of them will be slaughtered, closing their accounts in the next 6-9 months, whipsaws don’t forgive).

    I agree that stock picking can be a key determinant for a successful 2019.

  3. The world and most of the things in it are driven by extremely complex intertwining pathways with much cross talk between pathways. You know that already or at least you think you know that already. But what you don’t know is that which you don’t know that you don’t know. Three apparently non coordinated events occurring about October 1, 2018 got you here today: #1. Pence got toChina and says the US means business with the trade war #2 Powell giving his hawkish appraisal for the us interested rate environment #3 the assassination of Koshogi in Istanbul. These events started the chaos in the already strained financial system. Not all of the stress has been received. The system will try to play catch up in an attempt to recoup the December losses. The. system will use high frequency trading techniques to try to catch up. There will not be enough liquidity to provide price stability with the high frequency trades. Then the feather will come. Apparently, out of the blue. What will happen then is what I know I don’t know. Good Luck.

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