A Summer Recap And A Look Ahead (Summer Letter)

By Christopher R. English, President of Lumen Capital Management, LLC

Below you will find an edited version of the summer letter I recently sent to my clients:

As hard as it is to believe, we have now bid adieu to the first seven months of 2019 and are well into what is traditionally considered Wall Street’s summer season. Between now and Labor Day, the leaders of the investment world will be more worried about where they will spend their summer weekends than the state of the markets. That means trading will slow down over the summer and markets will move languidly as the humidity rises, unless something unexpected washes over the transom.

A Bit Of Review

You may have heard on the airwaves that the S&P 500 hit new highs this July and finally breached the psychologically important 3,000 mark. While this is not to be discounted, let’s be realistic and note that this new level is less than a 3% advance from last September’s highs. Here’s a chart to give you a visual of the S&P’s progress since mid-2017:

All the market gurus proclaiming what a wonderful first half of 2019 we’ve experienced never seem to mention last fall’s rapid decline or the prevailing gloom that took hold back then. The investor consensus back in January was that things were about to fall off the cliff. I’m sure the average 20% decline in stock prices had something to do with that. In my "What Went Wrong" post from February 4, 2019, I stated that I doubted the premise that there would be a recession on the 2019 horizon. Instead of market declines, I thought corporate earnings growth would be in the 5-7% range for the year, GDP would be 2.4% in 2019, and that stocks had the potential to advance 10-15%. On the downside for stocks, I also thought there was a potential to retest or perhaps undercut last year’s lows.

Now that we have some data to look back on, we can see that there has been no recession and first-quarter GDP numbers came in at 3.1%. GDP has been slowing down but still clocked a respectable 2.1% advance in the recently finished second quarter. So far, second-quarter corporate earnings are coming in slightly better than the analyst community expected. Most broad U.S. market indices were up between 14% and 19% as of July 25th, while international markets have again underperformed the U.S. Finally, the markets never retested last December’s lows, but we did see an average 8% decline in broad market indices in May. I took that opportunity to do some repositioning in portfolios depending on client mandates during that decline.

Do These Market Highs Matter? 

The market, as represented by the S&P 500*, has recently broken out of a period of consolidation that now goes back nearly two years. By this, I mean that the index has been locked in a roughly 500-point price range, from which it has simply moved sideways since the summer of 2017. Markets that break through important psychological barriers force the investment community to take notice. Investors will watch carefully to see how the market reacts now that it is in the uncharted territory of all-time highs. This is especially true when noting that stocks have hit troubled waters the last two times they tried to make new highs. One of those failed attempts last fall set the stage for 2018’s 20% decline. The other failure this April led to May’s over 6% decline.  

The investment community is currently divided on their market outlook. Those who follow money flow analysis think that each time you test important price levels at either the upper or lower bands of a trading range, then the weaker the resistance is to stocks moving through those important price levels. The optimistic view, then, is that when stocks or indices advance through important psychological barriers, they should, in theory, continue to move higher. Investors who believe this would argue that, given the amount of time we’ve spent in the current trading range, we could potentially see a substantial price move in the coming months. Based on that thinking, probability would suggest an environment where stocks could trade higher. 

The other side has a more negative view of things. While we are near new highs, stocks have sold off each of the last two times we attempted this kind of vertical move. The fundamental backdrop is a bit dicey right now, and at these prices, stocks aren’t necessarily cheap. Also, history has shown in this consolidation that failed rallies have led to negative consequences. Investors in this camp would argue that the markets, at a minimum, should retest the prices we last saw in May and that would point toward some downside.

So there’s your summary of the two extreme views in play right now. The environment is somewhat negative in the investment community, and frankly, the Wall Street crowd is more interested in lowering their golf handicaps or deciding where to vacation until Labor Day than the day-to-day movement of stock prices. Still, if we get positive news out of trade talks this summer, a potential interest rate cut by the Federal Reserve this month, or better-than-expected corporate earnings news, then we could potentially see an upside surprise to stocks.

One major clue as to what might happen is how the major averages respond the next time the market has a sell-off. A market that bounces higher near the levels where stocks have broken out this month would suggest a larger sustained move in the months ahead. However, stocks that ultimately trade back into their previous price range would suggest an environment where markets have more work to do in their consolidative phase, or could even indicate lower prices in the weeks ahead. In any event, a sell-off in the coming weeks, if it were to occur, would also be in keeping with part of my theory of seasonality, which notes the late summer and early autumn periods as being traditionally the worst for stocks. I let my indicators be my guide as to this secular bull market’s health.  

And Then There’s Politics…

Given that we are a little more than six months away from the first caucuses and primaries in 2020’s Presidential election, it is worth spending some time to parse out what it could mean for investors. First, as always, I don’t cover political opinions for political opinions’ sake. Any discussion on politics is solely within the context of how they play out in financial markets. Having said that, the polling numbers right now would indicate the President Trump should be concerned and he will likely face a very tough bid to get reelected. He is behind in polls in many of the swing states he will need to carry next year. That doesn’t mean he’s sure to lose, but it does mean that his reelection is not guaranteed, especially if the Democrats nominate a more moderate candidate. Markets likely won’t really start to care about this until sometime next year, probably in late spring or early summer when the official Democratic challenger likely emerges.

What will concern the investment class is who emerges as the Democratic front-runner. Markets won’t like the nomination of a progressive who proposes all sorts of policies that would cost trillions of dollars. If the Democrats follow that route, then there is a very high probability you will have four more years of President Trump. The base of the Democratic Party is skewing more liberal these days, just as the base of the Republican Party has tilted more to the right. However, the vast majority of folks in this country reside closer to center and there’s no evidence yet that they are skewing that far into the progressive camp. Of course, all of that could change in a year, but present trends don’t support the notion of the vast majority in this country yearning for a more socialist economic system. Expect whomever the Democrats nominate next year to recognize that and rapidly move toward the middle once his or her nomination is secure. In any case, getting many of these policies through Congress, in their current proposed iterations, is unlikely to occur even if we have a more progressively inclined President in 2021. If we assume a best-case scenario for the Democrats in 2020, where they control both branches of Congress and the Presidency, they would still need to round up 60 votes in the Senate. Even if the Republicans take a shellacking next year, there is a low probability of them losing that many seats.  

Don’t Forget All The Other Factors At Play

TV and print pundits will note the many crosscurrents pushing and prodding stocks right now. There’s Iran, the trade war with China, immigration, and the beginning of the 2020 presidential cycle, just to name a few. Also, depending on whom you listen to, the economy is either doing great or beginning to slow down toward a possible recession. 

There are always crosscurrents in the markets. The important thing for most investors is to keep focused on the long term and their own unique investment plans. Stocks will rise and fall. We’ve chronicled time and time again that stocks typically experience at least one correction between 7-15% every year. We’ve already had one of those this spring. As I noted in my May letter  “Seven Trends That Make Me Feel Optimistic About the Markets,” there are simply too many longer-term positives out there for me not to think there is a higher probability of stocks advancing over these next few years than not. Regardless of what we see in the short run, these longer-term trends are not likely to go away. Pay attention to long-term secular trends, especially in times of heightened volatility, as that will give us opportunities to add to positions we like. In the meantime, remember that Wall Street, for the most part, will be calling a time-out until after Labor Day.

Got Questions?

I am happy to speak with you about your portfolio, its current asset allocation, and my market orientation any time you would like. Please also let me know if anything has changed in your current circumstances that would need me to review my investment profile for your account. Call my office at 312.953.8825 or email us at lumencapital@hotmail.com to set up an appointment. As always, thank you for your continued trust and support. 

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 312.953.8825 or emailing him at lumencapital@hotmail.com.

*Long ETFs related to the S&P 500 in client and personal accounts, although positions can change at any time. We reserve the right to change these investments without notice in writing, on my blog or via any other form of verbal, written or electronic communication.