Author: Randy Watts

Key points:

• The S&P 500 has risen ~22% over a two-year period, roughly in line with total earnings growth over that time.
• The generic expectation for S&P gains this year could be seen as roughly in line with expected mid-to-high single digit earnings growth.
• We think multiple expansion is more unlikely, but higher gains could come from a pickup in growth.
• The signs of a pickup are not yet here however. In fact, the opposite is true, as is evidenced by the value/cyclical/small-cap outperformance (versus large growth) and international market outperformance (versus the U.S.) which is already starting to wane after just one quarter.
  • Growth has quickly resumed its leadership role. While this is welcome for our strategy and we see plenty of names to buy (Technology, Health Care, Payments, etc.), it is unlike prior market recoveries/breakouts in 2012–2013 and 2016–2017, where value/cyclical/small cap/international led for several quarters.

Key points:

Global markets end the year on solid footing. Historically, years with similar annual gains are typically positive the next year.
The value/cyclical trade is global in nature but likely does not have legs for longer than a quarter or two more.
The broadening into value, confirmed by high breakout totals in the U.S. and developed markets, is a positive nonetheless.
There is risk in continued U.S. earnings deceleration and in the lack of a global growth recovery.
The U.S. is our favored developed market and will remain so until signals from its relative performance tells us differently.
The U.S. presidential cycle heavily favors third years ( 2019 ), with fourth years still being positive, but more moderately so.
After an annual gain of 20% or more, the following year is up 8% on aver­age and is positive two-thirds of the time.
Sectors with biggest potential: Energy ( catchup ), Health Care ( combined 2019/2020 growth and catchu p), Technology/Financial ( 5G, semis, soft­ware, payments, financial services ).
Europe and Japan ( near 25-year highs ) also have very favorable trends. Hong Kong has im­proved but remains riskier.
Top themes: luxury goods, multi-channel/specialty retail, outsourcing, health care ( pharma, supplies, systems/equip ), alt energy, semis/equip.
Emerging markets had a more mixed year, but large markets now generally have positive trends. Favored markets include Brazil, China ( A-Shares ), Taiwan, and India.
U.S. dollar weakness would be a welcome boost.
Recent South Korea/South Africa participation adds fuel.
Top themes: financials, consumer products, health service, semis/equip.

Key points:

• The deceleration of median sales and earnings growth for S&P 500 companies abated, as growth equaled that of Q2.
• Sales growth of 4% and EPS growth of 6% matched the lowest totals since Q2 2016 and Q1 2016, respectively.
• Versus an EPS bar that was lowered significantly coming into the quarter, companies beat by a median of 3%, which has been typical of the past several years.
• Health Care was the clear large-cap standout, with best growth and beats and an acceleration in growth from Q2. Tech, Staples, and Cyclical were among the weakest.
• On valuation, a much lower 10-year yield supports higher stock valuations, and as long as earnings remain positive, the market should move higher. However, Q4 earnings estimates are still being lowered, notably for small caps, meaning we are not at a clear bottom yet.
• Similar to the corrections of 2011–2012 and 2015–2016, sector rotation has favored small-cap, value, cyclical, and industrial initially (and coincided with ~1.5% 10-year yield).
  • Because of this our Focus List count has not increased much since October’s bottom. This should change if the rally persists and/or accelerates.

Key Points:

• A very strong first 10 months of the year has led to better-than-average returns in November/December.
  • Since 1900, in 33 years when the DJIA has gained 15%+ in the first 10 months of the year, November averages a 2.7% gain and December averages a 2.2% gain. This is much better than the November and December averages of 0.4% and 0.8%, respectively, in all other years.
• A very strong annual gain, however, does not lead to better or worse average returns the following year.
  • Since 1900, in 34 years of a 20% DJIA annual gain, the following year averages a 7% gain, versus an 8% gain for all other years.
• The current market leg on the DJIA of 8% is still well below the bull market average up leg of 14% and median of 11%.
• The current shift of styles to value outperformance is similar to the conclusion of the 2011–2012 and 2015–2016 corrections. In those cases, it persisted for 2–3 quarters before fading.

Key Points:

• Median 4% sales and 3% EPS growth expected for S&P 500. 3% sales and -2% EPS for S&P 600.
  • Fourth quarter of median earnings deceleration for the S&P 500 expected. Sales expected flat from last two quarters, which matches lowest in seven quarters.
• Notably, the trend of lower estimates has been happening for several quarters and is not abating. Since May, S&P 500 Q3/Q4 2019 and Q1/Q2 2020 estimates have all come down substantially. This is true even after a 3% earnings beat in Q2. But, full-year 2020 numbers (black line) have not come down much. This likely means a further revision lower is necessary.

Key Points:

Technically, the overall commodity complex remains very weak. The Invesco DB Commodity Index is nearly 20% off 52-week highs, well below both the 10- and 40-WMA. In addition, it has undercut the May lows suggesting further downside risk. There is support at the December 2018 lows. A retest of that level is possible as most commodities outside of precious metals ( majority of index weighting ) are trending lower.

Marked divergence within the space, as commodities related to agricultural consumption and most related to industrial production are very weak, while precious metals are trending higher.

We will be watching for some consolidation near highs in the leading precious metal groups and, conversely, weak bounces from lows in the other lagging commodity groups for new opportunities to play the inverse trends.

See attachment for stocks of interest in both best and worst groups.

Key Points:

S&P 500 gain of 4% and NDQC gain of 6% since the follow-through day (six weeks) compare favorably to historical gains after a correction (overall median is 3% after four weeks and 5% after eight weeks).

Looking at examples where the S&P 500 was up more than 3% after four weeks, we see it leads to better-than-normal 13-week performance. 

In nine instances, the median 13-week gain is 7%, versus a median gain of 4% for the other nine.

Sector-wise, expect more divergence from here. In those nine instances, the 13-week sector spread from best-to-worst averages +20%. Currently, it is only at 5%.

Long-term outperforming sectors like Retail, Health Care, and Staple have historically started better after a follow-through day but trailed off after the first eight weeks. Cyclical and commodity sectors have finished the strongest over the last five weeks.