Weekly Market Update (November 18 – November 22, 2019)

By Craig Fehr November 29, 2019

U.S. stocks took a breather last week, declining modestly, after six consecutive weeks of advances. Volatility remained low, but mixed. U.S./China trade headlines left investors wondering whether a "Phase 1" trade deal can be signed before year-end. On the economic front, the preliminary U.S. Purchasing Managers' Index for November showed improvement in economic activity, which supports our view that the worst of the manufacturing slowdown may have passed.

Looking Below the Surface of the Market Rally: Five Important Trends
The popular phrase, "It's not just what you said, but how you said it," acknowledges the effect of both content and delivery. Or said another way, the outcome is just as important as the process behind it. Improbable outcomes happen but studying the drivers behind these outcomes can be informative about the likelihood of such outcomes repeating or persisting.

When it comes to the market, it's not simply where it goes, but how it gets there. Stocks experience rallies and pullbacks, and an examination of the underlying drivers and the composition of that performance can shed light on the potential for those trends to persist. The market has performed quite well of late -- whether you define that as 2019 or the last three months (which have gains of 26.0% and 6.6%, respectively1). Do we think that will continue?

  • In terms of magnitude? We doubt it.  If the year ended now, this would be the second-best annual gain of the past decade. At this later stage in the economic cycle, we don't think another 20%-plus gain is likely next year.
  • In terms of steadiness? Again, no. The stock market has rallied lately, with virtually no volatility.. The market has only had 2 down weeks since September, and the last 5% pullback was nearly 4 months ago2. A so-called Santa Claus Rally could carry things through December, but we think 2020 will see a return of increased market fluctuation.
  • In terms of direction? Yes. We don't think the close of 2019 will bring the close of the bull market. We expect more moderate gains ahead, along with a choppier path toward those gains, because underlying fundamentals remain poised to support the market, in our view.

Speaking of fundamentals, as we noted, it's not just what the market does, but also how it does it. Here are five characteristics of the recent rally and what these characteristics signal about where we might go from here:

  1. Defensives vs. cyclicals – As the market has risen to new highs, it's done so as more defensive sectors have outperformed cyclical sectors. This reflects an undertone of caution amid the strong performance of risk assets (equities). 
    • Underlying signal: An ongoing level of skepticism is not surprising given the prevailing risks in the current environment (trade war, political uncertainty, manufacturing slowdown). However, a market rallying higher on the back of defensives suggests investor sentiment has not grown too complacent. Rallies in 2011, 2013 and 2018 were powered by outperforming cyclicals, but were also met with temporary pullbacks as that optimism faded. We're not suggesting the current market is immune to a potential short-term pullback, but persistent caution does help reduce the risk of the market running too far ahead of fundamentals.  
  2. Market breadth – The number of stocks participating in, and contributing to, the market's strength (the "breadth" of the rally) has risen. Currently, 75% of S&P 500 companies' stock prices are above their 200-day moving averages, reflecting steady moves higher3. This is up from 50% in May of this year, when there were growing concerns of an approaching recession3. This time last year (before the December sell-off), this measure was roughly 40%3.
    • Underlying signal: Market rallies driven by a narrow segment of the market or a limited number of stocks can be more vulnerable to setbacks, particularly if that segment falls out of favor. A larger number of stocks participating in new highs suggests a broader base of strength that could help the market hold on to gains or reduce sensitivity to weakness in a particular sector.
  3. Large vs. small – Small-cap stocks have outpaced large-caps lately, signaling the brightening (or at least less-sour) outlook for the economy.  Prior extended periods of relative small-cap strength (mid-2015 to early-2016, second half of 2018) were followed by solid overall stock market returns in the following year.
    • Underlying signal: Stronger performance from the economically sensitive small-caps signals an improving economic foundation for stocks, which will be necessary to support an extension to the bull market. In addition, it demonstrates the importance of portfolio diversification, because we expect investment leadership to rotate as we advance through the cycle. 
  4. Earnings vs. valuations – Earnings growth has been modest for 2019, with profits rising roughly 1%2. With the price of the S&P 500 rising 23.8% year-to-date, the composition of the gain has largely been the result of a rising price-to-earnings (P/E) ratio2.  This is a good sign from the standpoint that it potentially signals investor confidence about future earnings growth (we expect earnings to rise at a mid-single-digit pace in the coming year). With the rise in the P/E ratio, the market is trading slightly above long-term average valuations, telling us that the market is not overvalued, but that future gains will more closely track the pace of earnings growth. 2013 was similar – the market rose roughly 30%, driven largely by a rising P/E3. The following year saw a positive, but more moderate, gain. 
    • Underlying signal: The recent rally has not pushed valuations to extreme levels. Fair valuations suggest that further market gains will trend more closely to earnings growth, which we think will be modestly positive. 
  5. Fundamentals vs. headlines – Markets have shown less propensity to be whipsawed by headlines and short-term noise lately, which tells us there may be an increasing amount of weight being placed on the broader fundamentals. Last week, there was news that "Phase 1" of the U.S./China trade deal was hitting some snags, followed by other reports later in the week that an incremental agreement is still on track. For the better part of the last 18 months, varying reports/tweets like this have sent markets sharply higher and lower. Last week, the reactions were far more muted (-0.4% and +0.2% moves on the days of those announcements)3. Similarly, there were negative reactions over the past year to indicate that the Fed wasn't planning to cut rates aggressively. However, the market has not exhibited such a cold reaction to recent signals that the Fed may cut rates by less than previously expected. We interpret this as positive, since the market seems to be more comfortable that the economy is on sound footing without the need for substantially more Fed stimulus. 
    • Underlying signal: The market's ascent to new highs has coincided with a greater focus on fundamentals and fewer knee-jerk reactions to headlines. This is warranted, in our view, because fundamentals are broadly supportive – the economy is expanding, corporate profits are rising, and interest rates are not restrictively high. We think these fundamentals will support additional gains over the coming year, but we don’t anticipate the market to be resistant to overreactions from political and trade-related headlines. This market focus is a pendulum that swings; 2020 is likely to see it swing back toward a focus on headline noise periodically.  Fortunately, history shows that the influence of fundamentals is more dominant over broader periods of time. 

Craig Fehr, CFA
Investment Strategist

Sources: 1. Morningstar 2. FactSet 3. Bloomberg

Index Close Week YTD
Dow Jones Industrial Average 27,876 -0.5% 19.5%
S&P 500 Index 3,110 -0.3% 24.1%
NASDAQ 8,520



MSCI EAFE* 1,964.84 -0.6% 14.2%
10-yr Treasury Yield 1.77% -0.1% -0.9%
Oil ($/bbl) $58.04 0.6% 27.8%


$112.87 0.4% 8.4%

Source: FacSet, 11/22/19.  *5 day performance ending Friday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. 

The Week Ahead

In a holiday-shortened week, important economic data being released include consumer confidence on Tuesday and third-quarter GDP (second estimate), along with durable goods orders and personal income, on Wednesday.

Important Information

The Weekly Market Update is published every Friday, after U.S. markets close.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

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