January Rally Mirrors December Panic

The Dow has rallied over 3,000 points since the Christmas bottom (basis futures) and most indices are up 14 of the past 17 trading days. Financials have had their 2nd most rapid ascent in 20 years over a 15 day period. What’s more impressive is the psychology of the market that is now the mirror opposite of the 4th quarter. During the 20% downturn, we had a negative news syndrome where good news was an excuse to sell and bad news was crushed. Now weak earnings, lower guidance, Government shutdown, denials of China trade progress are met with new buyers – a positive news response syndrome. This doesn’t mean there will not be considerably more economic weakness over the next few months or longer. It means that the 50% cut in earnings forecasts (from 10 to 5%) and a 2% GDP economy is priced in. 

All the major averages have entered small resistance windows of time and price where at least a couple day pullbacks are due. Rolling over into a February or March (higher) low could begin next week or take more time as shown. We continue to feel the late 2018 through 1st quarter market bottom arrived over Christmas and corrections will be part of an ongoing uptrend into a summer peak that may outline a trading range for most of 2019. However, this is not the time for new buying. 

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It’s premature to create price and time windows for a new buying zone. Our projected time frame for a correction low encompasses most of February, assuming the top is confirmed before the end of January. If prices persist in a tight range at higher levels through February, then we may adjust the first significant pullback to occur as late as April. Good Bull market runs make it very hard to climb aboard, where waiting for a big pullback to buy can be quite elusive. 

The fundamental picture: The economy has moved from mild overheating to normal as of late 2018 – early 2019. Sub 2% GDP report in the 1st half of 2019 is likely, but only a political/trade conflict has any potential to allow for a stumble into a quarter of contraction. A failure to reach a framework agreement of a Trade Deal with China by the end of February that results in escalation could send stocks to new lows on fears of recession and contracting earnings that are not currently priced in.Even a Government shutdown that lingers into March could create a deeper correction. These unknowable negatives are not in our current outlook. Other than exogenous events, we view the longer term into 2020 as constructive with no recession red flags yet. Risk ratios and bond spreads are excellent. default rates remain at historic lows as do debt service obligations. Oil prices are healthy in the $50’s and only a systemic concern if falling below the upper $30’s. Interest rates have fallen from 3.24 to under 2.6% on the 10 year – goldilocks is about 2.4% to 2.9% range. The Fed will not raise rates unless the economy reaccelerates. Fed Quantitative Tightening (QT) draining of central bank reserves will stop and even reverse “if” the economy slips under 1% GDP growth (we expect 1.5 to 2% rate as early as the 1st quarter). China has been stimulating in many areas with greater frequency. Europe is the laggard, but part of its weakness is political and all countries will catch a tailwind if the European and China Trade Agreements with the US can show an agreed upon framework. This brief overview is to share that the lagging fundamentals are still weakening, but the overall health of the market and the economy is positive longer term.

Disclaimer: This report may contain information on investments that are high risk and have substantial risk of principal loss. It is for informational purposes only. Statements in this communication ...

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Moon Kil Woong 3 months ago Contributor's comment

The good news is interest rates are moderating, especially long term rates not just in treasuries but across the board. The Fed has been a follower not a leader. This poses a positive outlook in the near term and has been realized by the market. That said, a downturn will happen eventually. Hopefully the Fed will be more normalized and better able to deal with it when it appears.

The author is right that there are a lot of potential bad things that can happen but it is not right to add them into estimates when their occurrence is still not known. Hopefully the China trade spat will be resolved as well as the government shutdown. If this happens it will be quite positive for the market.

Peter Cooper 3 months ago Contributor's comment

Recent US consumer confidence surveys suggest this is a dead cat bounce rally. You can't have numbers like this and an economic rebound as the consumer is 70% of the US economy, see:

seekingalpha.com/.../3424272-consumer-sentiment-unexpectedly-tumbles