The Road Forward {Part II }

I've changed the title from my post from Monday as I intend to write a series now on what stocks may be telling us.  Today I want to give you a view of what I think is the probable environment we may be in for some period of time.  I want you to take a look at this long range view of the markets as I believe it will provide some context for what we've been in and illustrative of where we might be going.  The chart above is a weekly chart and is from Tradingview.com, although the annotations are mine.  As always I am showing the S&P 500's ETF, SPY.  I use this because it is an actual security that investors can buy.  I am using a weekly view so we can see a broader look back over trading history.

The current bull market was born in despair in March of 2009 and is now nearly a decade old.  From its lows back then to its most recent high it is up well over 330% without including dividends.  What needs to be noted is that this move higher has never gone up one straight line.  What has happened is that we've seen periods where stocks have moved higher and then paused to consolidate those gains.    I am showing those periods in the chart above.  Basically we can see three periods of consolidation since 2009, which I've labeled 1-3 above.  The first period lasted about two and a half years in roughly 2010-2013, the 2nd was also nearly the same length of time and lasted from 2014 to late 2016 and the third is what I believe we've been in for about a year now.  These periods of consolidation are healthy.  They allow the markets to lose speculative froth, while allowing earnings to catch up valuations which generally become extended during advances.  Investors though find these periods frustrating and sometimes frightening.  It is during these times that volatility picks up and it is usually during these periods where stocks see their most significant drawdowns.  Each of these consolidations has seen at least one decline of 10%.  Each has also seen some element of economic uncertainty and headlines proclaiming the bull market is over.  

Our current environment fits this pattern very well.  Certainly there is a lot of negative economic press right now.  Also there is economic and political uncertainty abroad while the political environment here in the US at times verges on toxic.  Yet the underlying economic news is still good.  The US economy will likely grow 3% this year and probably north of 2.5% in 2019.  More importantly, all of the secular economic trends we have talked about many times in the past are still intact.  These should provide some floor for stocks from a fundamental perspective.  In regards to valuation, stocks right now trade with a PE ratio of about 15.25 based on consensus estimates in 2019 and are trading with a 14 PE looking out into 2020.  {Yes, markets as discounting machines are starting to focus in on that number about now.}  My guess is investors fear more than anything the return of bear market similar to what we experienced a decade ago.  While nothing is guaranteed, right now there does not seem to be the kind of speculative excess in the system that would lead to a systemic failure of the kind we saw back then.  Financial institutions are much healthier today then they were back then.  The mostly likely way this decline turns into something approaching that is if an unexpected event shows up.  Away from that the overall system seems to be healthy enough that any decline should currently be viewed in the context of a normal, if painful, correction.  

If this hypothesis is correct then my guess is that we will continue in this sideways market for at least part, if not most of 2019.  I think that the S&P 500 has the potential still to finish this year 4-6% higher than where we are currently trading.  I also think it has the potential to trade 10-12% higher by the end of 2019 from these prices as well.  This of course is not a prediction or a guarantee it is what I am viewing based on my reading of what I see in the markets, the economy and over 30 years experience.  Obviously things could come up that makes this analysis wrong but it is my best guess right now.   Since I think we may be in this trading range for some considerable period of time next year, investors need to get used to an environment that is as volatile as what we've seen this year.  Investors also need to understand that volatility is part and parcel to investing in stocks.  It is part of the deal you strike when you invest in equities.  A year like 2017 where stocks showed very little volatility is an oddity.  Most years markets experience at least one correction around 10%.  This year is much more typical in terms of volatility.  

Next week I'll take up what I think investors should consider regarding asset allocation and what areas of the markets have the potential to benefit going forward in a choppy environment.

*Long ETFS related to the S&P 500 in client and personal accounts.  Positions may change at any time without notice or publication on this blog or on any other form of media.