John Jagerson is a columnist for Investopedia, as well as author of the Chart Advisor newsletter. The views expressed herein are his alone and do not necessarily reflect the views of Investopedia.
The Month Ahead
The rally that began following the Christmas holiday has had very strong breadth. That means that not only are most stocks rising, but other asset classes like high yield bonds, commodities, and emerging markets have been gaining together.
The breadth of the current rally is certainly part of the explanation for why stocks have rallied so quickly. From trough to the highest price in February, the S&P 500 was up almost 20%, while the Nasdaq Composite rose more than 21%.
However, very few rallies reach their ultimate target without a few interruptions along the way, and there are a few important issues over the next month that will determine the depth and length of the trend’s next interruption.
Oil & OPEC
Over the last week President Trump made two interesting comments to his followers on Twitter. The first was a plea to OPEC not to constrain the supply of oil too much. Specifically, Trump said energy prices were “getting too high”, which could make the global economy stumble.
I think President Trump has a point, but the issue is complicated. On the one hand, it seems like a good idea to keep gasoline and related commodities’ prices low, but the US has actually surpassed any other country to be the new largest energy producer; lower prices could be a bad thing for the US economy.
Traders should keep in mind that when oil prices crashed from $100+ per barrel in 2014 to $26 per barrel in 2016 that it triggered losses in many other sectors as well. For example, bad loans spiked, and retail spending collapsed enough to send stocks through an “earnings recession” of negative quarterly growth in 2015.
Oil has traded flat since President Trump’s initial plea to OPEC for lower prices, but I think investors should be on the lookout for OPEC to flex their independence with another cut (or threat of another cut,) in supply. The next big OPEC meeting takes place on April 17th-18th, but statements and announcements about supply levels will continue to stream in through most of March.
Because of the importance of the energy sector to the S&P 500, lower prices would be a big concern for profit growth in the second quarter.
The US Dollar
Later last week, President Trump spoke to a group of supporters about the strength of the dollar. Trump’s comments focused on a dollar that was so strong that it made doing business internationally difficult. I must agree with the President about this issue, although I might quibble with what I interpreted to be his assertion that the Fed is solely to blame.
The dollar is a tricky issue for the market, especially in the context of lower energy prices. Oil is usually priced in US dollar terms. Therefore, if the dollar weakens, it takes more weaker dollars to buy a barrel of oil. The relationship between the two assets isn’t perfectly inverse, but the correlation is high enough that it would be very difficult to intentionally lower the dollar’s value and oil prices at the same time.
The bigger risk investors should be thinking about relative to the dollar is its potential to drag on US exports. If international buyers must pay more in stronger-dollar terms for agricultural, equipment, and energy exports from the US, they will naturally curb demand.
While I don’t think Fed Chair, Jerome Powell, deserves all the “blame” for the strong dollar, more rate hikes and tapering the central bank’s balance sheet would make the problem bigger. In the last Fed statement (and subsequent testimony to Congress) the Fed has made it clear they don’t expect to raise rates in 2019 at the same pace that they did in 2018, however, those plans could change.
The next Fed FOMC meeting is March 20th, which is an opportunity for Powell’s team to reassure the market that they are not taking immediate action to tighten monetary policy which would otherwise increase the value of the dollar further. If their statement looks more accommodative, like the last one in February, traders will likely see that as a reason to push the dollar lower. The net effect of a weaker dollar may not do very much for President Trump’s goal of lower energy prices, but it could be very positive for the US economy.
Average estimates for earnings across the S&P 500 show that analysts expect growth rates to be slightly negative. This is a problem for the market because the market’s earnings multiple (PE ratio) is still roughly even with where it was the last time earnings dipped in 2015.
In order to maintain high valuations, you need high growth rates, which puts a lot of pressure on the first quarter. However, investors already know about these estimates so it’s reasonable to assume that bad news has been “priced into” the market already. The trend should be OK as long as we don’t get any big surprises.
Fortunately, we don’t have to wait until the calendar quarter has ended and the flood of reports are released in April to see whether earnings will be better or worse than expected. There are a few S&P 500 components that will be reporting before the quarter ends.
FedEx (FDX) will be reporting their most recent quarter on March 19th after the market closes. The mid-quarter reports from FDX are very useful because the company is such a good representative for transportation and shipping. For example, the disappointing report from FDX September 18th, 2018 was an accurate portend for the tough fourth quarter for the market.
Oracle (ORCL) and Adobe (ADBE) will also be reporting earnings in March and will give us a good idea for business spending and technology profitability. Expectations for first quarter profitability is very low, so a surprise from one or more of the companies that report mid-quarter could do a lot to lift expectations.
The Bottom Line:
Economic fundamentals in the US are still very positive, if a little a little flat. In my view, except for a strong dollar that may continue to drag on exports, the market seems poised to continue higher. In the near term, investors should be primarily focused on the Fed and some of the early profit reports before earnings season starts again in April. The performance bar is set low so positive surprises are likely, which is why I expect any trend interruptions will be kept to a minimum depth.