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The Brave Report: Market Commentary for January 2019

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Paging Dr. Jekyll or is it Mr. Hyde? The markets have been on quite a ride over the past two months, but with sharp selling in December and the rapid recovery we are almost right back where we were at the start of November. We have seen a perfect example of the irrationality of the markets and that forces other than fundamentals can often drive market performance in the short term.  Just as the selloff in December was exaggerated and no fire really materialized, the rapid recovery seems to be just as over-done.  Based on all the data, we seem to have ended up right about where we should have but the road we took to get here was irrational and driven by short term traders. My hope is that any long-term investors just chose to take the last two months off and didn’t lose too much sleep over the wild swings.

Market Overview

The markets bounced back rapidly over the month of January, with the Dow and S&P gaining around 8% and the NASDAQ jumping close to 9.5%. This marked the best month for the S&P 500 since October 2015. However, even with these great gains, it is important to remember the context of this performance as the S&P was down more than 9% in December and 6% in October. Part of this recovery can be attributed to how oversold the markets became in January, but the alleviation of some of the uncertainties we saw throughout the fall and relatively positive earnings results we have seen so far.

On the fixed income side, we saw a sharp dip in rates to start the year but since then have seen some pretty range-bound trading. Since January 4th the rate on the 10-year has traded between 2.64% and 2.78%. This was a nice stabilization from the rapid drop in rates we saw starting in November and it seems a realization that the uncertainties in the market weren’t as bad as everyone thought. It also shows that we may be approaching an environment of more stable rate policy as the Fed begins to slow its rate increases.

Uncertainties: The big theme last month was the uncertainties in the market.  Fed policy, trade negotiations and fears of global growth slowing all weighed on the markets. While some of these variables should be a concern, as is often the case we saw a major overreaction by the markets, driving stocks far too low in December. I am not saying some sort of pullback was not warranted, but the severity of the pullback was overdone. In these oversold situations, the recovery is almost just as rapid. That is exactly what we experienced in January. We did get some additional clarity around trade progress with China. We did get some further softening from the Fed (It is important to note: their recent comments are almost exactly the same as what they said in December, but the market read them as much more dovish for some reason. As I explained last month, I think the market was just looking for bad news and so they found it. This month was the opposite.) And based on the early earnings results, the fears of slowing global growth seem to be a little overdone. However, we did not see enough clarification in these uncertainties to warrant the type of move up in the markets that we saw in January. Just as these uncertainties were not bad enough in the first place to warrant the type of selling we saw in December.

I look at the last couple of months as a perfect example of the irrationality of the markets and an illustration of the other factors that drive day to day, week to week stock price movements.  If you had told me on November 1st that the markets would be about 1.5% lower at the end of January, I would have told you that sounds about right.  The surprising part is how we got here. If you are a long-term investor, you may still be down from the September highs but its as if the December sell-off didn’t really happen and as I have discussed in the past two month’s commentaries, this is exactly what the actual data told us should have happened. The data told us we should see some consolidation or a slight pullback into year-end as the uncertainties worked themselves out. The data didn’t say we should see a rapid panic a 13.5% correction and then a recovery that happened just as fast.  It’s the short-term traders or panic sellers that either made a lot of money or got killed during this timeframe. For the patient long-term investor, the selling in December and the rapid buying in January are just blips on the radar.

Earnings: One of the big uncertainties in the market has been the fear of global growth slowing.  While I do think global growth is slowing, the pace and severity of this slowing have been completely overdone. The start of earnings season has helped to prove this.  So far, 71% of S&P 500 that have reported have beat their earnings estimate. This is well above the historical average of 62%. On top of this, overall earnings growth is up 15.85%.  This is not quite the doom and gloom scenario that was predicted going into the earnings season. This has resulted in the best earnings day performance since 2009. On average stocks have been up around 1.1% on the trading session after they report.

There have been some negative adjustments to guidance as the uncertainties we have discussed weigh on forecasts. I view a lot of these adjustments to be planning for the worst-case scenario and an attempt to soften expectations as the benefits of tax reform drop off results and in case the trade war accelerates at all. I don’t look at it as a sign the recession is imminent.

Too far, too fast: My major concern coming out of the month of January is the pace of the recovery.  While we were coming from a very oversold market in December and were recovering from an exaggerated selloff, I think it would have been healthier for the markets to see a slow and steady climb higher. I don’t think we are in an overbought scenario yet but when markets move this fast higher, we often see some profit taking and this could take some steam out of the recovery unless we see some more positive news come out of the trade negotiations. I worry that in one month we have used up most of our upside for the year unless we get a major positive catalyst.

Strategy Commentary

I added back to some of my equity positions throughout the month as the relief rally materialized and the fear from December subsided. These additions were selective and opportunistic.  I am still not back to overweight equities but am moving in that direction.

Domestically, I added back to some technology and consumer discretionary positions. I also increased my allocation to industrials. With the divisions in Congress there doesn’t seem to be a lot of policy agreement.  The only area that could see some bipartisan support is in the area of infrastructure improvements which could benefit some industrial and materials names. I maintained my exposure to healthcare.

I am still maintaining my underweight to European markets. They performed well over the past month, but I still think the uncertainties are too great to warrant a substantial position.  I did continue to add to emerging markets as we have seen a pretty good recovery in some Chinese names.  I expect this to continue, especially if some progress can be made on the trade front

I am still taking a wait and see approach on the fixed income side.  We have seen some substantial swings over the past few months. I will be maintaining my underweight until we get some more clarity from the Fed and we get confirmation that they are going to be data dependent with any future rate hikes.

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