Earlier this week, I described the 4 Major Fears eating at the insides of this market -- and why it was setting up a huge buying opportunity.
Since then, Apple's warning and a big ISM Manufacturing miss delivered a tag-team blow to the emerging bounce off of S&P 2350 -- the site of a 20% correction for the US benchmark.
Lump those reveals under two of my "major fears," namely, Growth Peak and Trade Angst.
And just when it looked like stocks would head back down to test the lows -- as if investors were running for the hills on full-blown recession hysteria -- on Friday morning we heard some important words of flexibility from Fed Chair Jay Powell.
So is the correction finally over? Or should we listen to the bears and get ready for another 10-20% downside, since the average bear market/recession scenario produces a 35% swoon?
Or, as I have suggested, has this just been a gigantic overreaction destined to correct itself upward when money managers realize the error of their panic and come swooping in for bargains all around?
Let's look at 3 things that need to happen this month to establish a market low we can live with, and profit from, for the next 6-12 months...
1) US Growth Saves the World
We know that Q4 economic growth will slow from its hot pace of over 3.5% in Q3, but by how much? The peak in growth has definitely been evident in one pulse of the world's largest consumer economy: housing.
Sales of new single-family houses in October were about 9% below September and 12% below the October 2017 seasonally adjusted annual rate of 618,000. We saw this growth peak begin to show up in the housing stocks first this summer as they continued a steady decline, unable to move higher with the broader market.
And Thursday we got a big current read on growth expectations from the ISM manufacturing index which not only dropped 5 points to 54.1, but missed expectations by the most since January of 2014.
Granted, this data is a survey of purchasing manager sentiment about their economic outlook and activity, so it can have behavioral and emotional volatility -- especially after the S&P 500 dropped 15% in the first 15 trading days of December up to Christmas Eve. And at 54, it's still in expansion territory.
The crucial question here is this: are expectations "catching down" to how much of a slowdown is in the works? Some finally are. Two months ago, Goldman Sachs chief equity strategist David Kostin thought that the October market correction was an overreaction with the ISM so strong near 60. Last weekend, before this latest plunge, the bank lowered their GDP forecast for 2019 to under 2%.
Bottom line: If institutional investors are waking up and smelling the coffee here, they will also be lowering their 2019 earnings estimates from overly-optimistic 9% growth to something more in line with 2% GDP growth. And that should put a panic bottom in stocks this month or next, depending on our next two criteria. Overall, US stocks will remain the cleanest investing landscape in a messy global picture and I want to buy that panic.
Continue reading . . .
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2) The Fed Saves the Day
Large investors need to hear a message from the Federal Reserve this month that they are very cognizant of not only a growth slow-down here and abroad, but also the impacts of steadily tightening monetary policy on financial conditions. Interest rate-sensitive cyclical industries and credit markets have already felt the squeeze of this tightening.
While a rate cut any time soon is out of the question, a "big pause" in the pace of hikes and a nod toward flexibility about balance sheet liquidation will be very welcome. When the Jay Powell Fed indicated last month that the current $50 billion in asset "run-off" (maturity without replacement) of Treasury bonds and MBS (mortgage-backed securities) was on "autopilot," investors reacted very negatively.
In Friday morning’s Powell chat with his old bosses Bernanke and Yellen, aided by great questions from a NYT reporter, he clarified his beliefs and signaled that the central bank will be "patient" in its approach to monetary policy and has “no preset path" for raising rates or adjusting the balance sheet.
This seems to have at least temporarily assuaged the fears of those who see him as an inflation hawk out to pop all bubbles. But Friday morning also brought very strong data on jobs and wage growth, which will keep pressure on the FOMC to raise rates no matter what the market thinks or bets. So we need to listen to other member speeches and interviews in the next few weeks to get a better feel for their outlook.
Our data-dependent Fed will also have a lot of it to look at this month, from housing and credit conditions to the start of earnings season which will reveal corporate results, sentiment, and outlooks about global trade and US economic health. They even get a first look at Q4 GDP on the morning before their next official statement and Powell's press conference Jan 30.
Bottom line: The messaging before the next 2-day Fed-fest is really what counts here. The market needs to know the Fed "gets it" and soon. Anymore uncertainty headed into that event will put more pressure on stocks. Which will continue to present fantastic opportunities for both long-term investors and shorter-term volatility fans.
3) Credit Markets Save the Hysteria
As high-yield credit spreads have "blown out" (widened) by a significant margin, companies in need of financing for operations or to roll existing debt have been hampered, if not shut out. A credit spread is the difference in yield between two bonds or notes of similar maturity but different credit quality.
And as I discussed earlier this week, tightening financial conditions that lead to financial market stress fractures can often be the leading indicators, if not the tipping points, for an economic recession.
The negative feedback loop here, of course, is that falling stocks lead to tighter financial conditions, more worry, less risk-taking and lending, and ultimately further negative pressure on equities. This is the kind of financial contraction that invites the "R" word.
While some "bond kings" are worried over what this vicious cycle is telling us about the end of the economic expansion, many other big quantitative managers like Robert Michele, chief investment officer and global head of fixed income at JPMorgan Asset Management, believe that the Fed already "gets it" and will not hike rates at all in the first half of the year.
Bottom line: Investors recognizing that the Fed's Dec 19 Dot-Plot is not a policy prescription -- as much as a guesstimate based on old data -- will take the pressure off of credit spreads as the rest of the market gets it. And while stocks and growth estimates may fall a bit further, the combination of any two of these fears stabilizing will inevitably turn the third component.
Why This Correction is Different
Together, these three "saves" will provide greater visibility to see past the uncertain impacts of trade policy and negotiations.
But as it still evolves, the speed and magnitude of this stock market correction would lead any reasonable observer to think a recession must surely be on the way. And yet the economy slowing from 3% to 2% growth does not a recession make.
So what gives? If it's so rare for a 20%+ correction to not coincide with an economic downturn -- and foretell a stock market wipeout of 35% or greater -- how can I be so sure we come out of this soon?
While I can't guarantee these "saves" happen, what I can do is describe how every cycle is unique. We are coming off of an unprecedented monetary experiment after the last financial crisis.
And coming off of that QE-driven reflation of economic activity and assets, stock market participants experienced complacency which turned to panic.
They ran, and are still running, for the exits because they are sure there's a fire. But the only things really up in flames are their portfolios. Maybe this has created what is commonly called a "cyclical bear market" without a recession.
But odds are, it has also created one of the best buying opportunities in years, with 25% upside in the S&P 500 index, and hundreds of individual stocks that will clobber that potential -- especially as cash balances among money managers have risen dramatically and won't all go into bonds.
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Kevin, Senior Stock Strategist at Zacks, is a leading expert in biotech and medical stocks. He provides commentary and recommendations for Zacks' investment portfolio, Healthcare Innovators.
¹ The results for the companies listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors.