Many investors seem to consider themselves “forced” into the market by the dovish Fed policy turn of recent months as well as Team Trump’s constantly optimistic China trade deal chatter. The most bizarre part is that indices remain at record highs with global economic growth as weak as we have encountered in this cycle. Importantly, bonds and commodities still aren’t reflecting the same optimism as stocks.
Entering 2019, equity investors who based their bullishness on high expectations for earnings growth have been wrong. It sure looks like the 2000 dot-com era again and worse in some ways because now the median stock price is much richer.
We sense that many fully invested bears may worry about this dichotomy between stocks and earnings, but they must feel their hands are tied. Short-covering has taken over in a major way as well. Watching groups like memory chips and rails rally towards record highs on deteriorating revenues and earnings is a strange experience. Investors wanting to “gain exposure” don’t seem to care that enormous positivity is already priced into valuations.
Too make matter worse, U.S. GDP growth is likely running towards the lower end of the 0-2% band of this cycle and earnings estimates are falling. Global growth is quite weak as well with China’s economic output hitting multi-decade lows and lending failing to stimulate the Chinese economy like it once did.
We have been here before. Late in prior cycles, any focus on valuations was mostly deemed unnecessary and foolish. However, it is kind of tough to make the case that U.S. stocks are anything but expensive when so many metrics point to frothiness. Meanwhile, investors have clearly decided that high equity allocations are optimal despite these very rich valuations. And the average stock has lagged S&P 500 index rallies all year despite the bullish sentiment out there.
The Fed and other central banks have moved into overdrive to keep indices at the highs as Team Trump jawbones about a wonderful trade deal. These efforts have yet to meaningfully push enough stocks higher to change the broader market’s trend for now. Breadth is lacking. In fact, many of the most speculative growth stocks that drove this cycle are coming under enormous pressure as participants have begun to focus more on profitability after the WeWork fiasco.
Many value stocks have been left for dead. Most value managers have been labeled as bad stock pickers in this cycle much like they were in 2000 because they have again lagged their growth counterparts significantly for years.
We continue to think the corporate bond market will prove to be the undoing of this cycle. It provided the fuel for much of the financial folly of the last ten years. A large portion of existing bonds ratings are not supported by current credit measures. Interestingly, the collapse of major corporate bond issuers in 2000-01 marked the end of the dot-com bubble we mentioned earlier. We think the same dynamic is unfolding this time around. WeWork bonds anyone?
Investors must grapple with the notion that central banks have much less firepower at their disposal than they did at the end of past cycles. The Fed will certainly pack less punch if buybacks slow in the U.S. as credit markets weaken. Also, China continues to struggle to grow like it did earlier in the cycle as its debt burdens weigh.
Investors might be wise to recognize that there are inherent risks in betting on monetary policy to lead to future stock gains in a very expensive market because more recent episodes of extreme dovishness took place when the global economy was mostly on an upswing, however muted, not a pronounced downturn late in the cycle as is currently the case. Besides, the central banks have never been able to boost growth like they promised and most of the current economic weakness may not be resolved even if an agreement with China is reached. Remember, the only net buyers of stocks in this cycle have been companies themselves and investors seem fully allocated to the asset class already.
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.