Post Midterms Stock Market Outlook: History vs. Fundamentals in Conflict

by the Curmudgeon with Victor Sperandeo

Introduction:

What's the outlook for the U.S. stock market now that the November 2018 midterm elections are over? That depends if you value history as a guide or prefer to look at current fundamentals and interest rate trends.

History suggests the U.S. stock market should move higher, especially in 2019, but less so till the end of 2018. The fundamentals augur for caution as there are many economic uncertainties along with a Fed that is intent on continuing to raise short term interest rates.

Historical Post Midterm Stock Market Results:

From a recent Curmudgeon post,

“Leuthold Group found that since 1942, the mid-term election year’s six-month window, beginning in November of the mid-term year and extending through April of the pre-election year, has seen an average un-annualized S&P 500 total return of +17.2%. Indeed, none of the 19 six-month windows in this study saw a total return LOSS. That’s impressive!”

First Trust found that the S&P 500 Index posted a positive total return in each of the calendar years following the previous 18 midterm elections since 1945. The total returns have ranged from 1.38% (2015) to 37.43% (1995). The average gain was 19.13%

NOTE: CALENDAR YEAR is from January 1 to December 31 of the FOLLOWING YEAR - NOT 52 weeks or YoY from November midterm elections till 1 year later!

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This past week, Leuthold reported to institutional clients that the average S&P 500 gain from election eve through year end was essentially the same (+2.6%) as for non-election years as per this table:

Leuthold Group also found that when BAA yields have fallen over the six months leading up to election eve, the S&P 500 has rallied into year-end 82% of the time, for an average gain of 4.6%. On the other hand, rising yield environments (like the current one) have been followed by rallies less than half the time, with an average gain of just 0.6%.

In summary, Leuthold says that year-end rallies during mid-term years haven’t tended to be any larger than during other years, and this year’s S&P 500 post-election gain through November 8th has already reached the historical average. Finally, hostile bond market (i.e., monetary) conditions should temper any hopes for a year-end “melt-up.”

Fundamentals are BEARISH & “Don't Fight the Fed:”

As we've pointed out in previous Curmudgeon posts, the fundamental factors driving corporate profits and stock prices are negative. These include: China trade war, escalating tariffs, rising inflation, humongous budget deficits (that must be financed by ever more US Treasury debt) and the Federal Reserve continuing to raise short term interest rates.

The Federal Reserve Board (the Fed) is expected to raise its benchmark rate ¼ point in December and forecasts three more rate hikes next year. Some market professionals worry that the economy may slow down toward the end of next year, or that the Fed's tightening will slow growth and that could force the Fed to slow down its rate hiking.

At its meeting this past week, the Fed said the economy remained in good health. It cited strong growth and the continued decline of the unemployment rate. The Fed expects "further gradual increases" in the target range for the federal funds rate, but that will depend on continued economic expansion, strong labor conditions and inflation near its 2% target.

The Fed is currently raising its benchmark rate by a quarter of a percentage point every quarter. At that pace, the rate will reach about 3 percent by the middle of next year. That is roughly the level the Fed regards as neutral, meaning it would neither stimulate nor discourage economic activity. Some Fed officials are already pressing for the Fed to raise the rate into restrictive territory, arguing that inflation is likely to rise if the central bank does not begin to step on the brakes. That will all play out in 2019.

From Moody's Credit Outlook (November 8, 2018):

Global economic growth in 2019-20 will likely decelerate amid tightening global liquidity and elevated trade tensions.

Economic growth will decelerate across advanced and emerging market economies. In the US, the ongoing removal of monetary accommodation, waning fiscal stimulus, and restrictive trade policies will start weighing on financial markets and economic activity. Other advanced economies will also see cyclical moderation toward trend growth. Slowing global trade will have an adverse impact on open economies including Japan, Korea and Germany. We expect global growth to slow to under 3.0% in 2019 and 2020, from an estimated 3.3% in 2017-18. Real growth in G-20 advanced economies will decelerate from around 2.3% in 2018 to 1.9% in 2019 and 1.4% in 2020. Growth in G-20 emerging markets will decline from an estimated 5% in 2018 to 4.6% in 2019, followed by a pick up to 4.9% in 2020. Contractions in Turkey and Argentina, as well as slowing in China, will pull down aggregate G-20 emerging markets growth in 2019.

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Victor's Comments:

The U.S. stock market was trading on the historical statistics after the midterm elections this past Tuesday as can be seen from Wednesday's huge rally. As the Curmudgeon notes above, the post WW II stock market has been up 100% of the time in the year following the mid- terms. But there is an important difference between then and now.

In the past, both political parties (Dem's+GOP) wanted to get re-elected so they made deals that were good for the economy. However, the Democrats are now weighted and run by Socialists –- not Democratic centrist or moderates. They will never make a deal that helps Trump. Also, Fed Chairman Powell is strongly opposed to Trump who has criticized the Fed's rate rising agenda.

Trump's agenda is over and the Fed continuing to raise rates will cause GDP to decline – not only in the U.S. but all over the world. Therefore, all equity markets, especially Europe (DAX, CAC and Italy) are shorts! The equity bull market is over.

I recommend buying 2-year T-Notes at 3% and staying long the U.S. dollar.

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Closing Quote: Why U.S. fiscal policy will be on hold and the economy will decline

From The Road to Serfdom, by Friedrich A Hayek

"To weld together a closely coherent body of supporters, the leader must appeal to a common human weakness. It seems to be easier for people to agree on a negative program -on hatred of an enemy, on envy of the better off- than on any positive task. "

Good luck and till next time…

The Curmudgeon
ajwdct@gmail.com

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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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