2019: First Half Outlook
“Put on the Rally Caps”
Written by Chris Perras, CFA, Chief Investment Officer
Given the sharp rise in stock market volatility to a reading over 35 on the Vix index and subsequent dramatic fall in stocks in the 4th quarter of 2018, we are highly optimistic about stock returns in 2019. We believe the market can fully recover and hit new all-time highs by year end 2019! Call it SP500 3000 optimistically. We cover our first half outlook in this report.
As we stated throughout the second half of 2018, we see an almost perfect analogy in the markets to the 2015-2016 period for 2018-2019. So far so good for 2018.
The investment team at Oak Harvest FG believes the overall market returns for 2019 will come largely during two very short time windows with the first being a sharp recovery in 1st quarter 2019. In late December of 2018, with the global markets feeling the pain of slowing global growth, tighter global central bank monetary policy, and higher tariffs and costs (which are nothing more than higher taxes on consumers) driven by US/China trade disputes, our Federal Reserve, led by Chairman Powell, reversed its two yearlong monetary tightening policy.
In late December of last year, members of the Federal Reserve Board were quoted as saying they have” done enough”, are “on hold”’, are now “data dependent”, or are “considering final balance sheet runoffs” later in 2019. As you know, the team at Oak Harvest believes that 95%+ of financial news is noise, irrelevant, and merely written or produced to create emotion in its readers or listeners. This story is different. We believe this story is market changing news. One of the most sacred rules for macro investors is “DON’T FIGHT the FEDERAL RESERVE!” Repeat after us…DON’T FIGHT the FED! …or “DFF” for short.
We believe that much of 1st quarter 2019 will see investors, who sold over $150 billion in stocks in November and December, trying to get reinvested in the markets. Unfortunately for those sellers of the late 2018 market swoon, they should be met with relatively few sellers and very few true dip buying opportunities should present themselves until early summer. We strongly feel that market timing, or the now more politically correct phase “tactical allocation strategies” almost never work. They are generally high cost (management fees, transaction costs and tax generation) and almost always price momentum based, trend following strategies that sell too late and buy even later. While most claim to be “rules based”, those rules are set by a human being, tend to be emotionally driven, and rely on investors making multiple correct decisions. Oak Harvest’s investment philosophy is one of tempering one’s own emotions to market swings yet seizing on market volatility and the opportunities caused by other investors emotional biases.
The Federal Reserve controls the general monetary supply and if credit and money are easy or hard to come by. Whether by desire or chance, by controlling credit they also have affected overall market volatility the last few years. When credit conditions are easy (think 2016 and 2017), volatility typically declines and very few legitimate buying opportunities surface. Contrary to most market pundits, we expect a dramatic decline in market volatility in early 2019 which should help not only stabilize stocks but propel them back higher.
Besides fighting an easier credit environment, potential buyers of stocks in the first half of 2019 will be fighting corporate stock buybacks in January and February 2019 as the buyback window opens. We expect companies to accelerate their stock buybacks in early 2019 to take advantage of much lower valuations caused by late 2018 market downturn. This will further support a first quarter 2019 rally.
Besides the elements of lower market volatility and faster corporate stock buybacks driving up stocks, sellers of late 2018 who want to “get back in” will have to fight the rising seasonal tide of passive investment flows. As we have detailed at length previously, retirement savings fund flows are going increasingly into passive investing vehicles. As these automated retirement savings plans, think 401ks and IRAs, reload and see inflows on “paydays”, they blindly buy stocks. They are price agnostic. They do not care the price of the individual stocks they are buying or selling. Their only objective is to be 100% invested in the market by the end of each trading day! 100%! No cash! No other! This should help support stocks in the first half of 2019.
While positive on an early 2019 rally, we expect the price momentum to wane in the late 1st quarter as two negative traits resurface. In early March and extending into April, corporate stock buyers reenter their “blackout window” where they are prohibited from transacting and buying back their stock until 48 hours after they report the first quarter earnings. This seasonally reduces the demand for stocks.
Additionally, while tax refunds typically help support stocks in the early second quarter, 2019 should bring lower tax refunds to buyers of stocks as the tax code changes of 2018 are calendarized, filers of itemized returns shrink, and investors took net capital losses in 2018. This should reduce the amount of capital slated for buying stock in the second quarter. Finally, we think that a third unforeseen reason will surface late in the second quarter refocusing investors on slower global growth and concerns of a recession. Convenient reasons may include European Brexit, oil instability, launching additional auto tariffs, or federal deficit worries. Regardless of the cause, we think that a short-term rally in bonds and the dollar in second quarter is likely. Being two of the “3 bears” to earnings estimates and stock prices, a short and fast pull-back in the global equity markets would ensue.
We would be buyers of this early summer pull-back. Moreover, we would be aggressively looking to buy more growth and cyclical tilted stocks for the second half of 2019 and 2020. Our outlook for the second half of 2019 and for the first half of 2020 will be posted as we draw closer to those time periods, but the title is likely to read “The Bull is Back”.
Sources for data include Bloomberg, Investor’s Business Daily, other publicly available news sources, and Oak Harvest internal analysis. This forecast contains the generalized view of Oak Harvest Investment Services and should not be considered personalized investment advice. No assurance is made that Oak Harvest Investment Services will continue to hold the views expressed herein. Views and opinions may change based on new information, analysis, or reconsideration. In addition, Oak Harvest makes no assurance as to the accuracy of any forecast or projection made. Past performance is not indicative of future results. Investing involves the risk of loss.
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