Is this as good as it gets?
That’s a question being bandied about more and more as stocks continue to press higher after posting the best first half since 1997.
US equities rose for a fourth week in five as America celebrated George Washington’s legendary assault on Cornwallis’s “airports” in 1781. Equities wobbled on Friday after the blowout jobs number effectively took a 50bp Fed cut off the table in July, but by the end of the session, losses were pared and all was, generally speaking, well.
Friday morning’s action spoke to the perverse dynamic that reasserted itself after Donald Trump threatened to slap across-the-board tariffs on Mexico late in May. Markets reflexively gagged when June payrolls printed higher than the most optimistic estimate from 75 economists. Since the Mexico tariff broadside, bad news has been “good” news to the extent trade worries and growth jitters helped bolster Fed cuts bets, buoying assets of all stripes. Indeed, June was remarkable for the “everything” nature of the rally and in that regard, it was just a microcosm of 2019 more generally.
Now, some worry that the upside-down bad news/good news perversion isn’t a sustainable way to think about markets. Eventually, the story goes, economic weakness will show up on corporate bottom lines and, if it persists, the global manufacturing slump will spill over into the services sector and the labor market. At that juncture, no amount of Fed easing will be sufficient to cushion the blow and restore the good vibes, say those of a cautious persuasion.
“The S&P has reacted well to bad economic news of late [but] this is simply not sustainable”, Bloomberg quotes UBS’s Francois Trahan as saying. During previous slowdowns, “the upside for equities finally came to an end when earnings expectations began to decline”, Trahan warns.
Goldman underscored this recently. “While weak economic data have been ‘good news’ for equity valuations, data have been ‘bad news’ for earnings expectations”, the bank’s David Kostin remarked last week, adding that “since the start of 4Q 2018, 2019 EPS growth expectations have declined from +10% to +2%”.
(Goldman)
The bank is somewhat noncommittal about the outlook, taking a “modestly pro-risk” approach to the next 12 months. “After another ‘bull market in everything’, we believe multi-asset portfolios are likely to deliver lower returns and are again at risk of not being well diversified”, Goldman said, in a separate asset allocation note dated June 26. The bank recommends being overweight cash on a 12-month horizon.
If you’re wondering what history shows in terms of performance in the second half of a year following spectacular H1 returns, LPL financial notes that “after a big start to a year, the final six months not only have shown below-average performance, but also above-average pullbacks”.
(LPL)
Finally, at the risk of resorting to the same kind of cheap, bearish mic drops employed by those who have spent the last nine years insisting that a calamity is right around the corner, it’s worth noting that “we’re due”, so to speak…
(Goldman)
Trump’s July 4th extravaganza. Emoluments to Trump Inc. paid for by the America taxpayers.
p.s. The Donald doesn’t pay taxes, remember?
The upside scenario, on a 1 year horizon, looks like 50 bp Fed cuts + tariff rollback + US data/estimates stabilize + ROW weak so TINA. Then if SP500 cons 2020 stays $1.85 and fwd PE returns to 2018’s 18X, bulls see SP500 at $3,300.
The base scenario looks like 25 bp Fed cut + tariffs unchanged (can gets kicked) + US data/estimates mixed (like now) + ROW weak. That’s SP500 cons 2020 $1.85 and fwd PE about 16X, implying roughly today’s SP500 $2,950.
The downside scenario is no Fed cuts + tariffs increase + US data/estimates decline + ROW who cares. Then maybe SP500 cons 2020 looks more like current 2019 cons $175 and fwd PE declines to 15X, bears might see SP500 at $2,650.
There’s outside scenarios too, for more upside (estimates rise, China caves, cap gain indexing, Fed bullied into “rocket fuel” cuts, etc) and more downside scenarios (estimates fall more, Fed cuts in vain, etc). And of course liquidity/unwind can easily drive prices below/maybe above these valuation scenarios.
What probability to put on the upside, base, downside and outside scenarios? Plug in your best guess and translate that to current portfolio positioning. I think for most investors it will lead to something moderately defensive but not batten-down-hatches defensive. I’d guess from the BAML survey etc, that’s probably about where most investors are.
Nice. Following your lead, I’ll add the “most likely” scenario: 5o bp Fed cut by eoy + tariffs unchanged (can gets kicked) . SP500 @ 3,100. Not sizzling but better than a stick in the eye.