The fall/early winter rally continues a slow drift upward. Yesterday, the rally was led by Amazon, which has been a notable laggard throughout most of 2019. However, after a strong Christmas selling season, the stock reacted strongly. The strength in Amazon pulled more money into other FANG and related stocks.
There really isn’t much to add to all we have been saying for the past several weeks. The economic backdrop is strong and, if anything, appears to be getting a bit stronger. Easy monetary policy and expanded fiscal spending around the globe add the fuel necessary to sustain the economic advance. Of course, nothing is free, but the pain associated with too much debt and indiscriminate spending come much later, at least with interest rates still in proximity to record lows.
The other factor that is helping to sustain the market rally is an absence of sellers. That comes about for several reasons, all of which we have listed before. Taxable sellers are waiting until after January 1 to cash in, pushing their obligatory tax obligations out a year. Given market strength this year, compared to the sharp drop in late 2018, hedge funds are seeing much lower mandatory liquidation requirements. Third, corporations, flush with cash, have been actively repurchasing stock. That tailwind will stop shortly; for many companies it has stopped already as 2019 fourth quarter earnings season approaches. Fourth, traders chase momentum. Right now that trend says buy. The fear of being left out still is a powerful influence.
But what happens when the calendar flips to 2020? While the possibility of a correction increases, it isn’t guaranteed. Note that most daily equity trading is done either by non-taxable investors or by institutions that don’t consider tax consequences as they buy and sell stocks. No one reports mutual fund returns on an after-tax basis! Individuals, buying and owning individual stocks, make up a smaller and smaller percentage of daily activity.
All this suggests that while the absence of high volumes of tax selling may be helping to lift equity prices, the advance must have a more fundamental core. The main trust, obviously, comes from a belief that the recent acceleration in economic growth is sustainable. There are no more recession fears. There is no more inverted yield curve. The Fed has been the market’s friend. Even if it is done cutting rates for a while, monetary accommodation and money supply expansion continue. Impeachment probably was never a market threat but with the House finished its task and public opinion basically unchanged, it won’t be any market overhang if it ever was one.
As for the coming election, there is a very long history since FDR came to office in the depths of the Great Depression, that Americans want a centrist approach. The two candidates can move left or right of center but anyone who chooses to move too far is a likely loser. I have no idea who the Democrats will choose or what the platform will be. But in a world where the economy is growing, where unemployment across all ethnic classes are near generational lows, where the line worker is getting bigger wage increases than their boss, and where job security is high, it wouldn’t appear the majority of Americans are going to seek change for economic reasons. Obviously, other factors will take on added performance in 2020 and Republicans can lose for a host of non-economic reasons. But so far, markets don’t see the election moving the economic needle in an adverse way. Finally, I should note that markets are pretty good prognosticators of the near-to-intermediate future. While the financial media shook with inflation fears last summer, equity markets barely moved.
Prognosticators routinely look several moves ahead. They align the stars as they see them at the moment and make predictions. For instance, predicting recession earlier this year, based on slowing growth worldwide, failed to assume three Fed rate cuts and other central bank easing actions overseas. They ignored expansionary spending. They ignored a Brexit solution that isn’t likely to be very destructive. For every action, there is an equal and opposite reaction.
But in the end, we can’t forget valuation. As good as the economy might be in 2020, a fair amount of that improvement is already priced in. All I have been saying is now embedded in market prices. That is not to say stocks can’t or won’t go higher in 2020, but it does say that unless fundamental expectations actually accelerate from here, a good part of the 2020 gains are already priced in.
Today, Savannah Guthrie is 48.
James M. Meyer, CFA 610-260-2220