“Inauspicious” probably isn’t the right word considering how far stocks have run since the end of May, but “uninspiring” will work to describe US equities’ performance as earnings season got rolling in earnest.
Stocks had their worst week since the May selloff as folks digested big bank earnings, heightened tensions in the Strait of Hormuz and a rather unfortunate communications debacle from the New York Fed.
Nobody would blame you if you’re betting this week’s 1.2% decline presages a steeper selloff. After all, the usual laundry list of concerns are still in play. Friday’s events in the Mideast underscore the risk of miscalculation even as rhetoric from both sides (i.e., the West and Tehran) seems to suggest nobody really wants a serious escalation.
On the domestic political front, Donald Trump has infuriated half the country with increasingly vitriolic attacks on four congresswomen of color, rankling Democrats just days before Robert Mueller is set to testify for five hours on Capitol Hill.
Expectations for corporate profits are muted and investors remain concerned about the global economic outlook. BofA’s latest Global Fund Manager survey found 41% of investors saying global profits will deteriorate in the next 12 months. Last month saw the second-largest ever plunge in profit expectations over the 23-year history of the survey question. Meanwhile, 79% of respondents are bearish on both the growth and inflation outlook for the global economy over the next 12 months.
The trade war is still simmering, with Congress angling to enshrine Trump’s Huawei ban into law just as the administration looks to roll it back. Talks with Europe to resolve the Airbus subsidy spat and, more importantly, avert auto tariffs, haven’t even begun in any real sense.
And on and on.
Some pundits are fond of saying there’s always risk in the market and there’s always uncertainty. That’s true (in fact, it’s a truism, which means you aren’t saying anything that’s worth saying by uttering it), but considering Trump is in the Oval and stocks are loitering near record highs in a late-cycle environment, you can hardly blame anyone who’s nervous. Indeed, YTD cross-asset returns border on the absurd.
“Flow-less” is still a word many observers use to characterize the equity rally. $144 billion (net) as come out of equity funds in 2019, while more than $250 billion has been plowed into bonds. That only muddies the waters further. It suggests there’s “dry powder” out there for stocks, but it also conveys how nervous people still are after the Q4 2018 rout.
As BTIG’s Julian Emanuel told Bloomberg’s Sarah Ponczek, “I talk to people that are having fantastic years and they’re miserable [because] they don’t know whether they should be taking their chips off the table, or even if they would be taking their chips off the table, whether you cut back your winners or cut back your underperformers”.
While forward multiples may be stretched, it’s not clear that stocks are mispriced. “Based on the 45-year historical relationship between trailing Price/Book valuation and return on equity, S&P 500’s current P/B multiple of 3.5x is consistent with the index’s ROE of 18.9%”, Goldman’s David Kostin wrote on Friday evening.
At the same time, hedging or waiting on dips to buy has been frustrating of late. The average drawdown for the S&P is now virtually non-existent as it was last summer and in January of 2018, after Trump’s tax cuts catalyzed a melt-up.
And maybe that’s more cause to worry. After all, “melt-up” has become the base case for many on Wall Street, and you don’t have to be a market historian to recall what happened just weeks after January 2018’s “blow-off” top…