January 26, 2020

The Virus and the Antidote

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The Bottom Line:


Investors exited 2019 with lofty expectations, pricing in economic and earnings recoveries for 2020.  Early data releases have confirmed rising global economic momentum, surprisingly positive corporate momentum, and of course trade momentum with the US striking a Phase One trade deal with China.  These high expectations and early confirmations have boosted investor sentiment to dangerous levels.  Unfortunately, overconfident markets invite correction.  Catalysts for correction, by definition, surprise investors and arrive from sources unforeseen.  While the physical threat of the coronavirus remains unknowable at this point, a humbling of investor sentiment with a non-fundamental variable could provide a prescriptive antidote for this market’s ebullient fever. 



The Full Story:


Despite concurrent lousy economic and earnings fundamentals, robust asset class returns last year forecasted robust fundamental gains for 2020.  Fortunately, while the year has hardly begun, early economic releases have provided validation.  As stated within a recent J.P. Morgan release, “The December global all-industry PMI (Purchasing Manager Index) came in positively at the end of the year reinforcing a view that activity will improve in the coming quarters. The all-industry activity PMI increased for the second month to an eight-month high. Improving trends in new order inflows, employment, and business sentiment also suggest that further headway should be made at the start of the new year. International trade remains the main drag on efforts to lift growth further, so any moves that reduce tensions and barriers on this front will be especially beneficial.”


Six days later, the US and China inked a Phase One trade deal which added additional psychological lift.  2020 economic renewal?  It’s early but possible.  Shifting to Q4 earnings, analysts expected yet another quarter of negative growth.  Should they be proven correct, S&P 500 earnings will not have grown at all over the last year.  However, early Q4 releases have amassed historically high revenue surprises.  Given that revenues tie more closely to macroeconomic conditions, this could add further confirmation of economic acceleration.  2020 earnings renewal?  It’s early, but possible.  In fact, analysts now expect earnings growth of 9.5% for 2020 and 10.7% for 2021.  Durable economic and earnings renewal with inflation low and interest rates anchored should push equity indices far higher into record-breaking territory.  At least, that’s the consensus view.



The Bubble in Search of a Pin



Quantitative easing from the Fed.  A Phase One trade deal.  Accelerating economic growth.  Accelerating earnings growth.  Discussions of additional tax cuts with Trump 2.0 the heavy favorite.  A Super Bowl without the New England Patriots.  What’s not to like?  Basking in optimism, the S&P 500 hasn’t experienced a 1% pullback in over 70 trading days, the 6th longest streak in the last 20 years.  The NASDAQ hasn’t had a 1% pullback in a record-breaking 16 weeks. Relative strength measures, moving average comparisons, breadth calculations and oscillator limits all sit at relative extremes.  For visual confirmation, Ned Davis constructs a nice composite sentiment indicator included below:






Per its 25-year history, when this indicator rises above 62.5, returns over the following year have averaged -7%, contrasting the +30% average returns logged when sentiment readings fall below 40.  Clearly, when sentiment rises to this level, bullish consensus becomes vulnerable to a bearish counterpoint.  While the threat of WWIII with Iran wasn’t enough to dissuade the bulls, the viral outbreak in China may be.  While the coronavirus might instigate a natural sentiment correction, investors should maintain composure and take comfort in the longer-term market results following other pandemics:



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Have a great weekend,


David S. Waddell 
CEO, Chief Investment Strategist 



Sources: Charles Schwab, NED Davis Research
David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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