17 Dec C.J. Lawrence Weekly – Economic Fears Feed Market Volatility but Slow Stable Growth and Tame Inflation Could Be Bullish for Stocks in 2019
Stock prices tend to perform well in periods of economic and political stability. The current environment is providing neither. After pushing through the 3.0% level earlier this year, U.S. GDP looked to be on a trajectory to eclipse 4.0% on a sustained basis in 2019. But the negative impact of slowing economic growth in Europe and parts of Asia is seeping into expectations, with some prominent economists now forecasting only 2.0% U.S. real GDP growth for next year. What a difference a few months makes! In February and March, we were wrestling with the prospect that the Federal Reserve would have to act more aggressively to stay in line with advances in U.S. GDP and inflation. The 10-Year U.S. Treasury bond yield spiked in March and again in May, and the market debate focused on how quickly it would climb to 4.0% and beyond and upend the bull market in stocks. Now the debate has shifted back to whether the Fed is acting too aggressively and needs to scale back its interest rate normalization plans while the economy finds solid footing. The result of these cross currents has been a directionless stock market that reacts wildly to news headlines and events, of which there have been plenty.
To be sure, current economic and market fundamentals are sound. Retail sales, capacity utilization, industrial production, and business inventories all came in at, or better than, expectations last week. Recent inflation data has been tame. 3Q18 S&P 500 Index sales and earnings hit new records, and 4Q18 forecasts call for 7% sales growth and 14% earnings growth. But the market doesn’t care. Fears of dramatically slowing economic growth next year and beyond have permeated market sentiment and are unlikely to change soon. Costco’s fiscal first quarter report and market response were emblematic of current market psyche. The company reported results on Thursday night that included, among other metrics, 8.3% growth in U.S. comparable store sales and e-commerce comparable sales growth of 32.3%. But the market chose to focus on the 50 basis points of gross margin erosion in the quarter and sent the stock down 9% in Friday’s trading. To be sure, the stock’s fundamental debate is more complicated than just these metrics, but the 9% punishment to the stock price highlights the unforgiving nature of the current market environment.
Positioning portfolios for next year and beyond will be challenging for top down investors and managers. The 2019 and 2020 economic and corporate profit outlooks are murky and investors who remember the sting of the 2008 downtown may choose to remain in safe ports rather than face the risk that they could sail into a storm. To us, no dramatic storm looks to be brewing, but just the drumbeat that one could be over the horizon may be enough to keep investors defensively positioned. Corroborating their fears, 2019 and 2020 growth and profit forecasts are likely to come down in the coming months providing an additional headwind for stocks. But analyst forecast revisions tend to over-shoot to the upside and to the downside, potentially creating a washed-out scenario next year that generates opportunities for upside surprises. The recalibration process promises to be bumpy, but barring an unforeseen crisis or recession, the evolving set-up could be constructive for stocks in 2019. An environment that combines slow and measured economic growth, tame inflation, and low interest rates has been supportive of rising equity prices in the past. We’ve been there before and may be headed back there again.