On November 27th, 2018, we introduced the Wheel of FORTUNE's end of 2018 mega poll and invited everyone to spin the wheel with us.
In this poll, we asked participants to predict (guess or assess) the closing levels, on January 11th, 2019, of four of the most important gauges in the capital markets:
- S&P 500 Index (SPY, VOO), the main benchmark for stocks, both in the US (DIA, QQQ, IWM, IVV, VTI) as well as worldwide (VEA, EFA, IEFA, VWO)
- US Treasury ("UST") 10-Year Yield (TLT, AGG), the main benchmark for all kinds of credits, be it the safer Investment Grade ("IG"; BND, LQD, BSV,TIP, VCSH, VCIT, SHV, SHY, SPTL, VGLT, IEF) or the riskier High Yield("HY";BSJJ, SHYG, SJNK, SRLN, HYS, FTSL, BKLN, HYG, HYLB, HYLS, JNK) bonds.
- EUR/USD, the most-liquid pair among all currencies/cash instruments, involving the US Dollar (UUP) on one hand and the Euro (FXE) on the other hand.
- Crude Oil WTI (USO, OIL), the most-watched raw material among all types of commodities (DBC, GSG).
Many thought to themselves that only four questions and only 24 days (from 12/18/2018 to 1/11/2019, inclusive) of forward-looking are relatively easy requirements. Anyone who thought so a month ago was clearly and completely wrong.
In this article, we will touch upon each of the four gauges. Not only what they have done over the past month but also what they might be doing in 2019. Participants in the mega poll were required to look 24 calendar days ahead? We will try to look 240 trading days, into the future!
S&P 500 (SPY, VOO)
Performance between 1/18/2018 to 1/11/2019 (inclusive):
|12/18/2018 - closing price ("Start")||2,546.16|
|Lowest level between 1/18/2018 to 1/11/2019 ("Low")||2,346.58|
|Highest level between 1/18/2018 to 1/11/2019 ("High)||2,597.82|
|1/11/2019 - closing price ("End")||2,596.26|
|Performance: End / Start||1.97%|
|Volatility: High / Low (Low / High)||11.07% (9.67%)|
Observation Regarding this Period
This was an extremely volatile period for the S&P 500 (^SPX), and the SPDR® S&P 500 ETF (SPY), especially the first half of it.
During the 24 calendar days, there were only 16 trading days. Nevertheless, this was enough to move the market within a double-digit percentage range. The 11% gap between the highest to the lowest level during these 16 days is nothing short of stunning.
Moreover, out of those 16 trading days, no less than 7 (or 43.75%) ended with a move (based on closing prices) greater than 1.5% (in absolute terms). Here, they are (in a descending order): 4.96%, 3.43%, -2.71%, -2.48%, -2.06%, -1.58%, -1.54%.
Such a high volatility makes it extremely difficult to come up with a logical prediction, Indeed, as you can see below, this was the toughest of all four questions.
Poll Results - S&P 500
Only 8% of respondents gave an accurate prediction regarding the closing level of the S&P 500 on January 11th, 2019. That is the lowest percentage of respondents providing an accurate answer to any of the four questions.
Only 36% of respondents in total received points for providing an answer that falls within the top (most accurate) five answers. That is also the lowest percentage of respondents receiving points (for the best/closest five answers) out of all four questions.
Our Prediction for the S&P 500 Index at the End of 2019
In case you've missed it, 2018 saw the fifth largest decline in P/E ratio since 1946! On its face, that supposes to be good news, as valuations dropped dramatically to reasonable, if not attractive, levels.
Another good news comes from earnings.
It took companies 10 years to record higher earnings per share than they posted prior to the Great Financial Crisis. Late cycle earnings have pushed decisively higher, a trend that is likely to persist in the near term.
The bad news is that when I say "near term", I refer to the first half, if not quarter, of 2019. Beyond that, this late cycle upward trend may reverse, quickly and sharply, as the tax reform effects fade away and the slowing growth starts leaving marks on companies' results.
European (VGK, EZU, HEDJ, FEZ) equities have seen a massive devaluation in recent years, cutting the P/E ratio almost in half from almost 29 to just over 15 now. For the first time in years, European equities look cheap, if major economic shocks are avoided.
That's a very big "if", and we look more deeply into it hereinafter, under the EUR/USD section.
Emerging markets ("EM") equities (VWO, IEMG, EEM) could also make a comeback in 2019, mainly on the heels of a possibly weaker US Dollar (UUP) and a more dovish Fed.
Back to the US...
When we look at the ISM Manufacturing Index vs. the S&P 500 Index Performance, we are quite optimistic (at least short-term), because the below chart means that i) the ISM is likely to fall further in coming months (to close the gap with the S&P 500, down), and (even if the ISM moves down) ii) stocks prices will go up (to close the gap with the ISM, up).
Clearly, the S&P 500 Index has discounted a very significant close-to-recession-like slowdown. As such, any sign/"evidence" (whatever that can be...) that a recession is likely to be avoided should push stock prices up.
Sources say (to Fox Business) that President Trump's Attorney General William Barr is likely to focus on tech (XLK) companies as part of his antitrust enforcement. He is allegedly worried about the size of tech giants stifling competition, thus planning more scrutiny of Facebook (FB), Alphabet-Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and even Apple (AAPL), that currently has plenty of other things to be more worried about. No wonder then, that officials from these, potentially affected, companies are more worried now about an increased antitrust oversight that might be coming their way, real soon.
This could potentially be a big deal for big tech in the next year or two. It's something Tim Wu of Columbia University has been talking about, among other things, recently.
Verdict: We are going to be a "Debbie Downer" here, expecting the S&P 500 to close 2019 at a lower level than even the most bearish analyst on Wall Street. Although we believe that the S&P 500 has a chance to trade >2800 along the year, we believe that it will finish the year below the current level (as I write) of 2,616.
US 10-Year Treasury Yield ("UST10Y"; TLT, AGG)
Performance between 1/18/2018 and 1/11/2019 (inclusive):
|12/18/2018 - closing price ("Start")||2.823%|
|Lowest level between 1/18/2018 to 1/11/2019 ("Low")||2.543%|
|Highest level between 1/18/2018 to 1/11/2019 ("High)||2.861%|
|1/11/2019 - closing price ("End")||2.699%|
|Volatility: High/Low (Low/High)||12.50% (11.11%)|
Observation Regarding this Period
Don't get confused/distracted by the relatively calm chart (above) that shows the iShares 20+ Year Treasury Bond ETF (TLT) climbing (only) 1.1%, and the 10 Year Treasury Rate (I:10YTR) losing (only) 3.9% of its yield.
The volatility of the UST10Y was even greater than that of the S&P 500 (SPY)! The difference between the highest level and the lowest level, during the 16 trading days, was 32 bps, the equivalent of a 12.5% decline in the benchmark yield.
Having said that, the move was so one-sided that pretty quickly our lowest, most bearish, if you'd like, possible answer (i.e. <2.90%) became a "must pick" and, admittedly, an easy pick.
Thing is, when we prepared/published the poll, in late November 2018, the UST10Y was trading around 3.07-3.08%. So, a "<2.90%" seemed like an extreme case for a 16 trading days period that falls on the holiday season - traditionally, a more quiet/sleepy, with less action, across the world's capital markets. Who would have thought (back on 11/27/2018) that 12/14/2018 will be the last day for the UST10Y to trade above the 2.90% mark?...
Naturally, this has given a (fair) advantage to those who participated in the poll at or close to the deadline, because, on 12/18/2018, the closing level of the UST10Y was already 2.823%, so it made perfect sense to choose the "<2.90%" answer.
Poll Results - UST10Y
Unsurprisingly, 26% of respondents gave an accurate prediction regarding the closing level of the UST10Y on January 11th, 2019. That is the highest percentage of respondents providing an accurate answer to any of the four questions. I wonder why... (No, not really...)
Surprisingly, only 46% of respondents in total received points for providing an answer that falls within the top (most accurate) five answers. Putting it differently, 54% of respondents expected (still expecting?) the UST10Y to reach 3.02%, or more, on 1/11/2019. 46% is the second-lowest percentage of respondents receiving points for any of the four questions.
Our Prediction for the UST10Y at the End of 2019
There are two magic words playing a major role in 2019 - slowdown and recession. While the former seems imminent, the latter might be avoided. Whether we see "just" a slowdown, or a fully-fledged recession will determine the fate of both stocks and bonds this year.
There's plenty of foreboding data about the direction of developed economies. The question is, how much of the slowdown has already been baked into the markets?
Back in September, analysts expected S&P 500 earnings to grow 17% in Q4 vs. a year earlier. Now, analyst estimates have fallen to only 11% growth, the steepest drop-off since 2017.
A few days ago, Jeff Gundlach expressed his worries that if growth slows, and stocks slump, US Treasury yields (IEF, GOVT, SCHR, VGIT, TIP, SHV, SHY, IEF, TLT) may actually rise, given the tsunami of debt that markets are facing. He thinks that the S&P 500 would need to fall 30% from its peak for the Fed to begin altering its balance sheet policy.
Gundlach also hinted at something many have been talking about over the past few years: The Fed doesn't see much inflation, but Americans' every-day expenses seem to be rising at a notable pace.
Meanwhile, US Hourly Earnings rose 3.2% over the past year - the largest increase of the current expansion cycle. Wage growth has outpaced core inflation Y/Y for 73 consecutive months - the longest streak ever.
Back to recession (talks)... The main question is: Who to believe???
On one hand, we have Ned Davis' global recession model that shows a staggering 92.11% chance that we are (already) in one.
On the other hand, the NY Fed Research probability of a US recession, twelve months ahead, based on the yield curve, is estimated at only 21%.
Deutsche Bank (DB) is also one of those seeing the danger of a US recession as early as this year. The German bank thinks that if the government shutdown continues it could speed up, and actually be the cause of, a recession.
Societe Generale (OTCPK:SCGLF, OTCPK:SCGLY) agrees with DB. The French, known to be bearish, bank sees a recession just around the corner. The reason is that, according to SocGen, the Fed has tightened much more than rates suggest. By how much more? SocGen estimates that QE suspension corresponds to an interest rate hike of 3%! Imagine that...
However, as a very friendly reminder, it's important to remember that recessions occur at various levels of valuations, and certainly not only when valuations are high!
Verdict: Recession or no recession - that is the question. Nevertheless, when it comes to the UST10Y we tend to agree with Gundlach, meaning that we are looking at high yields.
The mounting levels of debts - national, corporate, and student - are unsustainable and, sooner rather than later, are likely to take a toll. China, Japan, and Russia are already reducing their UST holdings, and we expect this trend to continue - and even accelerate - in 2019.
We also don't rule out another (inverse?) Operation Twist ("OT") that will see the Fed selling the long-end of the curve and buying the short-end of it. In our view, this is the best action that investors may get from the Fed. It's also a very reasonable move by the Fed, because it will allow them to kill three birds with one stone, i.e. twist:
- Steepening the yield-curve, thus eliminating the endless "will it fully invert" debate, something that (for itself) intensifies the talks about recession.
- Don't inflate the balance sheet. Since OT is advocating for the same amounts of the selling and buying, it's a zero sum game.
- Boosting the (slowing) economy, by reducing the short-term financing costs (buying the short-end of the curve = short-term rates being pushed down).
Another, non-official, benefit (for the Fed) is that an OT is likely to kill the need to hike rates further. If this is the case, not only investors will be happy, but even the Fed loudest critique - President Trump, will be happy.
All in all, we expect the UST10Y to move back above 3%, but we don't see a move above 4% (5% or 6%...) as Gundlach expects.
Euro ("EUR"; FXE)/US Dollar ("USD"; UUP)
Performance Between 1/18/2018 and 1/11/2019 (inclusive):
|12/18/2018 - closing price ("Start")||1.1361|
|Lowest level between 1/18/2018 to 1/11/2019 ("Low")||1.1325|
|Highest level between 1/18/2018 to 1/11/2019 ("High)||1.1572|
|1/11/2019 - closing price ("End")||1.1469|
|Volatility: High/Low (Low/High)||2.18% (2.13%)|
Observation Regarding this Period
The Euro to US Dollar Exchange Rate (I:EURUSD) was the least volatile of all four gauges, by far. Both the point-to-point, as well as the low-to-high, ranges were relatively small (about 1.5-2%). That's especially noticeable, in light of the high volatility that both stocks (SPY, DIA, QQQ, IWM, IVV, VTI, VOO, VEA, EFA, IEFA, VWO) and bonds (AGG, BND, LQD, BSV, TIP, VCSH, VCIT, SHV, EMB, SHY, IEF, TLT, HYG, JNK, AWF, BKLN) experienced during the relevant period.
While the Invesco DB US Dollar Bullish (UUP) fell by 2.3%, the Invesco CurrencyShares® Euro Currency (FXE) gained 0.8%, the combined move (3.1%) was more than twice as much as the actual move of the EURUSD pair.
Basically, the EURUSD only moved about 1 point from the initial closing price (1.1361) to the final closing price (1.1469), making this question the easiest of all four to deal with, overall.
Poll Results - EUR/USD
23% of respondents gave an accurate prediction regarding the closing level of the EURUSD on January 11th, 2019. That is the second-highest percentage of respondents providing an accurate answer to any of the four questions.
No less than 69% (or 7 out of 10) of respondents received points for providing an answer that falls within the top (most accurate) five answers. That is, by far, the highest percentage of respondents receiving points for any of the four questions.
Our Prediction for the EURUSD at the End of 2019
Central banks ("CBs") shifting from QE to QT was one of the biggest stories of 2018, and it remains so in 2019, if not intensifying. With the ECB moving to the sidelines as of 1/1/2019, net asset purchase of the three major CBs just turned negative, for the first time in ages.
Of course, over the short term, things can look much different, and indeed, over the past few weeks, we're seeing massive liquidity provided by three out of the four most influential CBs. With the exception of the Fed, the Bank of Japan (EWJ, DXJ), the ECB in Europe, and mainly the People Bank of China (MCHI, FXI) are all injecting money into their struggling economies.
If you ask yourself how/why did the markets make a sharp U-turn over such a short period of time - all you need to do is to follow the balance sheets of these CBs. The correlation to stock markets is particularly high.
Eurozone December inflation came in marginally lower than expected, mainly due to prices in France (EWQ) retreating more than expected. Y/Y Eurozone CPI dropped from 1.9% in November to 1.6% in December vs. 1.7% expected, while core CPI was in line at 1% Y/Y.
ECB inflation forecasts for 2019 are now looking a little too optimistic, to say the least, if not (completely) out of line.
Recall that the industrial output in the Euro area fell the most in almost three years, in November.
If, and that's a big "if", the ECB's inflation forecasts, that are still below its 2% target, would materialize, German bond yields would almost certainly have to rise. Care to bet which gauge is providing a more accurate prediction?...
Bank of America (BAC) analysts calculated that "the world has become $62 trillion more in debt since Lehman, and many of the new vulnerabilities and debt 'hot spots' reside now in Europe."
The below chart of debt-to-GDP ratios shows how leveraged some nations have become, especially among the developed economies.
Goldman Sachs (GS) expects slower growth and elevated political risk to widen spreads in France (EWQ) and Italy (EWI). Spain (EWP) and Portugal (PGAL) should outperform on a relative basis.
With ECB net asset purchases behind us, spreads on European sovereign debts are entering a much less favorable macro environment, something that is likely to weigh heavily on less competitive economies.
Speaking of less competitive economies...
Germany (EWG) remains competitive, even after the recent strong wage increases. German's Unit Labor Costs ("UNC") continue to lag behind those of other countries in the Euro area, as opposed to Italy's (EWI) UNC that demonstrates how far the boot country is from being competitive.
Taking into consideration the widening spreads, no more ECB lifeline, tons of debt that need to be refinanced, and a non-competitive economy, can someone please explain to me who is going to buy Italian debt?
Even in Germany, Europe's largest economy, economic data is implying that a recession isn't out of question. Perhaps a less conventional way to prove it, but when one American bank, JPMorgan (JPM) is making more money (33% more!) than all German banks, together, you know that something is awfully wrong out there.
Verdict: Normally, taking into consideration the European extremely weak economic data, we would predict that the Euro is on its way to parity with the USD. Although we don't rule out the possibility that we will have another leg down, bringing the pair closer to 1.10 - we are actually seeing the EURUSD ending 2019 above 1.20!
Why so? Mainly due to three reasons:
1. The bad news of Europe is already baked in. Those coming (in the future) out of the US aren't.
2. Unless the ECB making a U-turn (also something we can't rule out...), the end of QE in Europe is a big deal that hasn't yet sank in fully.
3. Be it an OT, or something else, we believe that the Fed at the end of 2019 will be a much more dovish Fed than it's at the beginning of 2018. As such, investors with USD long positions might get spooked along the way.
Crude Oil WTI (USO)
Performance Between 1/18/2018 and 1/11/2019 (inclusive):
|12/18/2018 - closing price ("Start")||46.24|
|Lowest level between 1/18/2018 to 1/11/2019 ("Low")||42.36|
|Highest level between 1/18/2018 to 1/11/2019 ("High)||53.31|
|1/11/2019 - closing price ("End")||51.59|
|Volatility: High/Low (Low/High)||25.85% (20.54%)|
Observation Regarding this Period
The most volatile, but not the most difficult to predict, of them all.
Oil prices were all over the place between 12/18/2018 and 1/11/2019, posting a staggering range of circa 26% (!), when measuring the move from the lowest (42.36) to the highest (53.31) level.
Prices of WTI Crude Oil Spot Price (I:WTICOSNK) and United States Oil (USO) almost halved, from their peak in early October to their trough in late December. Only 11 weeks were needed to completely erase gains of 16 months.
Poll Results - Crude Oil
Only 15% of respondents gave accurate predictions regarding the closing level of the S&P 500 on January 11th, 2019. That is the second-lowest percentage of respondents providing an accurate answer to any of the four questions.
Contrary to that (low percentage) 59% (or 6 out of 10) of respondents received points for providing an answer that falls within the top (most accurate) five answers. That is the second-highest percentage of respondents receiving points for any of the four questions.
Our Prediction for Crude Oil at the End of 2019
American oil production climbed to a new record high last week. As a result, oil retreated to near $52/bbl as investors reassessed the surging US production against output curbs pledged by some of the world’s top suppliers.
To put the US production boom in perspective, the Permian shale play alone is set to pump more oil than the U.A.E. this month. While Gulf coast refineries can't process the crude, Asian ones can. The US is, therefore, working on ways to get it there.
As you can see from the below chart, energy (XLE) stocks are not only under-performing the overall market by a mile but they also lost touch with oil prices. This divergence, which started three years ago, "refuses" to fade away.
What does this tell us? Either oil prices are set to decline further, or energy stocks need to rise. We tend to think it's the latter, because oil prices are already quite depressed and are unlikely to move back under $30/bbl to justify energy stocks low valuations.
Earlier this week, Goldman Sachs cut its oil price forecasts for 2019 to an average of $62.50, from a prior estimate of $70. The bank is citing a re-emerging surplus and resilient US shale production as the main reasons.
So, it seems like everybody talk about oversupply, especially from the US end. However, it's important to pay attention to OPEC that slowly but surely is keeping up to its production cuts promises. Last month, OPEC's oil production fell by the most in almost 2 years!
Add to that equation Russia (ERUS, RSX), not an OPEC member, that is aiming at speeding up its planned oil output cuts, and you get a massive force producers that, as long as they stick to their plans/promises, can balance the US accelerated level of production.
Oil is a tough cookie this year.
In many ways, we foresee for oil prices exactly what we foresee for stocks. After all, the correlation over the past year has been pretty high.
The question is, therefore, who is leading who? Do stocks lead oil prices, or is it the other way around?
Admittedly, from the above chart, it's hard to say. However, since the fear of a recession is the main factor in 2019, and since oil serves as a sort of recession barometer, we tend to say that stocks will go in 2019 where oil goes.
As such, we expect oil to rise above $60/bbl during the first half of 2019, but not to exceed $70/bbl. As long as the "recession can" is getting kicked down the road, oil can keep its recent recovery. Oil prices are already up 20% since the December lows, and we see no reason why another similar move won't take place as soon as i) the market realizes that the oversupply fear is overblown, ii) the USD starts to weaken, and iii) the Fed is becoming more and more dovish, something that will weaken the USD and lift the prices of commodities. After all, it's a vicious circle and, whether we like it or not, everything is linked, one way or another.
Having said that, the second half of 2019 is likely to be a different ball game. The slowing economy, possibly getting closer to a recession, will form a "counter-attack" on oil prices that will get torn between contradicting, powerful, forces.
To make a long story short, we expect oil to trade as high as mid-high $60s, but to finish the year lower, around the $60/bbl mark.
The S&P 500 is at a critical juncture.
Past episodes of bear markets suggest that stock markets will either continue to rally or take another decisive plunge lower, real soon. We are talking of a 10-15% move inside this year.
A softer Fed policy definitely helps, but global macro data could easily (and is likely to) deteriorate further in 2019.
The main risk, as we already outlined above, is a recession.
Many, including yours truly, pay close attention to the yield curve. I can't emphasize enough the importance of a classic 2s10s inversion. If the UST 10-2 spread inverts - a recession is becoming a near certainty.
Nonetheless, even that (for itself) may not necessarily mean bad news for stock markets. While yield curve inversion is a very reliable indicator that a recession is underway, stocks can keep climbing while in the "waiting room".
There are 252 trading days in 2019, out of which 12 have already gone.
Fifty days ago, we asked you to provide your predictions for the closing prices of four very significant gauges, while adopting a forward-looking view/outlook of only 24 calendar days.
In this article, we have made our lives much more difficult. Instead of looking only 24 calendar days ahead, we are adopting a much longer forward-looking view/outlook, of no less than 240 trading days.
It's important to remember that, as much as future predictions are fun and important alike, what really counts is the daily-Sisyphean work.
Every day counts, every day matters, and every day brings you one step closer to fulfilling your goals, meeting your targets, taking better decisions, and (consequently) making more accurate predictions.