1st Quarter 2019 Market Commentary
BULLS, BEARS, AND INVESTMENT METHODOLOGY
I’ve often thought of our investment methodology as a three-legged stool. One leg is our quantitative models, the second is our fundamental research, and third is our technical research. Technical research mostly covers the behavior of market price and volume. Fundamental research examines the economic growth rates, earnings, relative interest rates and currencies. Quantitative models are mathematical and statistical financial models allowing us to analyze extremely large datasets. Some analysts depend on just technical charting to forecast patterns, some only study fundamentals, while others strictly follow quantitative strategies. By incorporating all three strategies, there are times when the models could contradict one another. Currently, the fundamentals and our quantitative models are forecasting a bullish market scenario. In our analysis of the fundamentals, there’s no economic recession in sight and the expectation for future earnings is still promising. Our quantitative models are also very bullish but are selective in their favor. They are more bullish on emerging market equities than they are on developed country equities such as Europe, the U.S., and Japan. However, our technical research is suggesting that we should have a consolidation period, which means the markets could be range bound for a while before surging higher.
Over the short term, we could experience a volatile period in the next few months. Issues with the Korean peninsula, Venezuela, France, European Union Brexit, and the trade deal between the U.S. and China could all be potential landmines for the markets. Concerns about the Federal Reserve’s tightening policy have at least been put to rest for now by their statement they will be data dependent rather than automatically making interest rate increases. Our expectation is the other situations will be resolved in a positive fashion but could still increase volatility over the next couple of months. However, a market downside could be used as an opportunity to add to equity exposure.
Some of the equity bears are worried about inflation rearing its ugly head. However, we have conviction that inflation should remain subdued for the next few years. Globalization has a positive side effect of importing deflation. When we outsource manufacturing and services to China and India, it deflates the costs for us. We will continue to import deflation from China on the manufacturing side and from India on the service side. Our economy is two thirds services and one third manufacturing, and the benefits of globalization will continue to keep inflation at bay here.
Bear or Bull Debate
There has been a lot of focus in the media referencing the debt level as a reason for an oncoming bear market. While that is an area of concern, I don’t think we’re facing an impending bear market because of a growing debt bubble. Most sectors of the economy go through a normal increase in debt during a recovery or during an expansion. When you look at the household debt and compare it to nominal GDP, the household debt to GDP is at its lowest level since 2001. This means the household debt has grown but not in proportion to the overall economy for much of the last 17 years. As of the third quarter of last year, the mortgage debt was 66% of the total household debt, precisely in line with the long-term average. It’s normal for a mature economy and a recovering economy of our size to experience an increase in debt. From a macro perspective, it is important to watch the debt to GDP ratio; however, it only becomes concerning if the debt increases at a faster pace than the GDP. Government debt has grown because of the spending but has been balanced out by the slower growth of personal debt in America. The federal government debt is the fastest growing of all the sectors. The Federal debt grew 6.8% in the third quarter of 2018 as compared to 3.1% for household mortgage debt, 5.4% for consumer credit, 3.9% for business debt, and -1.4% for state and local governments. Overall, the debt of all sectors together, including the household and the government, look benign and the financial health of the overall economy appears fairly stable.
All in all, even the technical variables we watch are giving us indications that we are about to resume another fresh bull cycle in this decade old secular bull. I had previously predicted the Dow could reach 36,000 in 36 months and I still stand by that over the remaining 30 months of that time period. Some of the technical indicators as well as our quantitative models and fundamentals are suggesting that we still have upside from here. However, technical indicators are also suggesting a short period of consolidation. We will continue to utilize our three-legged approach to investment management to provide a comprehensive approach for our clients.
Sources: Federal Reserve System, Wellington Shields LLC., Strategas Research Partners, Ned Davis Research, JP Morgan Research & Bank Credit Analyst Research
Shashi Mehrotra, Chartered Financial Analyst, is the Chief Operating Officer and Chief Investment Officer of Legend Advisory. The opinions and predictions expressed herein are those of Shashi Mehrotra solely and not necessarily the opinions or expectations of Legend Advisory or any of its affiliates. Such opinions and predictions are as of March 27, 2019, and are subject to change at any time based on market and other conditions. This material includes forward-looking statements that are subject to certain risks and uncertainties. Actual results, performance or achievements may differ materially from those expressed or implied. No predictions or forecasts can be guaranteed.
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