By the market action in October, it now appears certain that the nasty 12% market correction in August and September was just that, a “correction.” And if you ignored all the doomsayers, who finally had a down market after 4+ years, the correction proved to be a buying opportunity. Indeed, we can pretty well conclude what I said in the August and September columns that:
•China’s slowdown isn’t going to have a large impact in the U.S. China’s economy is not crashing, as retail sales are up 10.9% and real estate prices in large urban areas are once again rising after a nearly year-long downturn;
•It is a mistake to concentrate on China’s industrial sector, which is definitely in contraction, just as it is a mistake to believe that the industrial and manufacturing sectors in the U.S. (12% of GDP) tell us the overall health of the economy.
As I indicated in earlier columns, the China story turns out to be the “excuse” to sell in the correction. Remember, fear is more powerful than greed; Wall Street shoots first and asks questions later. China’s “growth slowdown” was that excuse. Like so many other issues in economics, “this time is different” is almost never the case. The fundamentals in the U.S. economy were, and continue to be, way too strong for a real bear market to develop.
The Upturn
Every market turn has some specific catalyst – just as the Chinese yuan devaluation and the growth slowdown story ushered in the correction, there were three catalysts responsible for the market upturn:
1. The first one was the mid-September Fed “non-action” regarding its long promised rate “normalization” process, and the continuation of underlying economic strength. The market was clearly priced for a rate hike, and the inaction was the equivalent to an easing (which equity markets love). In the late October meeting, the Fed once again refrained from raising rates, but once again, they promoted uncertainty by indicating that they are still considering a rate rise in December. Q3 showed some slowdown in the pace of economic growth as the first estimate of GDP growth was 1.5%. But, most of the softer growth from Q2’s 3.9% centered around a slowdown in inventory accumulation which subtracted 1.6 percentage points from Q3’s GDP growth. The good news is that consumer spending rose a healthy 3.2%, nearly as fast as Q2’s 3.6% growth indicating that the economy remains on a healthy growth track.
2. The second catalyst was the move toward ease by the world’s other major central banks. Specifically, the Peoples Bank of China (PBOC) actually moved rates lower while there was easing rhetoric by the European Central Bank (ECB) and the Bank of Japan (BOJ). As you know, equity markets love easy money and always respond positively to such central bank moves.
3. The third set of events, which took a slowly rising market up toward warp speed, was the better than expected Q3 earnings reports. At the time of this writing, 77% of companies have beat their analyst earnings expectations (ok – the estimates were low balled). The 5 year average for earnings “beats” is 72%. Leading the pack were the techs (Alphabet (i.e. Google), Amazon, Microsoft, Apple) and consumer discretionary companies like McDonalds (which was the biggest upside surprise of the reporting season so far). On the other hand, those companies that missed were severely punished price wise. In addition, only 43% beat on the top line indicating some growth slowdown in Q3, as evidenced by the first estimate of GDP growth at only 1.5%.
The Outlook
Now, the tricky part – what lies ahead. Here is what I see for Q4:
•The softness seen in Q3 will end – most of it has been caused by a slowdown in the industrial and manufacturing sectors due to a strong dollar and a slowdown in inventory accumulation. The headwind of the strong dollar is fading, as the value of the dollar appears to have reached at least a temporary peak, and the inventory cycle is quite short and most likely already has had its largest impact;
•The end of year holiday spending will set a record and that should change the negative economic news cycle. U.S. consumers have the best balance sheets of the century and are once again borrowing; auto sales are consistently setting new highs; the housing sector is awakening; and despite the contention by the Bureau of Labor Statistics that “average” wages are not rising (likely measurement issues and assumptions), other reports show significant uptrends. For example, ADP reports that average hourly wages (for those holding a job for 1 year or more) grew 1.9% in Q1, 2.5% in Q2, and 3.5% in Q3. In addition, those who changed jobs saw a 6.5% increase in hourly pay in Q3;
•The S&P 500 has risen in November and December in the last 6 years. The seasonal factors are positive in those two months. Just an observation!
Conclusion
There is always something to worry about. Don’t let that distract you from the underlying fundamentals, because, over the mid- and long-term, the economic fundamentals always prevail. And the fundamentals indicate a strong (yes – it could be stronger) economy.
Robert Barone, Ph.D., is an advisor representative of Concert Wealth Management, Inc. and an employee of Universal Value Advisors, a NV LLC. Advisory services are offered through Concert Wealth Management, Inc., a registered investment advisor. Robert is available to discuss client investment needs. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of Concert Wealth Management, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.