Overall, foreign markets faired very well in the first quarter. The EAFE International Index ended the first quarter up by 7.4%. The Pendo International Strategy followed suit and posted a 9.5% gain for the quarter. After years of volatility and taking a back seat to domestic markets, we see (finally) a reversion to the mean, and favorable fundamentals for international markets finally being realized and bearing fruit. We believe this will continue for the foreseeable future, and will discuss further on.
Here in the good ol’ US of A, the bubble-vision’s talking head’s obsession with all things Trump (even if all things aren’t) has carried over to the financial reporters as well. The market rally since the November election was called the Trump rally, or the “Trump Bump” by those favorable to him.
Unspoken was any mention of former journalistic staples such as the what, why and how this had transpired. Apparently, belief that a President Trump would be able to get everything he promised as a candidate through congress, and everything would work out as he dictated and lead to nothing but 100% successful and positive results – the best! – was more important than economic data or analysis. This was attributed to “animal spirits” [discussed in last month’s commentary]. To be consistent, the media and those not favorable to him (the “resistance!”) never gave him the credit, but as the rally faded and markets pulled back from all-time highs, they did assign him the blame. Both are wrong- Sad!
While the Trump rally was real, it was irrational. Survey after survey cited that positive sentiment, or ‘hope’ (hmm, that word sounds familiar…) that policies would be more favorable and unrestrictive to business overall, led the rally. However, shares are already trading near record-high multiples that are completely unjustified by slow earnings and economic growth; it would take a 40% increase in earnings to justify current multiples! Absent this, any good news is already “baked in,” while any surprises would only be to the downside. Indeed, failure to come to a deal on the ACA, aka “Obama Care” has given investors some pause, as they realize that the president does not possess a magic wand in one hand and a signature pen in the other.
Remember, Ronald Reagan is generally credited for a 16 year bull market, the “Reagan Recovery.” Often forgotten is that there was a recession and a market turndown to mark his first two years in office, and a 25% bear market. The difference is that Reagan was not saddled with the massive level of government debt that Trump has inherited. It is a generally accepted economic principal that spending initiatives and the dollar-multiplier effect diminish greatly at higher levels of debt.
Common to both Reagan and Trump (there are several other examples in between) is that each faced periods of the Fed in tightening mode; Reagan’s policies didn’t begin to take root until the Fed became much more accommodating to “Reaganomics.”
There are headwinds facing the economy to be sure, and years of liberal fiscal and monetary policy haven’t helped. There are now fewer tools in the toolbox to apply in case of an economic slump, and the needed systemic, long-term policies are just that: long-term and not a quick fix.
Some problems facing the US markets, while the economy is in the latter stages of a (weak) recovery and expansion cycle:
- Credit card debt nears a record $1 trillion, now close to student loan debt (Federal Reserve)
- Total household debt at record levels
- Fed planning to raise rates and remove $4.5 trillion from its balance sheet, draining liquidity and raising interest rates. This will increase the cost of debt service and divert funds from consumption
- Market success is not broad-based: Stocks making 52-week highs on the NYSE fell from 338 on March 1 to 72 (Barron’s). Broad-based markets are strong; narrow markets are weak
- Total US market cap: 207% of GDP; 2007 housing bubble 181% of GDP; 2002 tech bubble 202%
- US equity funds are seeing the largest outflows since Q3 2015, when the S&P fell 7%
- Emerging markets have seen inflows of $13 billion YTD
- US markets saw withdrawals of $14 billion for the first week of April
- GDP has grown at less than 3% for an unprecedented 8 years in a row. It is projected to continue
- The last bubble saw an S&P 500 P/E ratio of 18x; today it is 22x
- Foreign markets are undervalued, trading at lower multiples, have more room to grow and are attracting inflows of funds
- Bullish sentiment has gone from 54.4% in November to 62.6% in March
- Multiples are nearly two standard deviations out of line.
In layman’s terms: We are not saying that the US economy is in a shambles or has no bright spots, but we could literally fill pages with additional, similar data to that above. It is rare that people see a recession approaching, but we remember that in the summer of 2007 the bulls were at their most vocal.
We are not in the business of making predictions, particularly in the short term. However, based on history these data point to a 90% chance of a recession within a year. It may be time to take some chips off of the table of the US market, and keep some dry powder.