CAPITAL IDEAS: A lower high and icicles
Dalton — In Davos, Switzerland, the world of snow and icicles, the World Economic Forum’s annual meeting was held last week. Quarterly, my firm publishes a survey and sends it to 4,000 local business owners for what is called the Berkshire Business Confidence Index, or BCI (which, coincidentally is going out this week). It’s a formal assessment of owner confidence and intentions. Davos’ WEF is an informal assessment of more than a thousand global leaders and business titans.
The head of the International Monetary Fund, Christina Lagarde, chaired a panel called Global Economy in Transition, and she summed it up pretty well in the above graphic. The global economy is weakening but likely will avoid a recession in 2019.
One of the most interesting discussions was a familiar theme in the BCI newsletter, what I refer to as “The Amazonification of America,” which isn’t as direct a condemnation of Amazon’s shopping platform as it may sound. I like Amazon and often use other digital platforms that make my life easier while disrupting industries—companies such as Uber, Airbnb, Blue Apron, Tesla, Udacity, Spotify, DocuSign and Square.
For you and me, as consumers, these companies reduce our costs and improve our lives. For local businesses, small fries like me, they are competition that’s hard to compete with. The competition is so powerful that it’s creating market concentration and hurting small-town America.
The concept shared at Davos is similar to what we’ve been preaching: Local businesses need to embrace the new technologies to not only offer the services that their clients want, but also to use these technologies on the operations side, making their companies more efficient. The operational technologies of industry disruptors can be used to reduce the barriers of entry into areas that seem like new competition when, in fact, it can be a new service to provide for existing clients. Leaders in Davos encourage owners to get management and employers on board by “incentivizing the creation of alternatives” as opposed to drastically reducing costs or, worse, going out of business due to lack of profitability or customer attrition.
A lower high
2019 is off to a start that seems eerily similar to 2018—you know, before the market cratered 20 percent. So, should we worry? Short answer—yes. The longer answer—you’ll probably be just fine. First, let’s examine the first month of rallying from Dec. 24, 2018, to Jan. 23, 2019. The stock market rallied about 13 percent and is overbought. We are concerned that the market will retest its Christmas Eve lows. I had cited previously that the lows of a “waterfall decline” like we experienced at the end of December are almost always retested. I also said that we’d need a few weeks to look at the breadth to determine the likelihood of doing so beyond the historical near certainty. While the odds are still very high, we’ve moved from “almost definitely” to “maybe, probably.”
To measure breadth over that month, we consulted a recent publication by Lowry’s, the worlds’ oldest technical analysis firm, which measured only nine other such “extraordinary instances over the course of 80 years” when the breadth was as robust over a month. Following similar breadth thrusts “despite an average 1-month gain of nearly 10%, the S&P 500 Index was still higher by 30.1% one year later and 45.1% higher two years later, on average.”
All that being said, we’re still in a cyclical bear market until proven otherwise. If we can break the S&P 500 above the 2,740 level, its 40-week moving average, I’ll feel more comfortable. I give the market a 20 percent chance it will go back to its December lows, a 40 percent chance that it will decline about 8 percent down to 2,450 points before the rally can be sustained, and another 40 percent chance that any pullback in the very near term will only be about 5 percent.
The reason we assess only a 20 percent chance of a full retest, in addition to the breadth, is because negativity remains high (a contrarian signal). In 2018 we had a great start to the year, but optimism was extremely high, leaving little room for error in earnings, economics, valuation, political narrative, etc. This time, the 25-day put-to-call ratio is high, reflecting investor skepticism. This leaves room for upside surprises to make investors more comfortable about getting cash to work, thus pushing up stock prices.
Update on housing
A month ago I wrote in Capital Ideas that I was concerned about the housing market. Last week the National Association of Realtors reported that sales of existing homes declined 6.4 percent in December, adjusted for seasonality. That was the least amount of sales in three years. Economists polled by Reuters had expected just a small decline. That can’t be blamed on the government shutdown because most of these contracts would have had to be signed in October. And the bear market in stocks didn’t accelerate until mid-November, so you can also rule that out as headwind for December sales.
Confidence surveys with homebuilders and home sellers suggest an uptick next month, citing that the 30-year fixed mortgage rate dropped precipitously at the end of December, to a four- year low. Also boosting their confidence is that house price inflation slowed to 2.9 percent in December from a year ago to $253,000, the smallest increase in seven years. Maybe they are right, regarding a next-month bounce. But I have a hunch they’re wrong. And all I got is a hunch. The month long partial shutdown of the federal government has delayed some data for non-hunch number crunching. But given that some financing was delayed in getting to potential homebuyers, that optimism has some headwinds.
Allen Harris’ forecasts and opinions are purely his own. None of the information presented here should be construed as individualized investment advice, an endorsement of Berkshire Money Management or a solicitation to become a client of Berkshire Money Management. Direct inquiries to firstname.lastname@example.org.