How to Push Back Against The Bear – Investing Daily

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The bears are coming out of hibernation.

Consensus projections for the coming months aren’t encouraging: a corporate earnings recession, an economic downturn, and a stock market correction (or perhaps even a bear market).

How long can we keep the bear at bay? For the latest insights into these uncertain investment conditions, I turned this week to my colleague Nathan Slaughter, chief investment strategist of The Daily Paycheck and High-Yield Investing.

Nathan’s previous experience includes a long tenure at AXA/Equitable Advisors, one of the world’s largest financial planning firms. He also honed his research skills at Morgan Keegan, where he managed millions in portfolio assets and performed consultative retirement planning services.

Nathan [pictured here] holds NASD Series 6, 7, 63, & 65 certifications, as well as a degree in Finance/Investment Management from the Sam M. Walton School of Business. Let’s see what Nathan has to say about emerging trends on Wall Street.

Q: Morgan Stanley this week downgraded global stocks and projected “poor returns” over the next year, largely due to the trade war and softening corporate earnings. Do you agree with this assessment?

A: For the most part, I think Morgan Stanley made some well-reasoned arguments. I’m not telling my readers to run for the hills just yet, but I agree that a more cautious approach is warranted.

U.S. stocks rallied 7% last month, the strongest June since 1955, capping off a powerful first-half that saw the major benchmarks advance by 18% to 20%. That rebound was sparked by dovish Federal Reserve comments and an increased likelihood of interest rate cuts on the horizon.

Like a heavy dose of ibuprofen, the prospect of rate cuts has made the market forget all about the macro issues that gave it a pounding headache back in December. Those worries have receded for now, but will likely return as soon as this monetary medicine wears off.

Just this week, we are learning of a possible new front in the global trade war. Aside from tariffs, the White House is now leaning on the central bank and Treasury Department to deliberately weaken the dollar to put our exporters on a level playing field with other nations that have devalued their currencies.

Such intervention could produce mixed results, boosting the manufacturing sector while weighing on other industries. Either way, turning the dollar, which is the world’s reserve currency, into a political weapon is yet another uncertainty for the market to digest.

Before long, investors will shift their focus back to corporate earnings. And they will find that nearly 100 S&P companies have just issued negative earnings guidance for the upcoming quarter, the second most since 2006. That’s just another arrow in the quiver for bears who would shoot holes in this market rally.

With stocks at record highs, the market will be looking for any excuse to unwind some of these gains. And one way or another, it will find one. That’s why I’m starting to make subtle asset allocation changes in favor of fixed income.

With interest rates still at low levels and growth stocks overvalued, high-dividend utilities have been on a tear so far this year. Do you think this outperformance will continue for the rest of 2019?

As a Chicago Cubs baseball fan, I’ve watched our National League fall to the American League for the past six straight MLB All-Star games. Well, make that seven after this week’s 4-3 loss. It’s been a long dry spell.

I’m a Red Sox fan. If it’s any consolation for you, my team is struggling this year.

[Laughs] Well, in much the same way as the National League, value stocks, including utilities, have trailed growth stocks in nine of the past 10 calendar years. And by no small margin either. The iShares Core U.S. Value (IUSV) fund has posted a return of 246% over the past decade, while the iShares Core U.S. Growth (IUSG) fund has streaked ahead with a return of 434%.

This persistent trend dates back to the end of the 2009 recession. As you mentioned, it has widened the valuation gap between these two broad groups — particularly in certain sectors.

It’s no secret that leadership has been largely confined to a narrow handful of stocks. Through most of last year, six tech names accounted for more than 90% of the market’s gains.

But I believe in reversion to the mean — sooner or later, the pendulum always swings back the other way. Whenever investor confidence starts to buckle, momentum-driven gains stall, money flows out of riskier assets, and investors pile into safer havens.

That certainly includes the utility sector, which is known for its stout defensive characteristics. While sometimes viewed as a proxy for bonds, rate-sensitive utility stocks are looking more attractive these days with the Fed changing course.

Throw in steady cash flows, ongoing infrastructure upgrades and a constructive regulatory climate, and this recession-proof sector should continue to shine, particularly if the economic picture darkens.

Analysts expect second-quarter earnings per share (EPS) of the S&P 500 to show a blended year-over-year decline of -2.8%. The negative projection follows a 0.29% EPS decline in the first quarter. Do we face an earnings recession?

By the textbook definition, I would say yes.

Read This Story: Do the Math! The Numbers Don’t Add Up

First quarter earnings showed a modest contraction, a marked deceleration from the scorching double-digit growth we’ve enjoyed the past couple of years. In fact, it snapped a streak of 10 straight quarters of uninterrupted earnings expansion.

Now, it seems likely that the slump will deepen. While the final tallies have just begun to trickle in, the latest forecast suggests that second-quarter earnings will slip by about 3%. Barring a last-minute surge, we are headed for back-to-back quarterly declines — the first earnings recession since mid-2016.

In any case, while these short-term forecasts give media pundits something to talk about, my focus remains on the bigger macro picture. It’s the economy that drives earnings, not the other way around. And by most measures, it remains supportive.

What’s your hunch? Will the Federal Reserve cut interest rates when it meets again this month, or will it stand pat?

I would say the strong jobs report has somewhat diminished the odds of an aggressive rate cut at the next meeting. The Fed has a dual mandate to maximize employment and keep a lid on inflation, so Fed Chair Jerome Powell and his cohorts pay close attention to labor market trends. Payrolls expanded by 224,000 in June, trouncing expectations, while average hourly wages ticked up 3.1%.

Those numbers, while buoyant to the economy overall, weaken the argument that deep rate cuts are needed. At the same time, closely-watched inflation barometers, such as the Personal Consumption Expenditures (PCE) index, remain at benign levels.

Still, the Fed has indicated that other risks, such as trade tensions, business spending, cooling GDP growth, etc., remain a concern. The central bank sometimes loosens monetary policy proactively rather than reactively. That was the case with rate cuts in 1995 and 1998, both of which helped the economy skirt a possible recession.

Recent strength in the U.S. dollar signals that multiple rate cuts may not be a foregone conclusion. Falling two-year Treasury yields say the same. Before the jobs report, fed funds futures were pricing in a 40% chance of a half-point rate cut at the upcoming meeting. But that percentage has since fallen to just 16%.

While a 50-basis point reduction is probably off the table for now, I agree with most observers that we’ll see a quarter-point “insurance” cut. Considering this stock market rally has been predicated almost entirely on a rate cut, there could be a violent backlash if we don’t get one.

Which sectors look the most appealing to you right now?

Given earnings headwinds, geopolitical uncertainty, and the generally overvalued state of the market as a whole, I would dial back exposure to more cyclical areas in favor of defensive sectors.

As mentioned above, this could be a favorable climate for utilities. I am also overweight real estate investment trusts (REITs). Real estate has a low correlation to traditional equities, and property owners tend to have strong cash flow visibility. The prospect of cheaper borrowing costs sure doesn’t hurt either.

I’ve also been doubling down in the energy sector, which according to FactSet has the highest potential upside (19.9%) between current stock prices and consensus target prices.

Big exploration and production companies have been in belt-tightening mode for years. As a result, discoveries of new oil reserves in 2018 were the lowest since 2000. But producers can only take their foot off the gas pedal and coast for so long. Most have replenished their capex budgets and are upping spending for the first time in years.

Editor’s Note: As the above interview makes clear, the rest of 2019 is fraught with peril. But my colleague Jim Fink has devised an investment system that consistently beats the market, in up or down conditions.

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