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Weighing The Week Ahead: Should Investors Start Worrying About 2020?

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by: Jeff Miller
Summary

Economic and earnings data remain strong.

We have a big week for data crammed into four days - and divided by a holiday. More volatility? Or more time off?

The trade war remains the biggest economic issue.

Pundits are running out of current worries and looking far into the future.

Can investors constructively plan for 2020?

The economic calendar is loaded with the most important reports. The four trading days are divided by a Wednesday holiday, meaning some extra days off for most. Normally the data would dominate the discussion. But many find the current story - steady growth, improved earnings, and lack of oomph in stocks - a boring one. This week’s Barron’s cover story by Ben Levisohn, discussed more extensively below, is a good illustration.

With fewer immediate worries, the punditry is looking ahead. Are they correct?

Is it time for investors to worry about 2020?

Last Week Recap

In my last edition of WTWA, I guessed that discussion would focus on the apparent economic headwinds. While the data were not bad, the emerging story on trade grabbed attention every day. A slight increase in volatility provided more fuel for analysis, as we can see below.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. I especially like the version updated each week by Jill Mislinski. She includes a lot of valuable information in a single visual. The full post has even more charts and analysis, including commentary on volume. Check it out.

A close up of a map Description generated with high confidence

The market was down 1.3% with wider daily ranges than we have recently seen. The week’s trading range was about 2%, the highest in several weeks. I summarize actual and implied volatility each week in our Indicator Snapshot section below. Volatility is back into the long-term range.

A longer perspective (one of several great charts in this weekly article) puts the first half of 2018 in context.

This year’s flat stretch is not unlike prior periods in 2012 and 2013. The 2015-17 period was a longer version, ending with the election. None of this tells us what will happen next, of course, but it does show that periods like this are typical – even in bull markets.

Humor

I try, but Alan Steel is so much better – clever, witty, and colorful. I had the idea of including something about data from all the weeks that had a holiday on Wednesday. You could look at what happened in the first part and the last part. You could break it down by season. You might not have very many cases, but that is the way to “prove” anything!

Alan makes a similar point about slender and contradictory evidence. Here is my favorite segment, but read the entire post to pick your own.

These made-for-TV plots and market parodies are being paraded about in apocalyptic scenarios – aloof to any action or inaction on our part – where we’re damned in either direction… and there’s always a piano falling down towards the spot where we’re currently standing.

An example?

On any given day someone might say interest rates will rise, fall or stay the same, which will then be made to mean that something bad is, will or has already happened.

Now try replacing “interest rates” with any common market, economic or environmental parlance or barometer – like oil prices, iceberg melt or inflation – and see how panic and paranoia determines how long the story rolls on… and the increased charges to advertisers to capture all those clicks, hits and “uniques.”

Then watch as they roll out the TV news anchors’ protracted red carpets – with single variable correlation starlets posing garbed and garbled in a fancy dress extravaganza of big words with small meanings.

If you understand the line about starlets, you qualify as a veteran WTWA reader!

Noteworthy – Voice Search Facts

SEO Tribunal has a wonderful infographic with 106 facts about voice search. It is huge, so I can’t post it here, but it is interesting and educational. Here is one tidbit, questioning which voice search method is the smartest. Mrs. OldProf and I disagree on this – Mars and Venus, Siri and Alexa.

Another interesting segment looks at voice search by generation. Another traces the history. You get the idea.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • New home sales were up 14.1% year over year to a SAAR of 689K. Calculated Risk analyzes the report and updates the gap originally caused by distressed sales. For this gap to close, builders must offer some smaller, less expensive homes.
  • A “buyback bonanza” writes Ed Yardeni. He explains that repatriation of funds and the favorable comparison between expected earnings and the cost of borrowing explain the surge.

  • Personal income increased 0.4%, in line with expectations but better than last month’s 0.2%.
  • Serious mortgage delinquencies declined in June. (Calculated Risk). The recent increase came from hurricane effects, which do not show up for three months.

  • PCE prices remained stable at an increase of 0.2%. This is good news since it is the Fed’s favorite measure, implying a moderate policy course.
  • The chemical activity barometer continues to climb. Calculated Risk cites this as a leading indicator for industrial production.

  • Bearishness increased. Since this is a contrarian indicator, this is good news for stocks. David Templeton (HORAN) has the story and this chart. He notes the fourth largest swing to bearishness in the last five years.

The Bad

  • Pending home sales decreased 0.5%, falling (on an annualized basis) for the fifth straight month. Expectations were for a gain of 0.7%. Calculated Risk has the details, including explanations and a regional analysis.
  • Canada strikes back. The July 1st measure imposes $12.63 billion in tariffs on American goods and includes a C$2 billion package to assist Canadian workers. (MSN)
  • Initial jobless claims increased to 227K, up 9,000 from the prior week. While there are some weekly shifts, the main story is the continuing low level.
  • North Korea has increased nuclear production at secret sites. (MSN).
  • Personal spending increased 0.2%, below expectations (0.4%) and April’s downwardly revised 0.5%.
  • Michigan sentiment registered 98.2, missing expectations of 99.0 but above the prior month data of 98.0.
  • Consumer confidence from the Conference Board was 126.4 versus May’s adjusted prior reading of 128.8 and expectations of 127.1. Jill Mislinski’s article tells the story for both sentiment measures.

The Ugly

Hyperinflation. Bloomberg illustrates the Venezuela story with the cost of a cup of coffee, the equivalent of 29 cents. In bolivars, the cost has gone from 450 to one million over the last two years. It is now most of a worker’s entire month’s wages.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

The calendar is loaded with releases, featuring the employment report and both ISM Index releases. Auto sales remain important and we can expect careful attention to the Fed minutes as well.

And of course, we can expect plenty of trade news – probably with a patriotic theme.

Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.

A screenshot of a cell phone Description generated with very high confidence

Next Week’s Theme

This is another big week for economic reports. Like last week, there will be fresh news for those seeking to assess current economic strength. Except for trade issues (where opinion is divided), the economic news has been solid. I always read observers who lean toward finding the fresh worries. They are running out of near-term material. The solution? Look farther into the future! My dependable sources are now emphasizing events they expect in fifteen to twenty years.

This week’s Barron’s cover story cites more imminent concerns, suggesting signs of a bull market ending in 2020. That may be two years away, but their viewpoint is that it is time to prepare right now. This type of story often sets the agenda for discussion, but I would put the question differently:

Should investors start worrying about 2020?

I have subscribed to Barron’s for over thirty years, frequently citing both the publication and the author of the cover story. I often find useful ideas, and I urge you to read the article for yourself. It includes stock ideas that fit the theme. For purposes of WTWA, it provides an interesting framework for discussion. Since I disagree with the conclusions, I will intersperse their contentions and my own response. [Usually I keep my own opinions to the Final Thought section. For this week’s topic, it is easier to follow it point by point instead of jumping to the end].

Since this is exactly the type of article investors are seeing, it deserves a closer look. My responses are italicized.

All of us, at some point, must confront our mortality. So, too, must investors prepare for the demise of a bull market that began in the depths of the financial crisis in 2009.

Comparing the market to a human is very misleading. The fact that cycles end at some point is completely unhelpful in our investment planning.

There’s no denying this one is getting long in the tooth. The average postwar bull market gained 161% over 1,821 days. This one, at 3,400 calendar days, is already the second-longest on record, lagging behind only the 4,494 days during the marathon run from 1987 through the peak of the tech bubble in March 2000. The S&P 500 has gained 302% since its bottom in March 2009, the second-longest run on record. During the 1987-2000 bull, the S&P 500 rose 582%. And while bull markets don’t die of old age, each day brings a reckoning that much closer.

The comparison of this bull market to those in the past is meaningless. There are not that many cases. This one started after a deep decline and featured a long and slow rebound. It should be expected to last longer. The amount of the rebound should be compared to the decline, and to the change in earnings.

The “each day brings us closer statement” is pure rhetoric. It could be said on day one of a new bull market. It is this kind of statement that identifies a writer with a mission.

“Like the human body, the market becomes less resistant to shocks and viruses the older it gets,” says Christopher Smart, head of macroeconomic and geopolitical research at asset manager Barings.

This is another unsupported assertion that has a plausible and convincing sound. The data show that bull markets are more likely to continue after five years than before five years. I would be interested in seeing some evidence from Mr. Smart.

While a correction from its Jan. 26 highs has removed some of the market’s most egregious excesses, signs of investor complacency abound. The Cboe Volatility Index, also known as the VIX, remains below its long-term average around 20 times, and investors continue to put money into mutual and exchange-traded U.S. stock funds, even as they have fled other markets.

Once again, a market statistic is given the characteristic of humans. The VIX, which I track weekly, is below the long-term average because actual volatility is even further below that average. Egregious excess is another of those telling phrases of a man on a mission. Investors move money into and out of U.S. stocks on a regular basis. The preference of one asset class over another is not a sign of complacency, since there are always buyers and sellers, often with intense but opposite opinions. The stock flows in the week of publication of the article included major outflows.

If nothing else, it’s time for investors to think about the types of companies they own, and to begin shifting away from the riskiest and most indebted toward those better-positioned to withstand a downturn. And while it may reduce short-term returns, there’s nothing wrong with holding a little extra cash to tamp down a portfolio’s volatility and deploy when stocks do fall. Because the market always falls, eventually.

Investors have already bid up defensive stocks because of attractive yields. In the most recent major downturns, there were no “hiding places.” All stocks declined. Raising cash reduces volatility, but it is costly unless risks are real and imminent. “Because the market always falls, eventually” is another unhelpful bit of sophistry which could be uttered at any time.

Like any artificial high, the good feelings won’t last forever. By the end of 2019, the last of the fiscal intoxication should have worn off, and the hangover could begin. Economists expect the U.S. economy to expand by 1.9% in 2020, and earnings to increase by 10%.

Whether or not the “high” is artificial is an unsupported opinion. Those monitoring earnings growth cite more than “good feelings.” Assuming that economists can accurately predict 2020 (they can’t), an earnings increase of 10% is pretty good.

The stimulus, however, isn’t occurring in a vacuum. The Fed is already raising interest rates, and is doing so at a faster pace than some investors had counted on. At its current pace of a hike every three months, the federal-funds rate should hit a range of 3.25% to 3.5% by the end of 2019, up from 1.75% to 2% currently.

At the same time, the Fed is shrinking its behemoth balance sheet. That means monetary policy could be hitting its tightest levels just as the impact of the government stimulus begins to wear off.

Speculating about the pace of Fed rate increases makes little sense when Fed members themselves have a range of future policy choices. They all agree that it depends on data. There is no reason to extrapolate the “current pace of a hike every three months.” While the pace is “faster than some investors” expected, it is slower than the guesses of others.

The yield curve hasn’t inverted yet — but it’s getting close. The two-year Treasury’s yield was at 2.524% on Friday, while the 10-year’s was at 2.844%. That 0.3195 of a percentage point difference is the narrowest since the financial crisis ended. If the Fed continues to raise rates at its current pace, the yield curve is likely to be flat by year end, says David Ader, chief macro strategist for Informa Financial Intelligence, and to invert during 2019’s first half. “That would point to recession in the second half of 2019 or early 2020,” he explains.

What is Mr. Ader’s record on predicting the yield curve changes? As Dr. Robert Dieli, the leading business cycle expert, explains – you should not forecast the forecast. Guessing about a yield curve inversion requires complete speculation about rate hikes, inflation, policies of central banks around the world, and demand for long-term bonds.

“The bull market will last as long as the economy expands,” says Ed Yardeni, chief investment strategist at Yardeni Research. “I don’t know anything today that leads me to put a time frame on when this bull market ends.” That means stocks’ path to 2020 could be as rocky as 2018’s has been, or that equities could see one final melt-up before it all comes crashing down.

Investors need strategies to handle both potential scenarios.

So, the market may take various paths and Dr. Yardeni cannot say which, nor can he put a time frame on the end. That is an honest and helpful statement. The author appends his own “path to 2020” opinion. Most people probably would not notice what was a quotation and what was not.

Investors trying to create a strategy for all scenarios may well develop something that does not work well with either. I prefer instead to take what the market is giving and reduce risk when there is more clarity. That does not involve attempting two see two years into the future.

I have emphasized the points raised in the article, but we need not stick to that agenda. I have some additional observations in today’s Final Thought.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

A screenshot of a cell phone Description generated with very high confidence

Short-term trading conditions continue at highly favorable levels. Actual volatility was higher last week, but still below long-term levels. The VIX continues to overstate volatility. The decline in the rate for the ten-year note, coupled with lower stock prices, has made stocks even more attractive by comparison.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score.

Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

Guest Sources:

Scott Grannis notes that “Corporate Profits are Huge.” Those skeptical of GAAP profits should look at his conclusions, based upon data from IRS filings.

Brian Gilmartin (using forward earnings) describes the continuing surge there.

Jeffrey Zabel (Econofact) asks Are We Seeing a New Housing Bubble? This is a balanced assessment, considering differing places and measures in a comparison to 2008. He also takes care to look at households, not just average data. This is a great post for those who agree with the author (and with me) that it is important to watch housing indicators closely. His overall conclusion:

Measures of debt burdens and delinquency rates are indicative of a current housing market that is in a stronger position than at the peak of the recent housing boom in the early 2000s. So, while a crash in the near future is probably not likely, it is important to keep tabs on these fundamentals going forward. It is also important to recognize that while many of these statistics are at the national level, there is considerable variation across at the local and city levels across the country, so keeping track of trends for individual housing markets is also essential.

Timothy Taylor analyzes home ownership, demographics, and current limiting factors. In another balanced look at important data, including material for chart-lovers, he reaches a policy conclusion:

The US homeownership rate has turned up just a bit in the last year or so, after hitting a 50-year low in the second quarter of 2016. But if the US believes that a higher homeownership rate is a valuable public policy goal, the challenge seems to be to find governing rules for the housing market so that it is profitable for builders to construct a greater quantity of housing, especially at lower and moderate price ranges.

Insight for Traders

Check out our weekly Stock Exchange post. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week our models had a tough day on Monday (the last day of our reporting week). Lots of winners were being sold in some mechanical rebalancing, Art Cashin suggested. An advantage of a trading system is that a bad day does not generate an emotional reaction. We invited other traders to share their thoughts on dealing with a bad day. We also cited some trading experts and highlighted some recent picks of our own. The ratings from Felix and Oscar this week feature the Russell 2000 Small Cap Index. Blue Harbinger is our editor for this information and ringleader for the group discussion.

Insight for Investors

Investors should have a long-term horizon. They can often exploit trading volatility.

Best of the Week

If I had to pick a single most important source for investors to read this week, it would be Colorado Wealth Management’s post, How to Retire in Your 60s Without Going Broke. Here is the starting point.

The article goes on to cite several stock choices that fit the requirements. There is also a selection of REITs and an explanation of why these are better than real estate purchases.

This is a sound approach, with an emphasis on dividend stocks and reasonable expectations.

The prolonged bull market brings up a major problem when investors are only focusing on the short term. Unreasonable returns seem reasonable if we’re just looking at the recent bull market. When it comes to investing over several decades, a 14% yield is a quick way to go broke.

Investors using this strategy may be tempted to “diversify” their portfolio by investing in several high dividend yield stocks. This results in having a portfolio filled with significantly risky investments. “Diversifying” a large portion of the portfolio in high-yield stocks with very little understanding of the underlying fundamentals is a bad idea. Instead, investors should be looking to build a well-rounded, diversified portfolio.

While you and I might differ on some of the pieces and specific stock selection, there is plenty of good advice in this article.

Stock Ideas

Chuck Carnevale continues his series on dividend aristocrats. His look at Coke (NYSE:KO) shows why valuation analysis must accompany a look at the dividend history.

GE (NYSE:GE)? Upside of 47%? Victor Dergunov sees a bottoming process with a lot of bad news and sentiment already reflected.

Cash in on Trump’s ‘Zero Tolerance’ immigration policy? Bloomberg explains the opportunities in private prison REITs.

Marc Gerstein’s excellent screening methods suggest consideration of J. Jill (NYSE:JILL). It is more attractive now than at the time of the IPO.

Stone Fox Capital likes the massive capital return plans of Citigroup (NYSE:C).

Blue Harbinger runs the numbers on a high-yield retail REIT (NYSE:CBL).

Peter F. Way uses his market-maker based, upside/downside ratios to analyze the DJIA stocks. In this method, there is no single winner. It generates a “frontier” of strong candidates based upon risk and reward. It is easy to identify companies that are not on the frontier!

Portfolio Construction

The Financial Samurai aims for an allocation that will provide steady conservative returns. He provides several examples for people of differing ages and lifestyles.

Cinthia Murphy (ETF.com) cites research from Daniel Kahneman on the need to emphasize risk in investing. It will not surprise regular WTWA readers that I strongly endorse this viewpoint. He recommends having two portfolios, with the “safe” choice buffering volatility in the other. That is a method I frequently use.

Many hope for double the CD rate in returns with no volatility. That order is too tall, but one can create higher returns while smoothing volatility.

Personal Finance

Seeking Alpha Senior Editor Gil Weinreich has made a few more changes in his excellent series for financial advisors (and serious individual investors). Not only does he include some podcasts, but he also highlights other key issues. This week I especially enjoyed his post discussing the debate over the proper role of ETFs. He highlights ETFguide’s rebuttal to John Bogle’s well-known views. He includes a point-by-point discussion of the various Bogle arguments.

Congratulations to Tadas Viskanta, now the Director of Client Education for Ritholtz Wealth Management. He explains that he will continue the regular Abnormal Returns posts in full glory. I’m not sure how, since he must read voraciously, curate, and carefully link the articles. I know the difficulty in that! He also rarely takes a vacation. We all wish him well, but also hope he meets his goal of identifying and sharing valuable information we would not otherwise see.

On Wednesday, he has a special group of links for those interested in personal finance. As usual, this week included many good ideas. My favorites were practical advice about when to start taking social security (Wealth Management) and the need to plan ahead for RMDs (Vanguard).

Watch out for…

ICOs. As I have noted in the past, as long as new cryptocurrencies can be created, a limited supply of one type does not really matter. Coinopsy estimates that more than 1,000 variants have failed and Dead Coin lists 800. (Bloomberg).

Final Thoughts

In addition to the specific points discussed above, there are some strong general reasons not to worry about 2020.

  • No one can predict the market or the business cycle in that time frame. My indicator snapshot looks ahead less than a year on the business cycle. The results are not “yes” or “no.” The percentage chances, drawn from the complete data history, indicate risk, not certainty.
  • Many of the oft-cited worries cannot occur in tandem. This is a problem with the laundry-list approach, no matter how skillful the journalist. To take just one example, if the Fed sells balance sheet assets that affects rates on the long end, steepening the yield curve. You cannot have both problems simultaneously.

If we cannot predict the exact path of the business cycle, is there anything we can say?

  • The current growth phase is very likely to last for another year.
  • There will probably be a recession with the next five or ten years.
  • Investors who can dodge most or all of the recession will do well.

Market timing is not feasible, but risk recognition is.

I’m more worried about:

  • Trade policy and retaliations. The poker game has high stakes, with no clear ending in sight. If there was a clear sign of stabilization and compromise, it would spark a four percent rally – just for starters. Peter Navarro’s brief CNBC appearance on Monday was worth a 200-point bounce in the DJIA, despite a lack of anything specific.
  • The doomsday clock, now at two minutes to midnight. Neil Browne, citing New York Magazine, reminds us of the stakes and the number of cases of lost or stolen materials.

I’m less worried about:

  • The economy. The general pattern of data remains strong, with the trade war as the main threat. Steven Hansen (GEI) has a good summary.
  • Earnings. Both results and estimates continue significant growth.

Disclosure: I am/we are long C, GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Short calls against both C and GE