Brendel Financial Monthly Newsletters

December 2018

 

What triggers the market to go up one week and down the next? The real trigger for the rally, which pushed the market up, was a comment from Fed Chief Powell that interest rates are "just under" a level he would call neutral (neither restricting nor accommodating).  In early October Powell said just the opposite; he expected a rate hike in December and three more next year.  Those thoughts triggered the October sell-off.  So why did Powell change his outlook in a few weeks?  Perhaps because growth prospects are weakening due to the soft housing market, rising mortgage rates, tepid auto sales, the impact of higher tariffs, uncertainty about Brexit, the outlook in Europe, the strong dollar and more.  Some economists see GDP growth slowing to a 2 percent or even slower annual rate late next year.  If true, profit growth might slow to the mid-single digits.  Possible?  Of course, anything is possible.  No one really knows.  No one.

Economists on campus and in government enjoy the respect of the media and the public whether they've been right far more often than not or invariably wrong (Paul Krugman, for one).  It doesn't seem to matter.  Economists on Wall Street and in business are not accorded the same respect though many have been spot on with their forecasts.  Evercore ISI's Ed Hyman has been Wall Street's top-rated economist for 30 years.  He is seldom quoted or interviewed and is hardly a household name.  He has just been right.  Economists and most investment professionals who a week ago were virtually certain there would be four rate hikes through 2019 heard two words from Jerome Powell and changed everything.  And they didn't miss a beat.  They are now as confident as they were before, only about a far different outlook.  They are well paid to do this. 

Predicting interest rates is a frustrating exercise, which is why for years I have said that the smart investment approach is to have some exposure to assets that would do well if rates rise and some to positions that would do well if they stay flat or fall.  So, when so-called experts were sure that rates would continue rising through next year, as seemed logical (I agreed), I still chose to keep preferred stocks and exchange-traded debt.  Their relative stability (still down a little) showed that many investors didn't believe the Fed would raise rates much. Investors had a better understanding than the pros. 

In the boardroom directors are still optimistic.  S&P 500 companies are buying their own stock at a record pace of about $200 billion a quarter.  No doubt some or many are using cash freed up by the tax cuts and doing so makes sense.  They are also increasing dividend payments and capital expenditures, so the buybacks are not at the expense of expansion and maintenance projects nor at the expense of stockholders. 

Wall Street analysts are even more optimistic than directors, CEOs and small businesses.  They expect S&P 500 earnings to grow 13.3 percent annually for the next 3 to 5 years.  Oh?  Earnings growth has averaged 7 percent for the last two decades while revenues have risen 4 percent.  It would take an extraordinary combination of positives (on productivity and revenue growth, for example) for analysts to be right.  If they will be right, stocks will soar for years along with earnings.  Seems a stretch, to put it mildly.

Preferred stocks - Adjustable-rate issues from Goldman Sachs, Bank of America, Morgan Stanley and U.S. Bank,  all tied to three-month LIBOR, have fallen more than fixed-rate preferreds and are under $20 and yield more than five percent.  Investors are pricing them as if the adjustable feature won't be triggered for several years, if then, so they are considered intermediate-term vehicles.  Their declines are not related to credit concerns, only to the rate outlook. 

As for the market, enthusiasm over U.S. and China talks at the G-20 meeting and the new outlook for interest rates turned stocks around late last week.  Good news from the G-20 extended the rally into Monday.  Then the selling appeared yesterday, caused (we're told) by a focus on slowing growth, as if that expectation is something new.  In truth there are many potential and real negatives (see above) and some positives (optimism, sentiment, etc.).  To explain why prices rose or fell on a given day is speculation and pointless.  No one could know for sure.  When sentiment is so one-sided (in this case negative) a move the other way is almost a certainty.  Expect a rally as investors again focus on the real positives, not the potential negatives.

The overall market has gone sideways this year. I don't expect the market to rise or fall more than single digits next year given the GDP and earnings outlook and current valuations.  But once again, Wall Street does two things very well; they push stocks up higher than they should be on good news and push them down lower than they should be on the bad news. I expect high quality stocks to outperform the market. Starting tomorrow would be nice.


Sincerely,

 

John J. Brendel, Jr. AAMS

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