The Market: May 2019

The stock market is gripped once again by the US-China trade negotiations.  The US has upped the ante by increasing tariffs on $200 billion of goods imported from China.  President Trump has threatened to expand the list.  China has retaliated and could consider other measures.  It may well be that the threats and negotiations will go on longer than most have been expecting.  At this point, it is unclear what a win looks like to either side.  While most believe it is in the best interest of both countries to get a deal done as quickly as possible, the two sides may not be able to deliver.  The markets have been down in response to the escalating trade tensions but this is after the market hit fresh highs. It seems that the trade issue will hang over the market, dampening any good news.  Earnings for the 1st quarter came in better than most feared.  According to FactSet, with 90% of S&P500 companies reporting, 76% of S&P500 firms beat their earnings estimates and 59% reported positive revenue surprises.  The markets are a game of expectations. The earnings beats drove stock prices higher but it is important to note that earnings were actually down 0.5% when compared to the same period last year. This is the first decline in earnings since the 2nd quarter of 2016.  Analysts forecasted that earnings would be down 4% from a year ago.  Being less bad than expected is good. The S&P500 trades at 16.5 times earnings which are about the average for the past five years. The market is not cheap but also is not extremely overvalued, especially considering interest rates are so low.  The earnings picture for the second quarter isn’t shaping up to be great.  Sixty-five of the 500 companies have offered lower profit guidance versus just 17 companies guiding higher.  This makes the trade issue more concerning. It’s one thing to introduce some profit uncertainty when earnings are rising.  It’s another when earnings are soft.  While 16.5 times earnings are within the market’s recent average, if the earnings component to the calculation declines, the price-to-earnings ratio will increase, adding to the precariousness of the market.  I would suggest that investors today need to be more cautious than in the past because computer algorithms can take hold and sell programs can be triggered.  As we have seen in today’s market structure, without an uptick rule or market-making specialists, selling can become relentless.  This is what happened in the 4th quarter of 2018.  With computer-driven trading taking up an ever-larger portion of daily volume, it seems like the markets move around in the short-run irrespective of the fundamentals. Despite the fierce ups and downs, the stock market has not really gone anywhere in 15 months.  Investors need a robust portfolio with quality growth, value and cash reserves to withstand the downdrafts, to take advantage of buying opportunities and to participate in the upswings. — Ian Green, Pendragon Capital Management

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