Wait & See

Nov 25, 2018 | Dann Cushing


The “unconvincing” late October rally discussed in the last update proved to be exactly that:...

...US equity markets have since fallen 5%. Our short-term thesis remains unchanged: with earnings wrapped-up until the New Year and with the Fed’s intentions for December and March well-signaled, the only catalysts left for 2018 are tariffs and (possibly) inflation. Both are negatively skewed risks.

A major event for the former arrives next weekend, with President Xi and Trump meeting bilaterally after the G20. Recall that the risk for equity markets from this event is less about a “No Deal” headline – arguably that is somewhat priced in by now – and more about the knee-jerk fear that would ensue from a subsequent devaluation of the Yuan.

If these or other events trigger a further 5% - 10% decline in the S&P, it would signal a buying opportunity to us (more on this below). In the very immediate term though, it creates uniquely interesting set-up for tax-loss harvesting this year: sell now with the intent to repurchase around Christmas, when prices are quite possibly lower given the macro events above and at the very moment when tax-loss selling traditionally peaks. 

Headlines about slowing iPhone demand and rising US mortgage rates dominated headlines, leading to some of the more violent individual equity price moves of the past two weeks. Those issues notwithstanding, US unemployment remains at 50-year lows, real rates remain negative globally, and the demand impulse form US tax cuts will continue for several more quarters. A further 5% - 10% drop in the S&P would put it in classic correction territory, and to me then a buying opportunity, as an outright bear market seems very unlikely in the current economic environment.

That said, a “profit recession” – where earnings growth turns negative despite a growing economy – is possible. Arguably the true cause of current market volatility is fear of exactly that. Specifically, fear that corporate margins will decline (due to higher interest costs, absorbing tariffs and wage inflation), as well as the second derivative which is that business confidence declines as margins fall, which in turn would reduce capital spending. Of those, wage inflation and business confidence are the most impactful issues, and both are trending – modestly – in the wrong direction. Interestingly though, almost all of those factors are also US-centric…for the first time in years, we see some signs that equity investing in Canada and the rest of the world is starting to look more appealing than the US on a relative basis.