Weekly market update

We did it!

New all-time highs in the S&P 500 and NASDAQ!

2019 has been full of a lot of small up days in the market which compounded to bring blazing fast gains and then followed was a strong move Tuesday. The S&P 500 closed above its previous high from September 20th by almost 3 points. It took 7 months for the full turn around to play out. Once again, the NASDAQ 100 led the charge to new highs first. The Dow still has a little work to do as well as small caps (Russell 2000).

Looking at historical returns, since the Great Depression, the S&P has been up better than 15% YTD after the first four months of the year only 5 times. Every single time was a pre-election year and 2019 just became number 6.

But, the skepticism on owning equities this year has been startling. That just goes to show how much damage was done to investor confidence in the last quarter of 2018. It was so financially and emotionally devastating for so many that it left the typical investor—risk and volatility phobic.

Yes, we have had a fantastic start to the year, the Dow is up 14%, the S&P 500 17%, the NASDAQ up 22% and the Russell 2000 up 18%.

We’re at the half-way mark for first-quarter earnings. With 261 companies reporting in the S&P 500, earnings are up 0.7%. Analysts began cutting estimates in late December on fears of a global slowdown led by China. They continued cutting in January and into the end of March. By the early part of April, earnings were expected to be down 2.5% for the first quarter, a big reversal from early December, when the same first-quarter earnings were expected to be up nearly 7%.

But then a funny thing happened: Early reporters like Adobe and Nike reported much better than expected earnings.

What changed? The global growth narrative changed, due mostly to central banks. “First, the FED backed off, then everyone realized that China was stabilizing, Europe was not as bad as feared, the U.S. economy was still strong and the analysts had cut their numbers too much. The big story for earnings this year is, it’s a lot better than feared.

The big problem for the markets now is valuation. Stocks are pricey, trading at around 17.1 times forward earnings, well above the historic average of 15 to 16 times forward earnings. Even if you take 2020 earnings estimates, the S&P 500 is trading at roughly 15.5 multiple, near the historic average.

Bottom line: A lot of things are going to have to go right in the global economy to justify these prices. There is very little room for error.

Turning to the economy, the U.S. economy brushed off disruptions caused by the partial government shutdown and abnormal weather, and grew strongly in the first quarter, beating consensus expectations (3.2% vs 2.3%). However, behind the sheen of the solid headline, the drivers of growth were not as lustrous. Domestic demand growth weakened, with consumers saving a little more and businesses slightly more cautious with their investment dollars. Instead, inventories and net exports—the more volatile components of GDP—provided the heavy lifting. The build-up of inventories is now a three-quarter trend. It is likely to be reversed in the quarters ahead, dragging on real GDP growth. The good news is that with temporary disruptions dissipating, domestic demand should improve next quarter, taking the mantle in driving growth. Amid the hurrah of strong real GDP growth, the one segment of the economy that continued to underperform was housing. The economy’s growth in the first quarter was supported by consumer spending, business investment in inventories and sales of U.S. exports abroad. If we didn’t have a government shutdown and a trade war, this number may have been over 4%. As usual, all of the market pundits were wrong.

So, here we are—May Day. And as usual, the cries for “Sell in May and go away” are starting to be heard. BUT the market could likely drift higher on that bullish GDP number, earnings backdrop and the dovish FED, plus it’s the pre-election year. And that is the best year of the four-year cycle, historically speaking.

I would say that we would not be surprised at some type of a pullback, consolidation or whatever you want to call it, we are not throwing caution to the wind just yet—it can be healthy digesting the gains we have seen since Christmas. I did not say crash.

So, please stay tuned and we’ll keep you posted and if you have any questions, comments or concerns how any of this impacts your own personal situation please reach out to us. We’re here to help.

Todd Day, MBA
Portfolio Manager
Horizon Financial Services, LLC
May 1, 2019

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