Key Points

  • As is often seen in investing, we believe the pendulum swung too far in the negative direction for equities late last year, but now may have swung a bit too far in the positive direction.

  • U.S. economic data has deteriorated and the threat of recession, while still relatively low, has risen. The Fed is reading from that playbook, hence its more dovish tilt since it last hiked rates in December.

  • Slowing economic and sales growth aren’t the only things to be watching—rising wages around the world could pressure earnings and profit margins.

“History has always been a series of pendulum swings, but the individual doesn’t have to get caught up in that.”
- Robert Johnson

Complacency danger?

65%! That’s the annualized gain for 2019 if the S&P continues along the pace of gains registered year-to-date. Of course, that’s highly unlikely. And with volatility across asset classes in very low territory, we’re also concerned that a bit of complacency among investors may be setting in.

The sharp rebound…

S&P 500

…and declining VIX cause us concern.

VIX

With the winter weather much of the country has seen recently (congrats to those who escaped, those of us who didn’t are jealous), a young driver trying to correct a skid on ice came to mind—they often overcorrect, making the situation worse. We’re concerned that’s the environment we’ve entered as we begin the final month of the first quarter. With the stock market’s gains, alongside a deteriorating corporate earnings outlook, the valuation recovery suggests equities are priced for a stream of good news—a deal with China, a continued-dovish Fed, no inflation, continued economic growth, no damaging Brexit, etc. While we believe there is hope for some of these to come to fruition, it’s a stretch to assume the full crescendo. And with investor sentiment continuing to extend into the overly optimistic zone, according to the Ned Davis Research Crowd Sentiment Poll, contrarian analysis suggests a near-term pullback is increasingly likely.

Economy slowing

The recent market gains are in contrast with the slowing in economic data. We’re not calling for a recession in the near-term; but as we often say “better or worse tends to matter more than good or bad,” and the trend in many indicators is decidedly down. Perhaps the best overall picture of this can be seen in the Index of Leading Economic Indicators (LEI) from The Conference Board, which peaked last September and has declined in two of the past four quarters, including last month.

LEI rolling over?

Leading Economic Index (LEI) w pullout

According to the National Association of Realtors, existing home sales, which can impact consumer confidence as homes are the largest asset most Americans own, fell 1.2% in January, to the lowest level since November 2015. That said the recent fall in mortgage rates did help the National Association of Homebuilder Index Housing Market Index (HMI) increase from 58 to 62, revealing relatively healthy optimism among homebuilders. But the weakness in sales could help to reinforce the weak retail sales reading from December, with the Census Bureau reporting a 1.4% drop ex-autos and gasoline. That reading may be a bit skewed as some other reports (MasterCard spending pulse, Johnson Redbook, etc.) regarding holiday spending indicated a more positive season. Nonetheless, the trend in consumer spending has deteriorated. And while the labor market retains its healthy glow, we are watching the forward-looking jobless claims closely, given the general uptrend since last fall. Persistence in this trend, based on history, would suggest elevating risk of a recession.

Uptick in claims concerning

Weekly initial jobless claims - 4-week MAV

As a result of the deterioration in data, the Atlanta Fed’s GDPNow estimate for this year’s first quarter has dropped from around 2.8% at the beginning of February to 1.8% now; while the New York Fed’s Nowcast is only 1.2%.