Macro Musings May 21, 2019
A SMALL CORRECTION AFTER ALL-TIME HIGHS
- The MACROCAST™ score continues to suggest low risk of both a recession and major bear market.
- After a big rally since Christmas and a new all-time high, the market is in a mild correction. This price action is normal, and often resolves higher in the year ahead.
- Despite the shallow nature of the correction, sentiment has tanked. From a contrarian perspective, such a reaction after a decline is bullish.
- The trade war with China remains front and center. We believe the impact will be smaller than headlines suggest, but we are monitoring the situation closely.
THE MARKET IS CORRECTING AFTER A BIG MOVE HIGHER
The S&P 500 is pulling back after a strong rally. After a deep correction last fall, the market rose 25% between December 26 and April 30. As of May 21, it is down marginally, trading around 3% from its all-time highs. We believe this is a normal pullback and not the start of something larger.
History supports this view. When the market reaches a new all-time high after going at least 6 months since the last occurrence, it was higher a year later in all but one instance with average returns of 13%. Historically, over the near-term, there have been several bouts of weaker performance (table from LPL):
SENTIMENT TURNED NEGATIVE RATHER QUICKLY
One reason we think new highs will come sooner rather than later is the sudden turn in sentiment. Despite rallying 25% off the lows, and despite the fifth best start to a year ever through the month of April, investors are not in a bullish mood. Below we highlight three examples of the increase in negative sentiment, despite a strong economy and rallying markets.
First, a look at State Street’s Investor Confidence index. The overall figure is the lowest ever recorded. The smoother one-year average is at levels similar to early 2013, a year when the S&P 500 rallied 30%.
Second, while the market is only modestly lower, the weekly survey of the Association of American Individual Investors (AAII) showed a sharp drop in bullishness and rise in bearishness:
Finally, investors have pulled out over $30 billion from equity ETFs and mutual funds in the past 4 weeks. In previous instances, short-term outflows of this magnitude have been mostly contrarian signals, leading to strong positive returns a year later.
Taken together, these are not the actions or attitudes of a market that is anything close to euphoric.
TRADE WAR ISSUES REMAIN IN THE NEWS
While the headlines remain concerning, we don’t believe recent developments are enough to impact economic growth in a meaningful way for neither China, nor the US. Consider the following:
- China’s GDP from exports to the US (the money they make selling us stuff), is at a 20-year low as a percentage of their total economy.
- The bulk of the tariffs will be borne by the importer (US companies) and will either be absorbed by the companies (resulting in lower profit margins), or more likely, they’ll passed on to the consumer.
- The estimated dollar impact to the consumer is meaningful but not massive. According to Econofact, the impact of tariffs is in the $300 range for the average household.
More tariffs could be on the agenda, but in the meantime, we will monitor the situation using MACROCAST™, as any impact will be captured by its underlying components. So far, we haven’t seen weakness in the indicators that would be affected by the dispute, but we are monitoring the situation closely.