February 18

What does victory look like?

By David Nelson, CFA

Another very strong week for stocks on the heels of comments from the White House and China that trade negotiations are going well. This puts us right up to the break-out point and triple top established during the October – November time frame. In addition, a reverse head and shoulders pattern is developing adding fuel to the excitement of technicians.

spx reverse head and shoulders

In the end, charts are helpful and can give us some lines in the sand but for the most part they are better at telling us where we’ve been rather than where we are going. The combination of technical analysis and fundamentals offers the best chance at success. Either on their own are limited in scope.

We still have repair work to do on estimate revision. Perhaps a positive outcome on trade talks will force analysts to lift their outlook for the remainder of 2019. FactSet data puts current consensus at $169 for the S&P 500. That’s down slightly from the end of last month and off about 5% from the September highs. Not the end of the world but obviously in the wrong direction.

Q1 est rev

Echoes of the concern show up in many of the Q4 releases. Guidance for the first quarter of 2019 is skewed to the downside. Again, according to FactSet data, of the companies that have issued guidance for the first quarter, 76% have lowered expectations. Albeit, 59 companies out of 500 are a small sample size but enough to meaningfully suggest the quarter is a challenge.

There’s no shortage of reasons to explain the shortfall. The ongoing trade war with China, a dysfunctional Washington and late cycle economics would top anyone’s list but for me #1 with a bullet is slowing growth overseas.

economic outlook germany

Germany narrowly missed a recession coming in with flat Q4 GDP following a slight negative GDP in the third quarter. Recent PMI data with a reading under 50 confirms China’s manufacturing sector is in economic contraction and BREXIT looms for both the EU and Britain

For most, the S&P 500 is the benchmark of choice. It’s of course market cap weighted, dominated by some of the largest multi-nationals on the planet. Amazon (AMZN), Microsoft (MSFT), Apple (AAPL) and Alphabet (GOOGL) all delivered Q4 earnings that were a disappointment from expectations just a few months ago. Apple managed to step over their self-imposed lowered bar having pre-announced negatively at the start of the year.

Spx international
About 38% of revenue for companies in the S&P 500 are derived internationally. Ultimately, these countries represent a huge part of the customer base. I think it’s safe to say if their economic output slows eventually it hits the top and bottom line of companies here, especially those at the top of the food chain.

Sector Revenue Breakdown
Sector ref breakdown

The geosynchronous growth that became the rallying cry of market bulls 18 months ago has been replaced with the United States is the best house on a bad block. 

So just how important are the trade talks?
Trump xi flags

From a sentiment perspective huge. In terms of economic impact, very important but likely less than forecast. Look, no one expects a deal signed, sealed and delivered by the March 1 deadline. The best we can hope for is an outline and an agreement to extend the dialog. I’m convinced President Xi will offer a lot to help close, maybe even eliminate the trade gap between the two nations. Just how far he will move on the forced transfer of intellectual property remains to be seen.

Certainly, both sides need and want a deal. With 2020 just around the corner a political win would be an advantage for the President. For Xi, the need to shore up what is rapidly becoming an economic albatross is re-enforced with each economic release. Both sides need to be able to sell this as a win. The question that looms: What does victory look like?

*At the time of this article some funds managed by the author were long Amazon