Goldilocks and the Three Bulls

What actually makes up “Goldilocks” conditions for the stock market? CIO Chris Perras discusses three key indicators he looks at when forming his view of the market.

Chris: This is Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. Welcome to the April 12th edition of our weekly Stock Talk podcast: Keeping you connected to your money. Each week, we share with you our views on the market, what we see coming down the pike for the economy and the markets. We also try to educate you to how the stock and bond markets work. This week’s episode is entitled, “Goldilocks and the Three Bulls”. Here we revisit a topic we first addressed in the early fourth quarter of last year. That topic is, “What exactly is a Goldilocks situation for the economy and stock markets?”

The S&P 500 is now rally right back to the 2880/2900 level over the last three months. As our listeners know, this is pretty much right in line with the outlook that the team at Oak Harvest Financial Group laid out in our first half outlook published in early January. This can be found on our website at oakharvestfg.com, as in a financial group, 2019: First Half Outlook. It is done so in a rapid fashion, in an almost straight line, leaving most market pundits, tactical asset allocators, and the financial press largely bewildered. Moreover, the rally has left most market timing and trading type investors largely under-invested. We discussed the number one reason for this rally many times over the past two months. That reason, the Federal Reserve pausing their interest rate tightening cycle. The last two weeks have heard the term Goldilocks used multiple times on TV by the exact same commentators and portfolio managers who only four weeks ago were doubting both the economy and the stock markets.

To these people, I say, “Wow, whoa now, not so fast. Please define Goldilocks. What does it mean?” To which they almost all reply, “It’s an economy that is growing not too slow and not too fast, an economy growing just right like the final porridge in the Goldilocks and The Three Bears story.” My response to this is, “That means nothing to me.”

I ask, “How can I follow things that show me it’s Goldilocks? What data can I follow that shows me it’s all clear environment for stock market?” To which most of these people respond back, “Well, there’s the jobs data, the government employment reports, the inflation data, the durable goods orders, consumer price inflation, or leading economic indicators data.” I’m sorry, but I have to roll my eyes to this response. Why? Because almost all of this data is government data that is released weeks, if not, months after it’s useful to investors. This is data of economists not of investors.

In a prior podcast, we covered the three most important factors driving stock total returns. Recall, those three factors were stocks’ earnings per share. Second, a stocks evaluation is usually described by its price to earnings multiple and changes in that ratio. Finally, third, its dividend yield. I now want to divulge a secret. I want to divulge what I believe are the three things the, three real-time economic inputs that will reveal whether Goldilocks exists for both the economy, but more importantly for investing in stocks in this economic cycle. I introduce to our listeners the story of Goldilocks and the Three Bulls. I believe, from 25 years of experience in investing in public markets for hedge funds, mutual funds, and pension funds, the following three factors more than any other can help you determine when Goldilocks is appearing, present, and leaving the economy, and more importantly when it’s in the stock market. Why are these factors so critical? Because these three data sets when aligned lead to significant upturns and downturns in the overall earnings of the S&P 500. They lead earnings stabilization, they lead earnings growth, they lead earnings peak, and they lead earnings troughs. This cycle, when all three data series have aligned, the US stock markets have advanced materially and consistently to new all-time highs. Without all three, the markets have at best-treaded water, and at worst, corrected almost 20%.

The first and most important bull of all three is long-term interest rates. Contrary to popular belief, the US stock market has needed slightly higher-trending long-term interest rates to advance and stay at new all-time highs this cycle. Yes, you heard that right, higher long-term interest rates are good for stocks. Why do you ask? Because long-term interest rates are a function of two things. They’re a function of real growth and a function of inflation. When long-term interest rates are rising gradually, and I don’t mean exponentially, I mean gradually, this is a real-time indicator of a profit acceleration in the overall stock market coming over the next two to four quarters. More companies in the S&P 500 are helped by gently trending higher long-term rates. Think of the bank group, financial group, think of deep cyclical and value stocks like JP Morgan, Caterpillar, and Deere. More companies are helped by this trend that is hurt by this trend. Companies hurt by this trend, think home builders or highly indebted companies. When it comes to the stock market, the steeper is better. A steepening yield curve, even slightly, is better for the overall stock market.

The second most important bull of these three is the US dollar. Contrary to the talk on CNBC and other financial networks where a good strong dollar policy is good for the economy, that’s not the case for the stock market. A strong absolute dollar is bad for most stocks. Why? Over 50% of sales of the S&P 500 come from international sales. A strong trending absolute US dollar hurts those companies versus their offshore competition. What hurts in slow sales growth, it even has a bigger effect on their earnings per share growth. When these companies convert their foreign earnings back into US dollars, they are penalized by a strengthening dollar. Goldilocks for the stock market and Goldilocks for stocks is a high relative dollar versus the world, but a slow controlled and weakening dollar direction that keeps US companies competitively internationally, and helps earnings per share when their offshore earnings are translated back into US dollars. As an investor, look for a gradually weakening dollar to spot Goldilocks for stocks.

Finally, the last piece of real-time data one can monitor is oil and energy prices. The USA and US markets are 72% to 75% consumer and service economy. Given that, energy costs now account for a much lower and increasingly less meaningful variable for S&P 500 earnings. However, a slightly higher trending oil price does help increase overall S&P 500 earnings by way of both energy companies earning more money, as well as through cost inflation for those companies that can pass on higher energy customer costs to their end customer. Think of the railroad group. Investors should look for a slightly higher trending oil price for Goldilocks and the stock market.

If you want to monitor two bonus real-time data series, I’ll give you those. First, watch the trend in lumber prices. This is a great leading indicator on the domestic US economy given its domestic demand is driven by housing and construction markets and its supply is almost 100% entirely derived by North American supply and Canadian markets. Second, you can watch the trending copper prices. Some people say copper has a Ph.D. in economics. In fact, some people refer to this commodity as Dr. Copper. Why do they do this? Why do so many people track the trending copper prices? Well, copper prices are a great leading indicator for global growth. Copper is used in almost every stage of the economy, particularly in emerging markets. It’s used in residential and commercial constructions industries, it’s used in communication cable and wiring, it’s used in semiconductors, it’s used in appliances in computers. It’s used everywhere. There it is, the basis for a new story to tell your kids. The story of Goldilocks and the Three Bulls. A story of real-time data one can use and see to monitor whether the US stock market is entering Goldilocks, whether it’s in Goldilocks, or whether it’s exiting a period of Goldilocks for investing.

Finally, the initial response to Disney’s launch of its direct consumer streaming and subscription service, Disney Plus, looks like it will be well received. Our outlook for Disney hasn’t changed as we expect the second half of this year to be filled with hit after hit at the movie box office with the release of the next Avengers movie this month, and probably the most widely awaited movie in years, the sequel to Frozen being released in the fourth quarter.

Additionally, JP Morgan reported earnings this morning and as we expected, they beat estimates and provided a very positive outlook. The financial sector, including banks, has been loved by investors for almost 18 months, but outside of transaction processing names like Visa and MasterCard, PayPal, and Square, the group has been horrible performing versus the overall stock market. Up until the last two to three months, we’d been underweight financials particularly bank stocks. However, as we previously have mentioned, it’s our belief that second half of 2019 and 2020, and for the bull market to continue and gain strength, the phrase “Without fins, you can’t win” will slowly enter the market.

In closing, if you find this content helpful, please forward it to friends or have them give us a call at 281-822-1350. Go browse our weekly updated website and all of our new content at oakharvestfg.com. You shared your vision for your money with us during our meetings, and we’re here for you. Occasionally the investment environment will change and in those rare cases, we will make strategic changes to your asset allocation. These are rare 1% events but they happen both ways, not just negatively. They happen as tailwinds to stocks in the economy too. They happen as positive setups to the market and the economy. When we see these rarities, we’ll adjust your allocation. Our main job at Oak Harvest financial group is to have you retire only once in your life with a customized retirement planning. Many blessings, Chris Perras.

Announcer: The proceeding content expresses the views of the speaker, and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, statistics, and sources are not guaranteed. Content ideas and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax or legal advice, or an offer, or solicitation to buy or sell securities. Investing involves the risk of loss, and past performance does not guarantee future results.