Where can we go from here?
If we told you that this market has gone almost nowhere over the last
18 months, would you believe us? Well, you should. From the highs in
January 2018, the S&P 500 is up only about 3% as of this writing.
Remember, we had a blast up in 2017 with the tax cuts and then in 2018
near the end of the year we sank before rising back up again in 2019.
Years ago, the world economy used to hinge on the U.S. economy and
that started to give way in the face of globalization. However, as we
face threats of tariffs between our neighbors and China, we are back
to "as the US goes, the world goes." Our GDP has moved higher,
unemployment lower, and inflation remains in check. As you can see
from the chart below, the market may just be catching its breath
before continuing higher.
What factors could make our GDP move higher? Interest rates and tariff
Let's discuss interest rates quickly. Rates have continued to move
lower with the 10yr floating around 2.07% as we write this. This
recent decline in interest rates from 2.7% in March is one of the
bigger reasons for the stock market increase. Why else would the
markets move higher in the face of a tariff stand-off with China as
well as the President calling on the Fed to lower rates? There has
been some slippage in the economy with freight rates declining and
rumbling about GDP coming in a bit light. With the prospect that the
Fed may actually cut rates and inflation being in check, this has
propelled the market upwards. The only issue we see with this, is that
the reason the market rose is due to a prospective increase in GDP due
to a decline in interest rates. We would prefer the market move higher
because the economy continues to move forward at the same pace or
better rather than being fueled by anticipated monetary stimulus.
Tariffs: We think the stand-off is coming to a head. We have seen both
U.S. and China try to save face by putting further tariffs on hold
until we can come to some better terms for both countries. Frankly,
leaders in both the U.S. and China are more concerned about how they
are perceived and much of this is tied to the wealth of the citizens
and the stock market. As long as they both use the stock market as a
proxy for their administrations, tariffs will likely be in a holding
pattern and just more talk.
Last quarter we discussed the stock market doubling and how this would
happen. The following chart shows the returns of the Presidential
Cycles. Using data as of July 9, 2019, it appears the third year in
our Presidential Cycle is right on cue. The question begs for the rest
of this year and next if we will see similar returns to the historical
returns or will this election cycle get ugly and take no prisoners?
We guess that it will be ugly. However, we think the market will be
resilient and recognize additional growth of GDP and earnings of
companies, while a low inflation and interest rate environment will
keep us close to average returns that we have seen in years past. The
remainder of our returns for the rest of 2019 will keep us paying
close attention to future returns if we fall back or get ahead of
One chart shows that we are nearing an overbought position in the
stock market. For this to come back down close to the 50 mark, we need
to see higher GDP and earnings growth from our public companies.
Lastly, one area of the stock market that remains under-loved and
ignored is value stocks. Since 2009, this stock market has focused
mainly on growth stocks. We see this as the largest undervalued area
and poised to outperform growth over the next 10 years, or at least
keep up with growth stock returns. We have focused much of our
attention to value stocks over the years and will continue to do so.
It is not always what you make in the stock market, but also what you
keep in the down years.
Forward Price Earnings Ratio on the S&P 500 is 15.8, which is close to
the average over the last 20 years. We think the market may be
slightly overpriced, but not by much. In fact, based on these low
interest rates, the market could move another 25% higher and by some
estimates still be fairly priced.
Being a bit more conservative, we would rather see an increase in
market earnings and GDP propel the markets higher so that when rates
do rise (and it may be a while), the stock markets here in the U.S. do
not feel the lumps of a higher rate environment. A final thought on
interest rates for those who may still be worried about the inverted
yield curve on the. One reason for this is that many countries
currently have 10yr Bonds trading at less than 1% or even at a
negative rate. This is driving our rates down further as foreign
governments look to invest here.
Raj Goenka, CPA
Paul Sullivan, CPA
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