Fall 2018
Originally published November 21
It has been a while since my last writing, those of you that know me know that I don’t like to write just for the sake of it. The story this year has not changed much, but we have had lots of noise, mostly geo-political in nature. We have known since the beginning of the year that this years’ earnings were going to be great, and we have not been disappointed. +20% earnings growth in the U.S. Europe has been impressive as well with +15% EPS growth. Therefore, the question to ask is what has happened to the markets these past two months?
Since the beginning of this year I have repeatedly expressed my concern was not for 2018 earnings but rather how the market would react as analysts started to put a pencil to their 2019 earnings estimates. Analysts usually start this process post the Q3 earnings. One subtle change for the past two quarters has been although earnings have been stellar, future guidance is beginning to disappoint.
The economic data has been good, though some signs of weakening are beginning to appear. The U.S. is now considered to be running at full employment and we are finally seeing real wage inflation. While this is good news for some, we must remember that this is a lagging indicator and normally a sign that we are past the peak of the economic cycle. We are beginning to see some negative impact on U.S. corporates as the tariffs placed by the current administration begin to take effect. Housing sentiment in the U.S. has been falling for months. When one looks at the best performing markets like NYC, LA, San Francisco, prices are already well down from their peaks, and unit volume sales are falling. Overall, the indicators are showing a slowdown in economic activity, both in the U.S. and to a lesser extent, Europe. Current forecasts are not for a recession, though the risk of one is clearly higher over the next twelve months. Whether one looks at Business confidence, PMIs Industrial Production, or ISM, the data is supportive of economic growth, but the momentum clearly shows a slowdown. Durable goods Ex Defense were actually down -0.60% in their last report. All said, we should be particularly alert for further economic slowdown.
Earnings will be the driver moving forward in equity markets. With interest rates where they are, and they will most certainly move higher, one cannot expect any multiple expansion to help equity prices. Below are the current SP500 earnings expectations vs. from a very well-respected strategist:
Consensus Earnings Estimates for the SP500:
2018 full year at 162.65 Yardeni estimate: 162.00
2019 full year at 177.25 Yardeni estimate: 170.00
2020 full year at 194.88 Yardeni estimate: 179.00
I use Ed Yardeni estimates as I have followed Ed for +25 years and he has proven to be the most accurate over time. All credit for this data goes to Yardeni Research. I would highly recommend following him.
I believe the difficulty of the equity markets for the past six weeks has been in digesting the recent data (economic and earnings). The market never trades on past, or even present earnings, rather only on future earnings. The market is beginning to seek clarity as to what awaits us for 2019 and beyond.
Predicting what will cause the next correction or bear market is a fool’s game. What I try to do is keep a list of positives and negatives. This year the negative side of the list has been far outpacing the positive side of the list. Therefore, I would urge a more prudent approach to equity allocations as we are clearly very much in the late innings of this bull market. Over the course of this year I have been reducing my net exposure, which currently stands at +27%. Performance for this year stands at +6.25% (as of 19 November). While the performance has not been what I would like, a positive performance when the SP500 YTD has a -0.83% return is satisfactory though one always tries to do better!
I have begun my work for 2019 and beyond in terms of portfolio construction and ideas generation. The good news for someone in the long/short space is that this year has presented more opportunities both on the long and short side. Shorts positions this year with a few big industrials and techs, while a volatile year, have proven to be very profitable. On the long side Emerging markets are beginning to look interesting for the future. While I am hesitating to commit assets in this space just yet, it will likely be an area for 2019.
2018 has proven to be a challenging year for most, and I believe 2019 will be just as challenging. Good luck to everyone as we approach year-end.