Market Commentary – 2018 – Limping Through The Tape
While I have never been brave enough to run a full marathon or a half for that matter (Go Jaymye!), I imagine if I ever did, my finish to that race would look much like the global equity markets in December of 2018 … limping through the tape! The fourth quarter in the US was marred by a steep sell-off in “Risk” which included commodities (Namely oil), equities, credit, etc. The almost panicked selling that took place on a few days during the quarter reminded me eerily of trading that I witnessed during the depths of 2008… yes that bad. Which begs the question, “What the heck happened at the end of September to cause this about face?!”.
While the financial news media would have you believe it’s the trade war with China or the government shutdown to blame for all of this recent volatility, we believe it’s simply what we have been worried about since the beginning of 2018 – convergence. International economies by and large have been slowing all year whether it be in Asia, Europe or the myriad of Emerging Markets around the globe. The US economy, at least through the second quarter of 2018 seemed to defy this slowing with a print of 4.2% GDP growth in Q2. However in Q3 the economy only grew 3.5%… yes a terrific number for such a large economy, BUT a slowing in growth. Experience has taught us here at Koa that it’s not the absolute level but the rate of change that matters most. Remember the stock market is a discounting mechanism, it’s more interested in where we are going vs. where we have been. If the market thinks the rate of profit growth will pick up (generally speaking), the market will move up ahead of the actual earnings increase resulting in Price to Earnings (PE) expansion – the inverse is also true. What we saw in Q4, was the market trying to discount what it believes will be stagnant or possibly shrinking profits in 2019 vs. 2018 hence the PE multiple compression we have seen the last 3 months. IF the market has gotten overly pessimistic we set up for a nice rally at some point in the next number of quarters to properly value where earnings ultimately come in.
Our outlook for 2019 is based on the following factors 1) Can the US Government solidify new trade deals with each of its partners – businesses want certainty to make investments 2) Will China and Europe unleash a large stimulus plan to turn around the growth trajectory in their respective economies 4) Will “Brexit” be an orderly process 3) Has the US Federal Reserve reached neutral and are they done hiking for the cycle? If we can tick off all of those boxes and earnings come in at least even with 2018 overall for 2019, we think the market can rally to perhaps test the highs that were put in September of 2018. However we think a range bound market with the lows we put in last December and the highs we put in 3 months earlier in September (A 20% high to low range) is starting to look like a higher probability outlook for this year. If we had to handicap, we would say a 20% chance we break to new highs, 50% chance we remain in the range we just suggested and a 30% chance we make new lows – which could be a violent outcome as that would require the market pricing in a recession to start in 2020.
Our strategy will revolve around the following tenants for 2019 – 1) Quality will win out – we are sticking to high quality credit and strong balance sheets for our equity holdings 2) Stock picking will matter more than beta (Broad market exposure) 3) The US Dollar may have peaked, we are becoming more constructive on Emerging Market Assets which tend to perform better during periods where the US Dollar is falling in Value 4) We are willing to hold more cash this year than usual, which should allow us more opportunities to capitalize on sharp sell-offs if/when they occur.
Securities offered through M.S. Howells & Co. Member FINRA/SIPC. Advisory services offered through Koa Wealth Management. M.S. Howells & Co. is not affiliated with Koa Wealth Management.
Sources: Michael Souza
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130