April 2018 Market Update

Brian Johnson

Brian Johnson
CIO and Shareholder

By Brian Johnson, Chief Investment Officer

Summary: Signs point to this correction likely being sentiment driven and nearing its end. A healthy earnings season, led by the technology sector, could be just the medicine that the bull market in stocks needs to resume its upward trend.

The father of value investing, Benjamin Graham, liked to say, “In the short run the market is a voting machine, but in the long run it is a weighing machine.”  Two months have passed since the market lows in February, and it appears that the selling that caused the market correction may be giving way to the weight of the evidence suggesting an economy that is simply too strong to allow the market to correct much further.

  • Leading Economic Indicators – At our client event in late February we mentioned the Leading Economic Indicators (LEIs), and specifically the absence of a recession signal. In fact, new highs in the LEI suggest that we are likely at least 12 months from a formal recession[1]. While pullbacks and corrections most definitely occur absent recessions, history shows them to be shorter and smaller than those that occur alongside recessions[2].
  • Sentiment – The consistent rise of U.S. equity markets from November of 2016 through late January of 2018 resulted in investor sentiment reaching unhealthy levels of exuberance. The correction that we’ve experienced these last couple months has served a valuable purpose – it has completely flipped that investor sentiment. Excessive optimism has been replaced by extreme pessimism. Because sentiment is a contrarian indicator, and that shift has not been backed by deterioration in fundamentals, the pessimism actually suggests positive future equity returns.
  • Fundamentals – Market fundamentals remain strong. Price/Earnings (P/E) ratios have dropped, and equities are cheaper relative to bonds as well, with interest rates still at historically low levels globally. We’re watching the technology sector in particular for signs that recent pessimism is overdone. Earnings season provides a renewed opportunity for tech stocks to lead the market higher.
  • Market Leadership – Leading stocks continue to act well. In a healthy market correction, there always exists a group of stocks that correct through time, rather than price, meaning they move sideways while the broad market falls. A number of retail and enterprise software stocks held up well in the face of the correction and are now already making new highs, a positive sign that asset allocators are still willing to add risk to their portfolios.

In summary, despite tariff negotiations, Facebook’s CEO spending two days getting grilled in Washington DC, and raids on the President’s personal attorney’s office, home and hotel, the stock market outlook remains positive. Economic indicators are not signaling a recession on the horizon, sentiment is back at pessimistic (and therefore bullish) levels, fundamentals remain strong, and leading stocks are acting as we want them to, the stock market appears poised to resume its long-term uptrend.

As always, we remind you that everyone’s investment needs are different. What makes sense for you may make little sense for your neighbor. We invest for the long-term and in a manner that we believe has the greatest chance of satisfying your long-range needs, wishes, and goals.  If your goals have changed recently, please give your Viridian advisor a call to chat. In any event, it is truly an honor to play even a small part in helping your dreams come true.

[1] Source – DoubleLine Funds, March 13, 2018

[2] Source – Goldman Sachs Global Investment Research, April 10, 2018

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