Monthly Outlook: July 2019
They say history doesn’t repeat itself, but sometimes it rhymes. While 2019 has its own set of specifics, it’s looking a lot like 2000 and 2007 in many ways. We’ll get into that in detail, below, but suffice it to say that’s not a rhyme we really want to hear. 2000 and 2007 were major tops that each endured a year of volatility (similar to now) and then ended badly with a recession and significant bear market. Then, as now, no one wanted to see it, even though fundamental data was flashing warning lights.
Let’s review the numbers before we dig into comparisons to previous tops. Global stocks had a good month in June, gaining back what they lost in May. Remember that the S&P500 lost 20% from October to December, then gained it all back by May. Then it sunk again in May by 6% only to gain it back a month later by June. Down, up, repeat. The market is exactly where it was nine months ago, but we’ve endured a roller coaster ride in the process. And it’s not much different than where it was a full 18 months ago when it first peaked in January 2018. It’s been a year and a half of volatility, mostly within a 10% sideways band. International stocks have been similarly volatile but with a downward tilt. The FTSE Int’l stock index is down about 7% from its January 2018 peak and has a similar Oct-May and May-June dip-recovery cycle. Bonds, by contrast, have marched steadily higher as interest rates continue to sink. The U.S. 10-year rate peaked at 3.2% in November 2018 and is just 2.0% today. As a result, bonds have gained about 6% this year and yet few people talk about it. What’s wrong with 1%/month?
Rhyming with 2000 & 2007
Market tops tend to have similar traits. Firstly, they are over-valued by traditional valuation metrics. Today, the market is as over-valued as it was in 2007, 2000, and even 1929 using our metrics of TMC/GDP, P/E10, Margin Debt, and ValueLine MAP. Valuation is not a great short-term indicator but it sets the background of possibilities. Secondly, the yield curve is inverted today with the 10yr U.S. Treasury rate of 2.0% being below the 3-month rate of 2.3%. That’s a consistent precursor signal to a recession within about six months. That also happened in 2000 & 2007. Thirdly, employment starts to soften after years of improvement. Today, the unemployment rate has fallen from 10% in 2009 to just 3.6%. On Friday (July 5th), we expect to see a reversal of that downtrend and an uptick in the rate. We’ll see. In October 2000 and August 2007, the unemployment up-ticked as well. Fourthly, corporate earnings growth and forecasted growth are slowing. Per Goldman Sachs, 2019 expected earnings growth was +10% at the start of the year, and forecasts have been cut to only +2% growth today. Further, 113 of the S&P500 companies have issued 2Q guidance so far, and 87 of the 113 have issued negative guidance, a near record. Fifthly, the Purchasing Manager’s Index (PMI) is a widely followed guide to the health of the manufacturing sector. A reading below 50 is concerning and indicates contraction. Today, Japan, China, Korea, Britain, Italy and others are below 50 already. And the U.S. PMI is at 51, teetering on contraction. And lastly, when these indicators are in place and the Federal Reserve finally cuts the Fed Funds rate, the economy has tipped into recession and stock markets have corrected, and sometimes a lot. Last month, the Federal Reserve stated after its June meeting that due to their read of slowing economic growth, they now stand ready to cut rates, and most likely at their July 31st meeting. Although the stock market seems to be cheering for a rate cut, factual historical data shows us clearly that a rate cut is associated with falling stock prices, not rallies.
So, What to Do?
Although today’s fundamentals rhyme with those of previous market tops and indicate caution, the stock markets have whipped back to uptrends in June. Investors don’t care about fundamentals this week, apparently. The right call is to stay cautiously invested, but we’d recommend a very vigilant watch for any market turning back down as a further sell signal. It’s always possible that global stock markets trend a lot higher, perhaps with the help of easy monetary policy. But it’s said that people who don’t learn from history are likely to repeat it. And we don’t want to repeat 2000 or 2007.