Stock Market Speculation Is Back
The stock market is seeing modest froth. This was unthinkable back in December when the stock market was at the trough of its 20% decline. Instead of a recession in the first half of 2019, traders have been greeted with a major rally.
In my opinion, investors were pricing in the worst case scenario in December, and now they are pricing in the best case scenario.
Just because the price action is amazing doesn’t mean I’m bullish. I’m now bearish on stocks. I think the ideal situation for this year is earnings growth in the mid-single digits and economic growth of about 2%.
In that scenario, because of the recession risk, I see stocks moving up 5% at most. The S&P 500 is already up 4.13% on the year which means it’s already near the high end of the best case scenario.
As you can see from the table below, when the S&P 500 is up at least 4% in the first 10 trading days of the year, the full year returns are always positive, and the rest of the year returns are positive 7 out of 8 times.
It’s interesting to note that January 2018 didn’t make this list even stocks soared higher in the first 3 weeks of the year.
To be clear, even though the market is experiencing froth, it’s nothing like January 2018.
Last January was following a year with almost no volatility.
January 2018 was the sentiment peak of the cycle. Obviously, that doesn’t mean stocks can’t surpass that level as they did in September. It simply means the euphoria won’t be met for years.
Make sure not to misinterpret this table. It doesn’t mean positive returns for the rest of the year are guaranteed or even that the year will have positive returns.
Generally, how January goes is how the rest of the year goes, but this case is different because stocks were coming off an unusually sharp decline. December 2018 was the worst December since 1931. The economic data doesn’t support 2019 being a fantastic year for stocks. I’m confident returns will be below average.
Stock Market - Stocks Continue To Ignore The Shutdown
Stocks rallied sharply on Tuesday as the S&P 500 was up 1.07%, the Nasdaq was up 1.71%, and the Russell 2000 was up 0.87%. The stock market continues to ignore the government shutdown which is what I expected.
Few traders believe the shutdown will have a lasting impact even though at 26 days, it is much longer than the previous record long shutdown which was 21 days. I don’t think it will affect future quarters, but I do think this quarter doesn’t need another headwind as there are already a few which will slow growth all year.
There is little evidence that suggests the shutdown will end in the next few days.
Stock Market - Netflix Raises Prices
Even though the CNN fear and greed index only increased to 31 on Tuesday, which is fear, I think the market is frothy because Netflix stock has been soaring.
Netflix is a great sentiment signpost. Netflix stock was up 6.52% on Tuesday ahead of its earnings on Thursday. The stock is up 32.5% year to date and 51.63% since the Christmas Eve bottom.
The big news from Netflix is it is raising prices from 13% to 18% depending on the subscription level.
On the one hand, everyone knows Netflix will raise prices every couple years because content costs are exploding. Netflix is like a snowball that keeps growing in size as it falls down a mountain.
The key for Netflix is to have total subscribers grow, time watched grow, and spending on content grow.
There will never be a point where Netflix’s profitability explodes.
Users increase their watch time while Netflix raises prices and lowers content spending.
To summarize this viewpoint, Netflix raising prices is a good thing, but it shouldn’t push the stock higher because it’s not a surprise. The positive surprise will come if churn doesn’t increase after this price increase.
On the other hand, Netflix’s price increase could mean the company is very confident consumers will stick with the platform because the latest results were great. I think the stock increased because traders viewed this as a positive pre-announcement. I wouldn’t be surprised if the firm had a great quarter because consumer spending growth is strong and “Bird Box” was a massive success.
This latest rally puts huge pressure on the quarter. If results miss the heightened expectations, the stock will crash like it did in December.
Stock Market - Sector & Treasury Movement
Consumer discretionary sector was pushed up by Netflix as it increased 1.13%. The best 2 sectors were communication services and healthcare as they were both up 1.74%. Healthcare was the best performer in 2018. The only 2 sectors that were down were industrials and materials which fell 0.32% and 0.65%.
Treasury market hasn’t moved much all year. This makes sense to me because the disappointing economic reports don’t support rising yields. The 10 year yield is at 2.71% and the 2 year yield is at 2.53%.
This means the difference between the 2 is 18 basis points.
The December Fed meeting was pivotal because investors weren’t sure if the Fed would raise rates, and they didn’t know how it would react to the volatility in the stock market.
The January meeting is completely different. No one thinks the Fed will hike rates as there is a 98.4% chance rates stay the same and a 1.6% chance the Fed cuts them. Fed will have dovish language and probably won’t change its guidance for 2 hikes in 2019 because it’s early in the year.
Stock Market - Conclusion
The stock market is overbought as the S&P 500 is up over 4% in the first 10 trading days of the year despite the weak economic data and the Q1 2019 earnings estimate cuts.
Netflix’s rally shows us the market is frothy. I think stocks increasing 5% this year is the best case scenario. Therefore, there is little upside even if everything goes well.