Fall Market Trends To Keep An Eye On

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

Fall is in the air, but Wall Street isn’t enjoying the season as much as most. In fact, the mood on Wall Street is about as sour as I can remember in a very long time. Market commentators and pundits are increasingly worried about a recession, if not in 2020, at least by early 2021. Then there are worries about China, the president’s political problems, and the upcoming elections. Many of these issues have impacted stocks for a while now. Let’s dig a bit deeper to see if we can make some sense as to what’s going on.  

Why So Glum?

Given the economic, interest rate, and fundamental backdrop, stocks are likely fairly valued in 2019, although there is probably still potential for some gains as we near the end of the year. Concerning a recession, we need to accept that at some point we’re going to have a contraction in economic growth. I am still not yet convinced it will happen next year. I have said this before, but it bears repeating: it is hard for me to contemplate us having a recession while unemployment remains at levels not seen since the 1960s, and while the scope of technological advancement remains so robust. Markets have experienced a profits recession in the last two years as earnings have remained flat, which has also led to a relatively flat market in the last 20 months or so. If that’s the worst we’re going to see as we’ve been in this period of sluggish growth, then things don’t seem so bad.

Stock Predictions

We are at a point in time where earnings expectations for stocks flip over into 2020, and in a few months, we’ll start looking out at 2021. Right now, expectations are for corporate earnings to recover in 2020 with profit growth for the S&P 500 in the 10-12% range. Wall Street analysts are traditionally optimistic about earnings out that far, so it’s likely those numbers will be paired back as 2020 progresses. Still, if we have 6-8% earnings growth, then I think the potential is there for stock advancement in the 6-8% range next year. Throw in a nearly 2% dividend yield for the S&P 500, and you see a total return potential that could be around 10% next year if certain things pan out. Of course, things can change drastically and there’s no guarantee that stocks will increase that much. Also, as I’ll discuss a bit later, I believe much of those potential gains will show up in the first half of 2020.

Trade Issues, Again

One of the reasons the markets have been so volatile this past year or so has been global trade issues, perhaps none more important than our quarrel with China. Simply put, we are going to have to come to grips with the fact that the Chinese have become a strategic competitor to the United States and, by extension, most capitalistic, democratic societies as well. I use the term competitor because it places the Chinese in a role that is not an enemy. China has a view of the world and their place in it that is different than ours. It is less an issue of ideology than one of culture. Whether their competing view of things will become more dominant or attractive to other societies is something that is going to play out in the coming decades. What we are experiencing now is a reordering of the world’s geopolitical order. It does not necessarily lead to war, as many fear, but these events will probably take some time to straighten out.

Along those lines, I will repeat my belief that in the current environment, a trade deal with the Chinese, or at least a meaningful one, is a low-probability event. In my opinion, the political class in both China and the U.S. view each other as that strategic competitor more than a reliable trading partner. As such, we probably won’t see the Chinese willing to give up enough for the Trump administration to come away with a comprehensive deal before next year’s elections. That’s not to say we won’t see something before we all vote in 2020, such as a deal on agricultural products, but it won’t be in China’s strategic best interest to give up on technology transfers or limit market access to U.S. companies. Our volatile but otherwise flat market is likely reflecting this “no trade deal” viewpoint as well as the impact of that on world growth.

Then There’s Trump…

President Trump’s political problems seem unending and won’t be covered here except as to how they affect markets and investing. First of all, I would caution us all to not get too worked up over the day-to-day headlines. “Headline risk” is the ability for an event, news headline, or even the rumor mill, to influence the price of a stock, sector, or broader market. We’ve seen several examples of this recently, most notably the current impeachment inquiry in the House of Representatives over whether or not the president withheld funds for Ukraine unless they agreed to investigate Joe Biden’s son. As these things play out, political pundits on both sides are the first to jump and scream about the alleged atrocity the other side committed. Whatever the allegations are, and no matter whether they come from the right or the left, these are almost always defined in a “death to the Republic” manner. Trump may be in hot water over his call with Ukraine, but investors are better served by reviewing all of the evidence and seeing how this will play out in the coming months than blindly assuming it will negatively impact their portfolios.

Traders, particularly those of the algorithmic type, get all itchy over headlines. However, most of us don’t adjust our portfolios by the minute, so this type of thing is usually best ignored until hard evidence is presented that supports that today’s headlines are telling the truth. Investors who make hasty decisions based on inflammatory news stories may wind up with a case of seller’s remorse in the coming months. I already think the President is going to have a tough time getting re-elected next year, so if I were the Democrats, I’d hold all this in reserve and go at him if he wins in 2020. However, there is a sizable group within the opposing party that wants to get rid of Mr. Trump and that passion may prevail in the coming weeks. I think it’s better to wait until we’ve seen how this pans out before we decide if this is significant to our long-term market outlook. 

I am often asked why the economy and markets have done well under President Trump. The reason for this is that whether you like them or not, the current president’s policies have been seen as market-friendly. However, when reviewing all of this, a more nuanced picture begins to emerge. This administration has seemed to be singularly focused on creating jobs and growing the economy. We have the lowest unemployment in two generations and GDP growth will likely come in around 2% for this year. If that’s the case, then it’s likely we’ll have averaged GDP around 2.75% for the first three years of the president’s term. That’s lower than the administration has touted over the years but better than the Obama era averages. The president passed a comprehensive rewrite of the U.S. tax laws and lowered taxes for millions, not just the rich. In the process, though, we have added billions to the federal budget deficit, and only time will tell how that will play out. Also, the economy has run into significant headwinds this year, most notably on trade-related issues. These will not be going away as the calendar ticks into 2020. In terms of the stock market, the S&P 500 is currently up about 40% since President Trump was elected back in 2016, excluding dividends. Most of that gain came between his election and late January 2018. Since that time, the S&P 500 is up slightly under 4%. We also experienced a 20% correction in the last quarter of 2018.  

Of course, some factors could limit market gains next year, and there is also a high probability that any advance will be front-loaded into the first six months of 2020 as Wall Street focuses on the presidential elections in November. The likelihood of the president being reelected will probably depend on whom the Democrats nominate. A centrist candidate would decrease Mr. Trump’s reelection chances, while a candidate in the Bernie Sanders/Elizabeth Warren wing of the party would likely raise the odds of Mr. Trump staying in office. It is unlikely that a Sanders/Warren candidacy would be viewed positively by the Wall Street community, and there is a significant possibility of market headwinds should it look like that wing of the party is advancing or has a solid chance of being elected. One final political notion to consider is that centrist Democrats and independents that become alarmed at the prospect of a left-of-center Democratic nominee might cast about for someone considered more electable. In that vein, you may start to hear Hillary Clinton’s name bandied about as an alternative. Expect the buzz around her to increase if the more centrist candidates falter in the coming months. Such a candidacy this late in the game is probably a long shot, but stranger things have happened in politics. However, all of this is far in the future, and we should first watch how the Democratic primaries play out next spring. 

A Word On Treasury Yields

Finally, in terms of the markets, I have pointed out repeatedly in the past 10 years about the relationship between dividends and treasury yields. Right now the yield on the S&P 500 is just slightly under 2%. Furthermore, the dividends that make up that index will likely compound at a 2-5% clip over time. The current rate on the U.S. 30-year treasury yield is close to 2%, while the 10-year rate hovers around 1.50%. If you invest today in a 10- or 30-year bond, you are saying that you have so little confidence in American growth during those future time periods that you’re willing to accept a rate of return that is unlikely to beat the real rate of inflation over those years. Equities or equity-related investments will be volatile, but I think I’ll take the bet that their rate of return will beat bonds hands down over a 10- to 30-year period going forward. As always, we’ll wait to see, and hopefully I’ll be around in 30 years to find out if I’ve won that wager!

Any Questions?

As always, we are here for you. If there’s a change in your situation or if you want to discuss any concerns that are weighing on your mind, reach out to me at 312.953.8825 or by email at lumencapital@hotmail.com. 

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.

The information contained here is taken from sources deemed reliable but cannot be guaranteed. Mr. English may, from time to time, write about stocks or other assets in which he or other family members has an investment. In such cases appropriate disclosure is made. Lumen Capital Management, LLC provides investment advice or recommendations only for its clients. As such the information contained herein is designed solely for the clients or contacts of Lumen Capital Management, LLC and is not meant to be considered general investment advice.

*Long ETF’s related to the S&P 500 in both client and personal accounts.  I reserve the right to change these investments without verbal, written or electronic communication at any time.