Last week, I noted that at least a couple of sell-side strategists are keen to compare the current rally on Wall Street to 2019.
Deutsche Bank’s Parag Thatte sees a parallel, for example, and so does Morgan Stanley’s Mike Wilson.
On Monday, in his latest weekly, Wilson elaborated, calling the summer stock melt-up “a policy-driven, late-cycle rally.” “The latest example of such a period occurred in 2019,” he said.
Any discussion of that year demands a brief trip down memory lane.
2019, you’re reminded, began with Jerome Powell’s infamous “pivot.” On January 4 of that year, at a roundtable event with Janet Yellen and Ben Bernanke, Powell said Fed policy wasn’t on a preset course.
“With the muted inflation readings we’ve seen coming in, we will be patient as we watch to see how the economy evolves,” he mused, adding that the Fed was “listening very carefully” to the market, which was screaming. Or throwing a toddler fit. Stocks were coming off their worst December since the Great Depression.
Although Q4 2018 was a very rough stretch for equities (and also for credit), there was scant macro evidence to support a recession narrative. At the time, JPMorgan’s Marko Kolanovic suggested a recession was mathematically impossible.
So, the problem wasn’t the economy, it was the Fed. It started with Powell’s “long way from neutral” faux pas in early October, and continued through the December 2018 policy meeting, when he described an “auto-pilot” approach to balance sheet rundown. That, despite loud calls from the likes of Stan Druckenmiller for the Fed to cease and desist from “double-barreled” tightening.
Politics wasn’t helping. The trade war with China was raging and Donald Trump was locked in a standoff with Democrats over the border wall. He was livid about Powell’s tightening efforts, which he began to berate publicly, a habit the former president never broke. On Christmas Eve, Trump took to the platform formerly known as Twitter to lampoon Powell using a golf analogy, facilitating an egregious selloff, the sixth in seven sessions.
It was an extraordinary time. Not as extraordinary as what Mother Nature had in store for humanity in 2020, but remarkable nevertheless.
With stocks on the brink of a bear market and Trump rumored to be considering legal options for changing the Fed leadership, Powell reinstated the vaunted policy “put.” Under relentless pressure from the White House, the Fed eventually cut rates.
It’s worth noting that Morgan Stanley’s Wilson actually predicted the 2018 mini-bear market in a pseudo-famous note published five years ago this month. In that note, he warned of a “proper rain storm” for equities, and particularly for mega-cap tech. Within six months, it was thunder storming.
On Monday, Wilson recalled 2019. “The Fed definitively paused and then cut rates and the balance sheet began to expand toward the end of the year,” he said. The balance sheet expansion wasn’t QE — it was liquidity management related to turmoil in the repo market, but liquidity is liquidity. “These developments fostered a robust rally in equities that was driven almost exclusively by multiples and not earnings, as has been the case this year,” Wilson went on.
In the figure below, Wilson compares industry group performance during the 2019 rally with the equity surge from the October 2022 lows.
“Both then and now, mega-cap tech has led and growth has outperformed value as equity market internals process a path to easier monetary policy,” Wilson remarked, adding that “the strong rank order correlation between the two periods is supportive of the idea that the market is trading similarly to the way it was in 2019.”
What does that mean looking ahead? Well, if you take the parallel at face value, it suggests stocks may have additional upside, and Wilson didn’t dance around that.
But he cautioned that the two periods aren’t directly analogous from an actual policy perspective. “We’d note that the Fed was already cutting rates for a good portion of 2019, and the market multiple is already close to 1 turn higher than where it peaked during that period,” he said.
As for the notion that this actually isn’t a late-cycle, policy pivot-inspired rally, but rather a “new cyclical upturn,” Wilson still isn’t buying it. “While we’re open-minded to this view eventually materializing, we’d like to see a broader swath of business cycle indicators inflect higher, breadth improve and front-end rates come down before adjusting our stance in this regard,” he wrote.
Net Interest payments were also not in free fall back in 2018, they continue to be in 2023.