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Q4 2018 Commentary / 2019 Outlook

Q4 2018 Commentary / 2019 Outlook

| January 11, 2019

"The Wall"

I’m already wondering how many won’t even make it to this sentence after reading that title.  For those of you that have, you can relax knowing that the wall being discussed is not what you are thinking…

So, we have once again arrived at that magical time of year when everyone in our industry finds the need to wow us with their predictions for the next 12 months.  As usual, we will partake in this exercise – but focus our discussion on items we deem to be most important for the short-term, rather than pretending we know what will actually transpire.  We will most hesitantly give our projections – but they (and those made by others) are best suited for entertainment purposes only.  Yet, if you give this a read - and focus on the reasoning rather than look for predictions - we are hopeful that the remainder of this outlook will prove both informative and maybe even a little entertaining.

First, let’s take a look back on last year’s update to see how we did:

Scenario One (highest probability) – Stocks Chug Higher, Rates Rise but Remain “Contained”

It is almost impossible to ignore the potential effects of this tax cut on the stock market.  For one, the new corporate rates increase earnings / share just by themselves.  Combine this with our belief that much of the tax savings will go to repurchasing stock, and it’s hard to imagine this not being Utopian for stocks.  Yes, valuations remain historically high using any number of metrics.  But this is also against the backdrop of the ridiculously low interest rate environment that continues to exist.  It is for this reason that interest rates – in conjunction with inflation – will continue to be what we are focusing on.  Yes, we had a wild bout of volatility earlier this year – but come to find out it had little to do with valuations and/or interest rates - and much more to do with (you guessed it) some sort of derivative-based, volatility trade widely in use across Wall Street.

Speaking of rates, things are getting very interesting for sure.  We have always viewed 2.9-3% on the 10 year as a focal point with rates.  It represents the lower band of our own research done on historical rates.  It also represents the “breaking of a trend line” when looking at the past 30 years.  We want to see whether or not the 10 year treasury closes the year “significantly” above 3%....or not.  We think that stocks can continue to rise while the yield on the 10 year stays below 4 or maybe even 5%.  We don’t think we will get to those levels this year….

Last note on rates here, the valuation conversation around stocks is going to get real in a hurry if and when we get close to 4% on that 10 year…

And of course, our more specific “predictions”, along with our coin-tossing exercise introduced last year:

Well, up until late September, we had just about nailed it.  From the beginning of last year through the 3rd week of September, the S&P 500 was up about 9% - while the yield on the 10-year treasury had risen to about 3.1%.  As anticipated, corporations were buying back stock at record levels and announcing future buy-backs by the truckload.  Our outlook was pristine.  We had proven our genius.

Then came October.

Between October and the end of the year, the S&P dropped about 20% from its peak.  At the same time, the yield on a 10-year treasury dropped all the way down to 2.67%.  So much for our outlook.  So much for our genius.  We were once again completely inept at predicting what would happen with markets, economies or interest rates over any 12-month period.

Note:     So was everyone else – that’s the point.  Disagree?  Send me the outlook that properly predicted last year.  I will not be holding my breath.  Stop believing anyone can – you will thank yourself that you did.  I digress.

For nearly 11 months, we were getting exactly what we had hoped for on behalf of responsible investors everywhere.  The Fed actually followed through on promised rate hikes for the first time in, well, forever.  That means yields on shorter-term income vehicles had nearly doubled from a year earlier.  We started to hear of 2, even 3% CD rates for parking cash.  Sure, longer-term rates weren’t rising proportionally – but hey, something was better than nothing!  And Powell actually sounded like he was intent on keeping those rate hikes coming – where did that come from?!  Life was good.

The equity markets, however, did not like Chairman Powell’s remarks.  They turned lower……and FAST.  The “buy the dip” mentality – which had completely dominated our equity markets for the past decade – swiftly turned into “sell any rally, and sell it hard.”  Forget 4% on the 10 year, that we previously predicted as potential trouble for stocks.  All the Fed had to do was publicly state that the stock market was in fact NOT its number one mandate, and all hell broke loose.  Of course, the responsible investor didn’t mind this at all – it represented hope of adding equity exposure without the nosebleed valuations we have become accustomed to.  Sure, it didn’t look great on the statement.  But the responsible investor is interested in the long-term – and all of these developments were more than welcome.

Then, it happened.  Not at all surprising, but depressing nonetheless.  Powell re-emerged to make clear to the public that he was not “automatically set” on raising interest rates further, and that he would “adapt to changing circumstances.”  Let me translate his comments for everyone:  “I – like all Fed Chairpersons of the recent past – am beholden to the stock market above all else.  I will tell you that our mandates are inflation and employment, but our only true mandate remains to placate Wall Street and all of it’s glory.”  Sickening.  Really.

Almost immediately, stocks rallied viciously – a trend which has continued through the writing of this piece.  The market went from pricing 2-3 rate increases for 2019 down to zero.  There even began talk of the Fed lowering rates in 2019.  Best employment in some 50 years.  An economy that has shown virtually no signs of slowing.  Trillions of dollars in current and future tax relief for the biggest corporations in this country.  Rates still near all-time lows.  And our best course of action is to keep them there - or contemplate reducing even further - if the stock market doesn’t behave??

This brings us to the title of this update – “The Wall”.  As promised, this will not be a discussion of whether or not we should be building a wall on our southern border.  The wall we are most concerned with is the wall of lies, corruption and deceit that our Federal Reserve and politicians have built for us over the years through monetary and fiscal policy decisions.

So here is a letter I would like to send them.  I might actually send it, or at least post it to The Donald on his Twitter feed.

To: Chairman Powell
cc: Chairpersons Greenspan, Bernanke & Yellen; US Congress; US Senate; The Donald

I write to you today in hopes I might provide some common-sense input as it pertains to monetary policy in our country.  Interest rates remain near historical lows, due almost entirely to your collective decision-making.  I know, I know – you will tell me that technology and globalization have removed inflation from the discussion, and you are reacting accordingly.  I beg to differ, as do most of the citizens who - directly or indirectly - elect you to your posts.  But that is beside the point.  I would like to present items for your consideration as you contemplate monetary / fiscal policies going forward:

(1)   Our people, towns, states, and country are drowning in debt.  We have a debt problem.  It is a large one.  You may have missed this in your last economics class, but the answer to debt problems is not the assumption of even greater debt.  Your policy decisions are the monetary equivalent of offering complimentary pizza buffets to deal with my expanding gut.  It feels good while it lasts, but it’s not gonna end well.  You know this.  Please, consider removing the free lunches before it is too late.  (Lauren, you might want to remind me to re-read as it pertains to my expanding gut)

(2)   We have an aging population who would like to enjoy their retirement.  Yeah, the baby-boomers might not have saved as much as they should – but let’s not forget that your tax and other fiscal policies haven’t made it easy.  Is it too much to ask for a decent rate of return for their savings, without having to take on risk they can’t afford and often don’t understand?  Or have we truly gotten to the point where corrupt politicians and their donors – or the snot-nosed punks on Wall Street – have become your only mandate?  May I submit to you, your priorities are way out of whack.  Furthermore, how will our economy - reliant on mass consumption - handle an entire generation with no money left to consume?

(3)     Even if you are so void of integrity that the items above remain meaningless, we should talk about your own self-preservation.  Your policies of the past 30 years are self-fulfilling.  Create debt-induced bubble – bubble eventually bursts – solve by encouraging more debt – then repeat.  If you can find no other reason to normalize interest rates in this country – then ask yourself – what will you do when the current debt-induced bubble bursts, and there are no interest rates left to manipulate?  I fear that you are running out of time, and I would guess that deep down you feel that same sense of urgency yourself.

I appreciate you taking the time to consider my thoughts.  You can all now get back to pretending that a single one of you cares about illegal immigration, the vanishing middle class, the cost of healthcare or any of the other pressing issues not directly associated with your friends and donors on Wall Street.

Wow, that felt great!  Now back to the outlook…  

Let’s change things up a bit.  To my recollection, we have never approached things from a “technical” perspective in our updates.  In other words, using charts and past price points in an attempt to predict what will happen going forward.  First off, here are my thoughts on technical analysis:  It’s bullshit, except it’s not.  It’s bullshit as it is yet another way humans convince themselves (and the algorithms they construct) that they have control over something they don’t - that being short-term movements in markets.  At the same time, there are SO many believers that it becomes a self-fulfilling prophecy in many cases.

This year happens to be a particularly interesting one to broach the topic, given the volatility in both stocks and rates over the past few months.  It has caused quite a bit of “technical damage” as you will see below.  This analysis is going to be the simplest, most basic technical analysis possibly ever published – but that will also make it much easier to understand.  As you are about to see, charts can tell you entirely different stories depending on the timeframe you are studying.  Let’s take a look at a couple of current examples. 

Above, we have a chart of the S&P 500 over the past 5 years.  You will notice the red lines we have inserted, which represent the “trendline”.  You can see that - until just recently - we had a pattern of “higher highs and higher lows” dating back to the beginning of 2016.  That is considered a positive sign moving forward.  However, you will also see that once this trendline was broken late last year, the index fell in a hurry – in no small part due to everyone (and their algorithms) looking at the same trendlines.    Once the trendline has been broken, the previous “support levels” often become “resistance”.  So based on the chart above, one might assume that 2019 could very well be a challenging one for stocks.

Now, let’s look at the same index – but go back 10 years instead of 5.

By lengthening our timeframe, one would likely come to a completely different conclusion about where the market may be heading from here.  Based on the lower end of the trendline above, it looks we might be staring at a pristine opportunity to buy stocks – assuming the longer-term trend continues and we are about to bounce higher off the lower end of the range.

So, the obvious question you are about to ask is “well, which is it”?  Before I answer, go ahead and guess what I am about to say.  Yep, you were right – we have no idea.  Nor does anyone else.  Don’t worry, that’s not our final answer as I know you won’t let us off the hook that easy (nor should you) – this will all make sense in the end.

But first, let’s look at some charts of interest rates using the yield on a 10-year treasury. 


Above we have a chart showing 10-year treasury rates going back to the 60s.  One can clearly see the trendline lower since the 1980s.  Using the bands that we have inserted for illustration, one might come to the conclusion that we are pushing right up against the upper ends of the trend, and that the next move for interest rates might be significantly lower.

Same drill, let’s see what happens when we shorten the timeframe that we are studying to only the past 10 years.


Now we are getting to the good stuff.  First, we can clearly see the downward trendline from 2009 until about the middle of 2016.  Introducing a new concept, we can then see a potential “double bottom” in rates around the 1.4-1.5% area.  This is represented by what is supposed to be the straight red line on the bottom (this is the straightest Microsoft would allow me, and I do these things myself – so cut me some slack!).  Technicians often look at “double bottoms” as a sign that a trend reversal can now begin – also commonly referred to as “re-testing the lows” for those religiously watching CNBC for some reason.  From our re-testing of the lows, we eventually break through the downward trendline around the middle of 2016.  Interesting to note for those recalling our first chart, the upper band of the downward trend then becomes “support” once the trendline was broken – further confirmation of a trend reversal.  And then we have the very end of 2018, where the new upward trend line seems to get breached on the low end.  This is where it gets entertaining.  If you watch 5 different technicians on CNBC, you will note that some draw their trendlines directly along the high and low points.  Others give a little bit of “wiggle room” when creating their ranges.  I am firmly of the opinion that which method they choose depends on which narrative they are trying to prove.  If I am correct (and I am), then I will let each of you decide for yourself whether or not we violated the upward trendline at the end of last year, as your now-educated opinion is certainly as good as theirs.

And now that we are such experts on the topic, let’s take it back to the S&P one more time to illustrate why we are at such an inflection point as of this writing...

So here we have a chart of the S&P 500 over the last 12 months, right up through today.  We can see the initial damage at the end of last year, which we already examined in our 1st chart above.  And since we now know about “double bottoms” and “support becoming resistance”, take a look at the straight red line running across the bottom.  Not only did we have a potential “double bottom” (which we obviously violated) late last year, but you will also note that we had some serious support at the exact same level earlier in the year.  And as you now know, previous support levels become the new resistance on the way back up.  It just so happens that we are currently butting right up against that level as of this writing – so the coming days and weeks will be interesting for sure.

In our opinion - if we can firmly break above 2600 on the S&P - the next big resistance comes at the 2800 level, as shown on the chart.  For further evidence of this, scroll back up to the very first chart we examined.  There, you will see it is at about this same level (2800) where the longer-term uptrend was breached.  And again, we know that previous support now becomes resistance.  Isn’t technical analysis fun?!

To put things in perspective, a move higher from here to the 2800 level would represent a gain of about 8% in the S&P 500 from today’s level.  Conversely, a re-test of the lows from last year (2350ish) would mean a loss of about 10% from the date of this writing.  If we can’t hold those levels to form a “double bottom”, it is our opinion that the next support moves down to about the 2150 level.  This would represent a loss of approximately 17% from where we sit today.  Yikes. More on that later.

Back to our outlook for the year ahead.  It is our sincere hope that the format of this update has shed some light not only on some of the items that most significantly demand our attention – but also some insight as to why we hate short-term “predictions” (and those who make them) with such vigor.  First, without further ado, the official Round Hill Wealth 2019 Outlook:

We will begin by stating that our opinion would likely be much more concrete if we had just a few more weeks before publishing.  As described in the technical analysis above, the coming days and weeks should speak volumes about what we might expect.  Of course, the technicals are just one of many considerations in forming an opinion for the short-term – so here is our take based on the information we have to work with:

(1) We interpret the latest Fed-speak as confirmation that their fear of disrupting Wall Street outweighs any other data they may choose to consider.  As such, we find it highly unlikely that the Fed will raise rates even once during 2019.  In our opinion, not a single other factor – technical or otherwise – outweighs what the Fed says and does.  This was proven repeatedly over the past decade, and once again only last year.

(2) The Donald has gone from calling the stock market a “fed-induced, crazy bubble” while he was running for President, to making it his primary measuring-stick of success once he took office.  To be fair, his stance on markets are the equivalent of TV Chucky Schumer’s stance on a border wall – calling it “absolutely necessary” a few years back, but finding that same wall “ineffective, cost prohibitive, and even immoral” under the current president.  *Sorry, just way too easy on both – back to the topic at hand.*  It is our belief that recent volatility in the markets – coupled with the new Congress and all of the mindless investigations sure to follow – make it highly likely that Trump will want a trade deal with China in the very near future.  Trade relations with China remain one of (if not THE) biggest uncertainties affecting stocks.  A resolution to this dispute would almost certainly be met with optimism by markets – and Trump desperately needs the markets at the moment.

(3) We are not sure what to make of the recent plummet in rates – but we are convinced that next year’s outlook will read “the 10-year told us what was coming”.  The move down from 3.1% to current levels was curious, though hardly inexplicable with the S&P 500 dropping some 20% at the same time.  What is perplexing is the fact they have not rebounded at all since stocks reversed course.  While the S&P has recovered nearly 10% from its bottom last year, rates on 10-year treasuries actually declined.  On one hand, this could very simply be realization that the Fed is no longer a concern.  On the other, rates could be signaling that this recent reversal off the bottom for stocks was nothing more than a “dead cat bounce”, and we should expect more troubles ahead.  We are ever-so-cautiously assuming the former, at least as of this writing.

(4) There seems to be no end in sight for the record levels of stock buy-backs.  This certainly provides the market some level of protection, although to what extent has never been (nor could it be) proven.  At the very least, it provides some level of demand for stocks.

It is for all of these reasons that our outlook is cautiously optimistic for both stocks and bonds in 2019.  We predict that the Fed will follow through on their more dovish comments of late, and keep interest rates in check.  That will keep the “free-money party” rocking for stocks – and buy-backs coupled with a resolution to trade disputes with China will serve as reinforcement booze that might just turn this thing into an all-out rage.

Our specific “predictions” – as always made under protest and accompanied by the coin-flipping analysis for integrity:

You can officially put us in the camp pulling for the coin to be right...

We should note that our use of the word “cautious” above pertains more to the conviction of our stance, rather than the potential strength of the moves.  If we are correct in all of our assumptions above, it would be more than plausible – maybe even likely – that stocks could have an exceptionally good year.  It would be tough to sell the same for bonds, mainly because yields are so low to begin with.

So why are we so cautious in our stance, and why do we remain to adamantly opposed to short-term predictions and those who make them?  Why do we prefer to lay out possible scenarios rather than specific predictions?  Let’s review the main items that went into our outlook:

(1) We cannot possibly know for sure how the Fed will ultimately act in 2019.  Therefor, basing a prediction based on the Fed is an educated guess at best.

(2) As shown in our discussion on the technicals, one could easily make a case for or against both stocks and bonds – especially when you consider the timeframe being analyzed.  Add to that the fact that the same charts are showing that we may be at or near “breaking points”, either higher or lower.  Anyone asserting that concrete conclusions should be drawn from this information is fooling themselves and anyone choosing to listen.

(3) We then have trade wars, geopolitical tension, political turmoil, as well as countless other opportunities or threats – any of which could ultimately decide the fate of stocks and bonds during the course of the year.

We don’t have the answer to these questions in advance.  Neither does Jim Cramer or any other talking head out there.  Even if we did, we still couldn’t tell you with any sort of confidence exactly how markets would react.  Yet many investors read or hear analyses such as this and take away from it just one thing – “so and so said markets would do xxx this year”.  These predictions are silly at best, and very dangerous at worst – to the extent that one actually acts on them.  Digressing one final time.

While cautiously optimistic as described above, we certainly do not view 2019 as without risk.  Equity valuations remain lofty using many different metrics, even after the declines of last winter.  We still have a queasy feeling in our guts concerning the drastic movement in 10-year treasury rates – especially when combined with the “technical crossroads” discussed.  If our optimism ultimately proves incorrect – and we re-test or break through recent lows - we will then focus on the 2150-2100 level on the S&P 500 as the next likely level of support.  We would likely – depending on other information available at the time - view this level as a good opportunity for adding equity exposure.  For now, let’s hope that our optimism proves correct and save further technical discussions for another update.

Finally, it is important to remember that this is a short-term outlook – 2019 to be specific.  Longer-term, we continue to view both Fed action (by choice, or if forced by inflation or other factors), political landscape and overall debt burdens as by far the biggest risks to markets.  Unfortunately, those risks are not small ones.  Worse yet, they seemingly grow larger by the day in the forms of additional debt we accrue, continued market / economic reliance on the Fed – and the stated agendas of the politicians seeking power going forward (as if the agendas of those already holding it aren’t bad enough).  Look for these issues to become even bigger parts of our commentary in the months ahead.

As always, we welcome and appreciate all questions or feedback.  Feel free to share with friends or family that might have an interest.  Most important, we want to wish you and your family an abundance of happiness and health in 2019!  

To all of our clients, we can never thank you enough for the trust and confidence you have placed in Round Hill Wealth Management. 

The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Statements of forecast are for informational purposes and are not guaranteed to occur.  Trends discussed are not guaranteed to continue in the future.

All performance referenced is historical and is no guarantee of future results.  Investments mentioned may not be suitable for all investors.

Equity investing involves risk, including loss of principal.  No strategy – including tactical allocation strategies - assures success or protects against loss.

Value investments can perform differently from the market as a whole.  They can remain undervalued by the market for long periods of time.  There is no guarantee that any investment will return to former valuation levels.

Bonds are subject to market and interest rate risk if sold prior to maturity.  Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. 

Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through HighPoint Advisor Group, LLC, a registered investment advisor.  HighPoint Advisor Group, LLC and Round Hill Wealth Management are separate entities from LPL Financial.