The economic cycle is rolling over for many of the usual reasons, pressuring profits. It is becoming a much more difficult operating environment for most businesses due to slowing growth combined with higher wage and interest expenses. Much to the dismay of many, the Fed shows no signs yet of abandoning its current tightening course as the ECB prepares to end its QE program soon.
Housing and auto production have likely seen their best days of this cycle based on comments from the management teams from both sectors during earnings season. Most of the widely held tech giants have all shown themselves to be less than perfect this year as growth drivers fade. It also seems that just about every chip stock has warned about slowing demand, confirming our thesis that the mid-year growth spurt was owed in a big way to companies trying to build up inventories ahead of new tariffs. Of course, a massive amount of deficit spending by the federal government is another unsustainable stimulant that is simply a drain on future growth prospects.
With crude oil having now quickly collapsed 25%, it seems to have joined other commodities in signaling less than stellar global growth. Credit markets are beginning to feel some additional downward pressure as well. We have long held the view that corporate bonds would be the center of the next broad downturn. We now suspect that a risk-aversion mindset will become the norm in the credit decision-making process. This should bleed into other markets.
The gap between the typical stock’s performance and the S&P 500 is pronounced with many names down 20% or more from their highs. Amazingly, GE has been decimated by 75% and has become one of the most despised stocks on the planet after years of being considered a major core holding. This sort of performance will not be unusual in coming quarters as it becomes clear that future profit expectations are not as bright as often portrayed by many companies.
Broadly speaking, volatility clearly picked up during third quarter earnings season, making for a growing list of names to consider for investment on the long side. However, it seems that it is mostly a situation where mediocre companies are becoming available at only fair values, so we largely remain on the sidelines for now. Importantly, we expect that many earnings estimates will be coming down to reflect the less robust reality.
We remain patient because it certainly seems that events, including powerful rallies to relieve oversold conditions, are transpiring in a fashion that fits with a cyclical top being put in place. Even in the face of major damage being done to many stocks, we have yet to see the sort of broad capitulation by investors that would signal to us that most participants realize that the old market regime of the last few years is no longer in place. A good deal of hope is being placed on a favorable resolution to trade issues with China, while ignoring the much more important issues of central bank tightening and cycle dynamics.
Wall Street is dutifully peddling the narrative that the upcoming third year of a Presidential term has historically been good for stocks. The theory is that the administration does everything in its power ahead of the next election to paint a rosy economic picture. Stock data would mostly support that view with some exceptions. However, we also know we can’t find a time when central banks were reversing years of monetary stimulus to an unprecedented degree. Also, the government is already running large deficits, so there is not much room to maneuver, especially with a now divided Congress. Most importantly, valuations remain well over two times normal for the median stock.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.