Stocks continued their rally on Friday in the most active trading session of the year as various futures and options contracts expired on what has been labeled quadruple witching, an event that happens four times a year in the middle of the last month of each quarter. But aside from the volume created by quadruple witching, it was actually a rather quiet session with orderly trading. The absence of sellers continues to be apparent. Anecdotal evidence continues to indicate a solid Christmas selling season. Aside from that there was little in the way of either economic or corporate news. The third revision to Q3 GDP data showed no surprises.
A year ago tomorrow, in a holiday shortened session stocks sank sharply completing a 20% retreat from the early October highs. Just a couple of weeks earlier, the Fed had raised rates for the fourth time in a year, something it had not done in well over a decade. Brexit fears were roiling Great Britain. Negative interest rates in Europe were helping to cause a slowdown on the continent. China and Japan were slowing as well.
The December 24 low would prove to be an important bottom. Stocks have rallied well over 30% since. The Fed has shifted direction and become quite accommodative. Not only has it cut rates three times, but money supply growth has accelerated as well. Governments around the world have been maintaining easy monetary policy and have started to open government purse strings as well.
The obvious question is whether the stock rally of the past twelve months has discounted all the good news or whether economic acceleration can continue to lift equity values as we move into next year. While the Trump impeachment process remains incomplete, the Democrats so far have failed to seize on the opportunity to gain significant popular support. Polls which showed the President having approval ratings plus or minus 40% before the impeachment process began still show them at about the same level. Moreover, with stocks at record highs and unemployment near record lows, his economic grades continue to be his one major plus. The Democratic response of a broad populist agenda backed by significantly higher taxes has not gained much appeal with the overall public. Within the party, there is a split between the very progressive Warren/Sanders wing and the more moderate but still populist alternatives of Buttigieg/Biden. For now at least, markets have dismissed the Democratic alternatives either because investors don’t believe they can translate policy into legislation or because they don’t believe they can win the Presidency. There remains plenty of time for that judgment to change.
Today, the real question is whether the shift to a more expansionary combination of monetary and fiscal policy around the world can create an environment that will allow earnings to accelerate beyond current forecasts. Given the lag time between policy implementation and economic impact, that argument can be quite persuasive. It depends, of course, on a relaxation of the trade/tariff wars that we have seen the past two years. Election politics suggests that tariffs will be used more gingerly in 2020 but trying to predict Trump isn’t an exercise that is formulaic.
The other obvious question is whether the New Year will bring more selling from taxable investors and others seeking to monetize recent gains. That is possible and one can remember 2018 when a February swoon could be attributed, in part, to just such a factor. But in February 2018, Mr. Trump introduced steel and aluminum tariffs. Thus, it wasn’t just a result of tax-related selling.
The last concern is interest rates, not the Federal Funds rates that the Fed controls but longer term rates that market forces affect. They have been rising lately and the general trend should remain higher should economic growth accelerate.
With all that said, there is always room for a modest correction, let’s say 5-10%. But a serious 20% correction probably requires a turn in economic events that isn’t apparent at this time. While it is always a good idea not to get too far from one’s basic asset allocation, the idea that cash needs to be raised simply because there might be a modest correction is probably a bad idea. That could have been done almost any time in the past year at significant opportunity costs. For sure, there are some stocks and stock groups that are at extended valuations today. But that isn’t true for all stocks and all sectors. At this time of year, it is a good idea to look for value among companies that lagged the market in 2019. Some deserved to lag, and their fundamentals continue to deteriorate. But some suffered from one-time events and will recover in 2020. There are always diamonds in the rough.
Today, Susan Lucci is 73.
James M. Meyer, CFA 610-260-2220