forecast-header

Market Forecast 2019

In The Highstreet Group by John Bartoletta


MARKET STRATEGY: The opinions outlined in this 2019 forecast reflect the views of the portfolio management team as we appear to resume this ten-year secular bull market. We were correctly positioned over the last ten years on the long-side of the market. However, the length of the bull phase, the amount of global uncertainty and the possibility of a further yield curve adjustment has us cautious with respect to directional certainty.

The market cycle above has played out during this ten-year bull phase and will either continue on its growth trajectory or will finally roll over if the financial markets reset due to the concerns stated above. If momentum weakens, due to uncertainty and the weakening of internal market variables, markets tend to reset or revert to the mean. This market has continually advanced at a pace well above the mean for an extended period of time with the exception of the fourth quarter of 2018.

Our goal is to evaluate opportunities, be aware of systemic risks and prepared to take action in an effort to protect our portfolios through risk mitigation while seeking income and growth appreciation by careful deployment of capital in markets that may become increasingly chaotic with the continued volatility we have seen over the past year.

Throughout 2018 we believed that the markets (and the FED) were complacent, and in our opinion, were in need of a reset. We felt it would be healthy if the market had a technical correction of -10% to -15% to take some of the froth (potential bubble) out of the market which could happen in the late fourth quarter 2018. Well that’s exactly what we received. If the market corrects and can withstand the FED’s adjustment to higher interest rates, we believe that the foundation of a continued bull cycle will remain in place. So we remain bullish for the first half of 2019 and will be monitoring the market behavior closely as we move into the New Year.

Markets move in cycles and now is a great time to plan for the next few years. These cycles repeat themselves and we believe we remain in a secular bull phase since the market broke out of the 16-year secular bear market in 2009. The stock market appears to remain in longer-term secular bull market that may have many years of potentially positive results ahead. However, past secular bull periods have not been straight-up affairs and tend to have many pullback periods that can keep the trend confusing for investors, but in time can become more obvious once the business cycle and the economic backdrop improve. For now, we suspect that further gains in the market will continue to be met with a fair amount of skepticism and even pessimism which justifies the recent increase in volatility.

In the next few years the markets have the potential to confirm the shift into a secular bull phase that could last for multiple years. Our strategy is to position our portfolios properly to take advantage of the next cyclical change.

Equity Market Environment: In the beginning of 2018 the markets finally saw volatility return to the market with a correction in the first quarter and again in the fourth quarter, as seen in the graph below. It took 8 months for the market to return to a new high in September.

During that time frame the markets have built a strong base of consolidation as represented by the blue shaded range. The market was also building what’s known as a technical “triple bottom” as representative by the red circles above but failed and new lows were made in December. Historically, triple bottoms typically hold and form the base for equity rallies. However, even with the break to new lows in December we feel the market is poised for a rally to new highs in the first two quarters of 2019.

Even though the markets are experiencing headwinds and a well-deserved normal correction, the foundation of the economy remains strong with respect to the full employment, strong corporate cash levels and still relatively low interest rates. We believe we are close to a possible retest of the highs within the next two quarters through June 2019. The biggest threat to the economy and markets are externalities such as a continued China trade war and Federal Reserve rate hikes but we believe these threats will lessen in the coming weeks and months.

We will be watching the markets closely so that timing of a resumption of the bull market back to the highs remains in our favor relative to our cash position. We will keep you posted on our progress and strategy.

Volatility (VIX): Volatility, as measured by the VIX, is a statistical measure of the dispersion of returns for the S&P 500 index. Sometimes it’s important to remember that some of the biggest moves in a trend come at the end of a trend, and it may be best to watch how things unfold rather than succumbing to the “Fear of Missing Out” that often occurs after the market has made a strong move to the upside. We believe the recent pick-up in volatility, coupled with the derivative volatility measures referenced in the charts above and below, is a possible sign of a near-term trend reversal. The recent weakness in the averages paired with the recent spike in volatility, lends credence to our belief that the markets have a greater upside potential than the probability of making new lows.

The VIX has had a weighted average over the past several years between 12-15. This means that there is a 67% chance the S&P 500 will fluctuate in a range between 12-15% over the next year, either upward and/or downwards. We are expecting that this range over the next 2-5 years will increase thereby increasing the weighted average of the VIX to 15-18. This is a most significant change representing an increasing importance on individual stock selection, risk mitigation and the increased potential for overall systemic failures. We do not believe passive investing, or buy and hold, will prove beneficial either financially or psychologically over the next 2-5 years or the foreseeable future. Volatility among all asset classes will rise, creating opportunities in the active equity management, commodity and futures management and hedge fund landscape.

The chart above is one of the more compelling charts in this report. It compares the price-to-earnings ratio (P/E) for the Standard & Poor’s 500 Index with the 30 day average for the Chicago Board Options Exchange Volatility Index, or the VIX. As you can see in the chart, the market has recently entered a skeptical range marked by a spike higher in the VIX without a commensurate decline in equity valuations (P/E ratio). This move lower makes stocks more attractive on a fundamental and technical basis.

Investor Sentiment (AAII Bears vs Bulls): The American Association of Individual Investors is an organization that polls its members weekly on whether they believe the market will be up, down, or unchanged, six months in the future. This is a graph (above) showing the percentage of the members who gave a bullish response, measured with a 50-week moving average in red plotted against the S&P 500 in black

The bullish investor sentiment has been rising over the last two years but still remains well below the kind of optimistic levels that can come after long rising trends in the stock market. This allows for much more room for improvement that tends to occur after much longer and pronounced gains in the stock market and the economy.

The chart above represents an overlay of the S&P 500 Index and the spread of the VIX spot (current) price minus the VIX 3 month futures price (as represented by the green and red shaded areas on the chart). It currently shows the VIX term structure known as “contango” (in green). The term structure when combined with the other volatility indicators can represent a near-term reversal (rally) in the equity markets. Conversely, when these series of indicators show a discount (shown in red) with a large spike lower, a short-term reflex sell-off ensued. What is currently at play is a probability of a near-term reversal rally. We will be watching this closely.

Equities: As mentioned in the discussion regarding volatility above, equities globally could be in for a roller coaster ride. One thing for certain, passive investing in equities will not be rewarded anywhere near the value of a seasoned active money manager or advisor. Buy and hold strategies may get tossed out the window in favor of periodic, if not frequent, rotations of industry groups and individual stocks held within as the stock market’s gyrations occur with more frequency and greater amplitudes.

The overplayed trading style of consistently “buying the dips” (RED) was replaced in the fourth quarter with “sell the rallies” (BLUE). “What could go wrong” may be overshadowed with “I need to get out”. Complacency may yield to fear as volatility ratchets higher. This is exactly what we witnessed in the fourth quarter. However, we feel that this will revert back to “buying dips” in the first two quarters of 2019.

There is a counterintuitive argument to make in favor of US equities specifically and in particular. This argument is in parallel with the tenet that the USD (US Dollar) will remain the global reserve currency. So long as the dollar remains preeminent and so long as the sovereign interest rate spreads favor the US treasuries, then dollar assets will be sought after for investors worldwide seeking a haven for their wealth and diversification from their homelands’ currency.

Coupling this “bid for USD’s” and the possible repatriation of trillions of dollars held in non-US banks if those monies have some form of tax amnesty for US multi-nationals; the most probable benefactor of a significant amount of those dollars would be invested into US equities.

A huge upside breakout could occur if either or both of these circumstances took hold. If these signs confirm, we must remain vigilant as demand for equities could surprise to the upside.

Attractive Sectors during a Bull Cycle: Based on historical data with a low and or slightly rising yield curve in place, the best sectors in later stage bull cycles are growth related sectors that are rewarded by continued economic expansion. Technology, Consumer Discretionary, Materials and Industrials (if China Trade issues get resolved) should be considered and overweighted in the portfolio. Non-growth related (defensive sectors) such as Health Care, Utilities and Consumer Staples should be under-weighted in the portfolio.

The chart below highlights our basic framework of overweighted and underweighted sector allocations.

The Future of Interest Rates: This chart (below) reflects the historically low interest rates that have been reached in the last few years. We feel that rates will stall or flatten here in the short-term and then begin to move higher in 2020, however, there is a slight chance this may begin at the end of 2019. Typically, and again in a normalized yield curve structure, money that exits (leaves) bonds typically find its way into equities furthering a bullish strategy to own stocks. Again, the chart below shows just how low rates are relative to history.

Curve flattening over the past two years has signaled investors’ concern that rising interest rates against a backdrop of slowing global growth could harm the U.S. economy. Inversion of the 2 year-to-10 year treasuries — where 2 year yields at the short end of the curve rise above those at the long end — has been a reliable indicator of recessions. Currently there is no indication that the 2 year treasury will invert versus the 10 year treasury. The spread between 2- and 10-year rates currently sits at 17 basis points but had actually improved (widened) from the 11 basis point spread a month ago.

Current Trading Update: Given the higher probability of the markets rallying from here, we are maintaining our current equity and cash allocation. Our main concern of being heavier in cash is that this market is currently news-driven and with a seemingly endless string of bad news, we feel that any good news such as resolution of our China trade war, positive earnings or economic surprises will result in a sudden reflex rally similar to those we’ve already seen.

Our Staff
Highstreet utilizes a team approach to the overall investment management process. We understand investing and the responsibility that goes along with prudent management. We are committed to forming a long-term relationship with our clients and providing them with the best possible client service experience. If you have any questions regarding our firm, please contact one of our staff members.

CLIENT SERVICE
Jody D. Clermont Chief Operating Officer Email: jclermont@highstreet.us
Michaeline K. Whitney Client Coordinator Email: mwhitney@highstreet.us
Thomas J. Sherk Communication Coordinator Email: tsherk@highstreet.us
RESEARCH | TRADING | PORTFOLIO MANAGEMENT
John J. Bartoletta Chief Executive Officer Email: jbartoletta@highstreet.us
Darren J. Clauws, MBA Chief Investment Strategist Email: dclauws@highstreet.us
Dan Nissen Research Analyst Email: dnissen@highstreet.us

FOR ADDITIONAL INFORMATION: If you would like to follow our strategy online, please visit our website at www.highstreet.us or contact us at marketing@highstreet.us to request access.

TO SCHEDULE AN APPOINTMENT: If you would like to schedule a consultation with one of our representatives please contact the office at 813.910.2500.

The Highstreet Group of Companies

Highstreet Group, LLC
Highstreet Network, LLC
Highstreet Financial, LLC
Highstreet Investment Advisors, LLC

Corporate Headquarters

Highstreet Group, LLC
12802 Tampa Oaks Boulevard, Suite 405
Tampa, Florida 33637-1915 • USA
813.910.2500 Telephone
813.910.2501 Admin Facsimile
813.910.2502 Trading Facsimile
Website: www.highstreet.us

Disclosures: Highstreet prepared this report and takes sole responsibility for its content and distribution. Data was prepared with the assistance of our research sources. The content may have been based, at least in part, on material provided by our third-party research provider. Our third-party research provider has given Highstreet general permission to use its research reports as source materials, but has not reviewed or approved this report, nor has it been informed of its publication. Our third-party research provider may from time to time have long or short positions in, effect transactions in, and make markets in securities referred to herein. Our third-party research provider may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any company mentioned in this report. Highstreet endeavors to make all reasonable efforts to provide research to all eligible clients, having regard to local time zones in overseas jurisdictions. In our investment advisory accounts, Highstreet will act as discretionary investment manager for our clients and will initiate transactions for those accounts. These transactions may occur before or after your receipt of this report and may have a short-term impact on the market price of the securities in which transactions occur. Highstreet research is posted to our Web site to ensure clients receive coverage initiations and changes in our investment strategy in a timely manner. Additional distribution may be done by marketing and consulting personnel via e-mail, fax, or regular mail. Please contact Highstreet for more information regarding Highstreet research. Highstreet is registered with the State of Florida Office of Financial Regulation as an investment adviser, offering investment advisory services. Highstreet Policy for Managing Conflicts of Interest in Relation to Investment Research is available by request and conflicts of interests related to our investment advisory business can be found in Part II of the Firm’s Form ADV. Copies of any of these documents are available upon request through our office. We reserve the right to amend or supplement this policy, Part II of the ADV, or Disclosure Document at any time. The author(s) is/are employed by Highstreet Financial a division of the Highstreet Group, LLC with principal offices located in Tampa, Florida USA.

Additional Disclosures: This comment is prepared by the portfolio managers of Highstreet. All views expressed are the opinions of the portfolio managers based solely on the historical technical behavior (price and volume) and their expectations of the most likely direction of a market or security. No guarantee of that outcome is ever implied. These opinions may differ from the fundamental research view(s) of Highstreet, its affiliates or its research providers. The issuance of this report does not constitute coverage of any of the issuers referenced herein and the technical opinions contained in this report are subject to change without notice. Highstreet has no obligation to inform you of such a change. The information contained in this report has been compiled by Highstreet and the portfolio managers of Highstreet, from sources believed to be reliable, but no representation or warranty, express or implied, is made by Highstreet, its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this report constitute Highstreet judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. This report is not, and under no circumstances should be construed as, a solicitation to act as securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice. This material is prepared for general circulation to clients, including clients who are affiliates of Highstreet, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Highstreet nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Highstreet. Copyright © Highstreet, 2019.