The U.S.. market has just hit highs not seen since October, with most of the gains coming from multiple expansion. 2018 was supposed to be the “big year” on the back of 22% earnings growth, but instead the market made fools of the prognosticators and most asset classes finished in the red last year.
While caution and fear permeated Q4 on concerns about a global slowdown, year-to-date the market has again confounded the skeptics with a 13% gain in the S&P 500 and even better returns overseas. This comes on top of paltry forward earnings growth expectations of 3% in the US, and rapidly decelerating economies in Europe and China.
The US market looked cheap in December at close to 14 times earnings and now looks fairly valued at 17 times, while international markets appear slightly undervalued. The fixed income markets appear to be pricing in a significant slowdown, so the key questions are around what keeps this global rally going after such a strong start to 2019. Will cap ex finally increase, and will consumer sentiment improve and lead to higher consumption? Will earnings re-accelerate or will the rally depend on central bank complacency and further multiple expansion? The latter may be the answer as volatility dries up and the “risk on” trade pushes more money into equities and other risk assets. In addition, technical factors may push prices higher.
For the first time since October, the S&P closed above the 2,815 level to end last week. Technology has driven this last leg higher with the equally-weighted Nasdaq 100 right on the cusp of fresh all-time highs and semiconductors continuing to exhibit leadership. More broadly though, the market still appears to be in the midst of a consolidation phase with the Russell 2000 still below its February highs and transportation stocks again lagging. This churn phase is usually a precursor to the next leg up, assuming these two laggards can catch up with the overall market. We have a trade deal coming by June (maybe), which could be the catalyst for the next leg up. In the meantime the market will need to get through mediocre Q1 earnings which should add credence to the consolidation theory over the next two months. Please call or email me with any questions about this update.