July 31, 2019

A Global Growth Resurgence Could Push Stocks Even Higher


With US stock markets setting new highs and the length of the current run-up in stocks
(originating after the Financial Crisis of ’08 / ’09) the second longest in history, there is a
reasonable temptation to sell and become more conservative in the near-term. This can be the
right move in certain circumstances, but for longer-term investing where boldly timing the market
has a poor track record, continued investing at target stock allocations is advisable.

First, some contrary indications that you might find interesting, that are often positive for stocks:



• As they have been throughout the 10-year expansion, investors are still skeptical of the

  stock market. Less than one-third of individual investors are bullish on stocks. This level

  of skepticism is often a positive signal for markets, as it indicates there are many

  investors on the sidelines with the potential to invest further as the situation improves


• Consequently, the flow of funds out of stock mutual funds into bond mutual funds has

   been strong. Investors have been selling stocks and investing in bonds. Such extreme

   fund flows out of stocks historically have marked good buying opportunities.


• Lastly, investment managers are extremely underweight to stocks. In particular, the

   strong month of June was a surprise to many professionals who were caught flat-footed.

   Bold positioning on the wrong end tends to lead to reversals – in this case, stock buying.


With this backdrop of investor and manager behavior, let’s update key decisions being made at
the highest levels:

• The Federal Reserve has done a complete about-face and is now lowering interest
   rates. After a treacherous 4th Quarter for stocks where the markets felt global economies
   were on a much weaker footing than the Fed believed, the Fed (to their credit)
   communicated they were pausing further increases in rates. As the stock market
   recovered, economies globally showed worsening growth data vindicating those that
   disagreed with the Fed.

• Not only does the US Federal Reserve feel that easy money policies are what’s called
   for, the European Union’s monetary arm has recently announced the intention to drop
   interest rates further and re-embark on quantitative easing policies. China is also
   following suit and potentially Japan as well.


• The trade war with China has for the most part been put on pause. Discussions are
   ongoing, but there’s a sense that difficult issues not yet resolved have been kicked down
   the road until after the US Presidential election late next year – this serves the interests
   of both leaders in the negotiation, and foretells potentially less volatility for stock

• An important element of any investment outlook nowadays has to be an assessment of
  President Trump. It is clear that the President wants to be re-elected. To the extent he
  has an impact on the economy and stock markets, it is in his interest to have policies
  that do not cause a recession and do not spook the markets with further trade rhetoric.
  There will certainly be more days (and maybe weeks) of trade tweets, but it is expected
  the frequency will be toned down to maximize re-electability – whatever side of the
  political spectrum you’re on, this is bullish for stocks.

• As corporations report earnings every quarter, we are currently in the middle of earnings
  reporting season. Though earnings have been falling ever since they peaked following
  the tax cut of late 2017, earnings estimates by analysts (in response to lower guidance
  by companies) coming into this quarter have consequently been lowered – creating
  lower bars for earnings to beat (this “dance” happens every quarter). The extent to which
  expectations have been lowered historically brings decent returns during reporting
  season – note this quarter is the weakest historically for this response of stock returns.

• Lastly, recession indicators have retreated somewhat from warning levels. At worst
  (historically…), if the flattened yield curve of the past 40 or so days is signaling a
  recession, an 18-24 month clock has started putting us in the first half of 2021 for it to
  occur. This signal has had many false positives however, and other indicators are not
  warning of a recession as yet.


Perhaps it can be summed up best that recent increases by stock markets worldwide are a sign
that investors feel the above setup may be working to again delay the recession we’ve all been
looking for the past few years. Economic data is beginning to turn positive, particularly in the
US. The consumer is strong – the housing sector is strong – and employment as well. With
healthy skepticism from investors and managers creating new invest-able dollars and a
President intent on being re-elected, the actions of central banks around the world to lower
interest rates may just spur a resurgence of global growth and power stocks further ahead.

Now the risks as there always are with investing:

• First of all, the calendar – the period of the summer between July 4 th and Labor Day is
  historically difficult for stocks. This is a cross-current to the positives listed above.

• In a study recently done, when stock markets narrowly escape a bear market like
  happened last 4 th Quarter (defined as a 20% drop from recent highs – the market fell
  19.98% late last year….. we can call it a bear market, but it’s valid to draw parallels with
  other periods of quick turnarounds from such a drop), the ensuing six months is very
  strong (this has happened this year). The period of 6-9 months is flat with pullbacks (this
  is period we are in right now and should prepare for this) – and the 9-12 month period is
  again strong (corresponding to the typically strong 4th Quarter time-frame for markets,
  though the reverse happened last year…). The point is that there’s evidence to draw

  from similar periods in the past where we are in a weak time for stocks, but with gains to
  hopefully look forward to.

• The conflict with Iran is a clear risk, and to a lesser extent at the moment, North Korea.
  These are the types of existential risks that have to be monitored continually and though
  it’s difficult to time stock sales on definitive news along these lines, stop-loss strategies
  have been used before, and bonds as part of a balanced portfolio can provide support in
  these situations.

• Ongoing tariffs and trade war frictions are also not to be ruled out. Existing tariff levies
  don’t appear to be having a big effect, but any rhetoric ratcheting up trade war risks
  would continue to weigh down the market.

• It certainly seems Britain is on the path to a no-deal Brexit in the next 100 days – a
  potentially new economic arrangement in Europe and further abroad with a clean break
  from existing financial connections. This will be difficult for Britain and companies
  domiciled there. It has to have some impact globally on commerce and on stocks,
  though as it gets deferred further, individual companies are making preparations.

• Importantly, the continued lack of investment by corporations in their own businesses is
  a risk to the markets and economies. Following the tax cut of late 2017, savings have
  been used moreso to buy back stock (which boosts share prices) rather than for
  investing in the projects that nourish long-term growth of businesses. If there could be
  more capex investment (capital and equipment), stocks might really respond to that.


Currently, Castle Wealth portfolios are concentrating as follows:


• Continued over-weighting to large US stocks and particularly to those set to respond to
  stronger global economic growth.

• After under-weighting International stocks for the past decade, we’ll be boosting
  exposure due to price attractiveness and easy central bank policies abroad.

• Increases in small-company stocks as well due to benefit from higher growth (this
  includes international emerging markets – helped by the likely weakening US$).

• IPO ideas as they emerge and are attractive. We’ve invested in some cannabis stocks
  as well and will continue to.

• We’ll be looking to position portfolios on target for stock % allocation and buy on
  weakness during this quarter.

• With an expectation for higher interest rates as economies grow, we’ll continue to keep
  bond maturities shorter than average (prices of short bonds are more stable, and these
  bonds will mature sooner to be reinvested at hopefully higher yields).

• Lastly, we’ve been doing a lot of due diligence in private property-related investments.
  These are only suitable for specific portfolios. If you have interest in these (or have
  comments/questions on any of the above), please contact us.


Nate Cultice, CFP, FSA
Castle Wealth Planning
Santa Barbara, CA
(805) 962-5630

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