Four reasons why there’s still a rally to come
About two weeks ago, all the assets classes that you could own—and I mean all, not just stocks or bonds, but also treasury bills, gold, oil, commodities soft and hard—were in the red. No one was beating inflation for the year.
Yes, the losses were not significant and stayed for the most part in the single digits, but they made it look like 2018, which started with a bang, was going to end with a bust. What had happened? February’s market fall was an inflation scare; after the January rally, the market brought it back to square one. It took the spring and summer to reach new highs in September.
Then, in October, the 10-year Treasury note reached 3.25%, which prompted the market to believe that the Fed was being too aggressive in raising rates and that it somehow had set itself on autopilot: normalize rates steadily and do not pay attention to short-term economic news, as the economy is doing great already.
However, there were signs that the economy was decelerating, and despite great earnings reports in the third quarter, the combo of higher rates and slower than expected growth prompted many pundits to determine that the market should reprice to a lower multiple. That led to another correction, which brought us back to square one.
So, with all this noise, we arrived at the sad situation of not making much money anywhere. However, I have some good news for you: In the last few weeks, four elements have appeared that make me believe that we are facing a good tradeable rally.
1. Interest Rates
‘Don’t fight the Fed’ is an adage that has to be respected. Since the beginning of the financial crisis over a decade ago, the Federal Reserve has been injecting liquidity in many different forms. The exercise is now coming to an end with rates going up and the bond-buying program finished, but there’s been the absence of inflation. It’s fair to say there’s been a good amount of confusion this year and at some points, the market assumed the Fed was just raising rates without looking at short-term economic data.
However, over the last few days the Fed has clarified its policy stating that it is very close to the end of the cycle of raising rates and that from now on it will be more data dependent. That’s a big relief to the market.
2. Holiday Shopping Season
Record holiday sales prompted the rally that started in early January in December 2017.
As we enter the 2018 season, some of the early reports point to a new record high, backed by very encouraging data from Black Friday and Cyber Monday. Online sales look very robust and also traditional retailers are experiencing record foot traffic.
As consumer confidence is at a multi-decade high, there is record unemployment and investor sentiment is very strong, this makes me believe that the story will repeat itself and we will see very positive numbers come early January. Remember that for many industries the holiday season represents up to 50% of their yearly sales.
It’s pretty widely agreed that at the start of the year, the equity market was at the top of the range in valuation with a price-earnings ratio of 18.
However, with interest rates near zero and record earnings, the case for a healthy market was not out of question. Moreover, this year the leaders of the market—including the well-known FAANGs plus other stalwarts like Microsoft and Cisco—kept on reporting very solid top and bottom numbers. Yes, there was a lot of noise on the regulatory front in Europe and the US about privacy issues and fake content, but these companies kept reporting solid earnings.
After the move in October, now the P/E is about 15. Not bad for an entry point, and it’s even better if you consider that the leaders have shown no signs of decelerating their growth rates.
4. The Trump Administration
American presidents know the midterm elections are key for their legislative agendas. We identified four issues in the current administration that we felt were crucial: the North American Free Trade Agreement negotiations, North Korea, tensions with the North Atlantic Treaty Organization and the trade deficit with China.
Over the course of the year, the administration was able to make progress on all fronts but one—the trade deficit with China. Clearly, of all the issues mentioned above, the most relevant for the markets was China. A trade war with one of our most important partners would have bode badly for all of us concerned.
Over the weekend at the G20 meetings in Buenos Aires, the US decided to postpone the automatic raise of tariffs from 10% to 25% and also had agreed in reviewing many sectors to soften restrictions of entry for American companies. As I write, both sides had commented that real progress is being made.
Have a great Holiday Season and enjoy the rally!
Por Fabian Onetti | 07