The Great Rally of 2019: Addition by Subtraction

January 20, 2018


Welcome, friends, to the show that never ends (but probably will anyway). Early in the cycle though it may be, I believe it’s time to throw a “rager” in celebration of the fabulous performance thus far generated by our favorite domestic equity indices.


So grab yourselves a brew and a slice (or if you prefer, some caviar and stronger waters), and raise your glass to our collective success. Through 13 skinny sessions this year, our Gallant 500 have thrown up an annualized gain of 263%. And, get this, the SPX’s half-a-league, half-a-league, half-a-league onward returns pale in comparison to those of other intrepid comrades, most notably Captain Naz (annualizing at 308%), and the stone cold biggest baller of them all: Ensign Russ (582%). Gentlemen, we salute you.


Yup, it’s been quite a run – not only thus far this year, but in fact since before the yuletide. Specifically, and while most of you are not likely to remember that far back, if we set our starting point to the close of that wretched Christmas Eve half session, the numbers are even more astonishing. From that point, the SPX return has annualized 543%, the NDX 670%, and the Russell 2000 a chunky 892%.


If investors keep buying them at this pace, 2019 will indeed be one heck of a year. But let’s cast our eyes back to that putrid Christmas Eve session, and let me ask you, with respect to the gaudy performance numbers inventoried above, who had the over? Well, I most certainly did not. In fact, as I was cooling my heels at my mother-in-law’s on the afternoon of December 24th, I was a’fearing we might be headed for an all-out crash. I’m not particularly proud of this, but as a scribe operating in a world where journalistic standards of adhesion to the truth are climbing to previously unimaginable thresholds, I feel honor-bound to record this history as it actually transpired.


Besides, I published the fears I had at the time far and wide, so, as a practical matter, there’s no escaping the historical record as to the divergence of my concerns from the pricing action that followed.


On the other hand, as I repeatedly remind myself and my readers, even a stopped clock is wrong 23 hours, 59 minutes and 58 seconds of each day, so there’s that. And now there’s nothing left to do but try to unpack what has happened, why it happened, and what may happen as a result. Moreover, at the risk of playing spoiler to my own article, I find that, while, at best, the pace of the rally is likely to slow considerably, some of the positive reversal has indeed been justified by subsequent events.


If I haven’t already lost you, let’s contextualize this by winding the clock back even further, all the way to mid-Summer ’18. During that time period, so I remind myself (perhaps as a balm to my bruised, soothsaying wounds) I correctly called for a big spike in volatility over the final trimester of the year. My justification for doing so was the myriad risk-enhancing catalysts that the global capital economy was confronting, including, in no particular order, a potentially investor-hostile mid-term election outcome, a burgeoning international trade war, an intransigently hawkish Fed, Brexit, a slowing global economic paradigm, a decelerating earnings outlook, etc.


I felt that, at best, many of these events could induce investors to pause for a moment of reflection, and might, in various combination, cause this here sweet 10-year rally to turn tits up at last. Well, we all know what happened after that. Market volatility did indeed accelerate like a particle collider, and most of the action was on the downside (something I did not predict). Nonetheless, and as I anticipated, the risk premium rose dramatically, implying that the cost of holding risk assets had increased, and inducing the more reserved among us to engage in some serious divestiture.

But knocking these off in chronological order, many of the risk-generating hazards that most vexed me have played themselves out in -- if not in bliss-inducing ways, then at least in non-fatal ones. The election produced a split legislature, which has historically been a fairly favorable environment for securities. The Fed has spun itself around like a whirling dervish, but, presumably having been chastened by the market’s reaction to its 12/20 hawkish hike, has placed itself on ice in terms of its ability to aggressively normalize rates and reduce its balance sheet. With respect to the latter, the same can be said of other Central Banks, as, over the last several weeks, the aggregate holdings of these entities has reversed dramatically to the upside:

Much of this reinvestment is owing to Chinese purchases of their own paper, and appears to be part of a broader initiative to inject multiple forms of stimulus into their gravitationally challenged economy. They’re likely to take incremental stimulative action from here, and, while purists may quibble, as for me, I’ll take it. With a visibility range of 0.0000%, the pundits nonetheless all agree that the numbers coming from China are looking weaker by the day, and, if the ruling cabal wants to use its unlimited powers, to reverse this trend, they have my blessing to do so.


Likely for similar reasons, the trade dialogue between the Chinese and the Americans has been almost unilaterally amorous in recent days.


So, we entered 2019, with reduction (call it subtraction) of the risk premium, and this, I believe, more than anything else, has catalyzed the maligned-in-this-space-but-ensuing-to-this-day V bottom, the back half of which began on Boxing Day, 2018. The market, I thus posit, is adding valuation by subtracting elements of risk concern that no longer seem as dire as they did a few weeks ago.


Obviously, we’re not out of the woods quite yet, but all we can do is knock off these risk annoyances one at a time.  This past week, like a lot of folks, I was paying close attention to bank earnings, not only due to my perpetual, obsessive hope that bankers receive the largest bonuses that humankind can bestow upon them, but also for signs often found in those realms of accelerating problems in the broader economy. Well, it was hardly a blowout quarter; in fact, on the whole, it can only be described as a disappointment. By all accounts, the big dog trading desks were caught sideways on more than one occasion during Q4, but deal flow and loan growth held up acceptably, and, on the whole, there was nothing that any of them said that indicated a dropping off of the bottom of the great financial engines of the domestic economy. I therefore subtract, at least for the time being, the world of U.S.-based international finance as an outsize risk factor.


But the earnings season has barely begun, and the early returns fall well-short of divine status. By all accounts, it looks like Q4 will hit the 10% year-over-year bogie, but not by much. Moreover, the broad consensus is that the extended, magnificent profit run of U.S. corporations may have peaked out. As suggested in the following chart (purloined, in accordance with time-honored tradition from the folks at Factset), guidance for the next two quarters has dropped in a manner not seen since Paulson was begging Pelosi to bail out his former partners and colleagues:


Anyone with the intestinal fortitude to extrapolate these numbers forward is bound to conclude that the NDX is unlikely to rally the full > 300% which it now projects, but I don’t know that it makes much sense to worry our little heads off just yet on that score. My strong sense is that we’ll learn a great deal in the waning days of January, when our betters: the leaders of Apple, Facebook, Amazon, Google, Microsoft, etc. take to the podium.


And when this transpires, I will be looking at the results through my thematic “addition by subtraction” lens. We should learn a great deal about how the economy is holding up by reading between the lines of business service flows at AMZN, GOOG, and MSFT in particular. If they continue to sell cloud services at heavenly clips, we can cross off another item currently prominent on our risk premium balance sheets. Alternatively, if the cloud outlook across the cloud is cloudy, it may again be time to worry.


Lord knows what February will bring. The reporting arm of the Federal Government may well still be shut down, but I’m fairly confident that the earnings cycle will continue on schedule (whether or not Pux Phil sees his shadow, I won’t hazard to speculate). But one way or another, March (not by a long shot my favorite month on the Julian Calendar) is certain to be a barn burner. It begins, as the fates would have it, with another episode (no one, somehow, can say for certain the date) of that great borrowing engine otherwise known as the United States Treasury Department hitting its statutory ceiling for debt issuance. Particularly if the current funding impasse has remains unresolved, this, of course, would be as good a time as any for the Thunder-dome showdown between Maxine (Mad Max) Waters and Donald (Nightrider) Trump (still, at the point of publication, President of the United States) to enter its final, fatal round. Two (wo)men enter, one (wo)man leaves, may not be the precise outcome, but you never know.


March 1 is also the pre-announced deadline for imposing 25% tariffs on hundreds of billions of goods imported from China. It’s hardly worth typing, but if that happens, look out below. If there’s a deal, though, then the biggest risk premium contributor on my list will vaporize exquisitely.


I remain worried also about the default implications of a hard selloff in the energy complex. And, as March performs its ritual “lion-to-lamb” transformation, we’ll be faced with a moment of truth respecting the Brexit Battle. March 29th is the date upon which Article 50 of the European Union Constitution calls for the Brits to exit, stage left (pursued by a bear?).  I have absolutely no idea how this plays out or what it means. Besides, we’re running out of space and bandwidth on l’affaires des risqué, and I’ll leave off by stating my continued belief that the big risks of 2019 are concentrated, with these events, in Q1.


In the meantime, I hope you’ve enjoyed the party thus far, but as any polite guest is well-aware, the timing of a departure from a celebration is as important as that of an entrance.  This, my friends, was never my strong suit, but it may be time to wind things down. It’s been a grand old time thus far, but the likelihood of indices continuing to annualize into the fat triple digits, is, in my judgment, slim. Moreover, if you find yourself the last partaker of the punchbowl, if you see your hostess lifting your feet from the floor next to the couch on which your slouching so she can run the vacuum, if the rice remaining on the sushi plate evidences discoloration, you’ve probably overstayed your welcome.


But we’re better than this, people! So, in closing, I suggest you don’t let your subtraction from this here wingding be viewed as an addition by your fellows, who will be only too glad to rest up and take your abandoned spot when the next party commences in earnest.




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