How the heck is it possible that the S&P 500 could be up 25% this year and so few stocks - 64 - are down for the year?
We are on the verge of a step up in the trade war. Our country is divided as I have never seen it. The earnings for next year are barely expected to be up. We have an avowed socialist as a potential winner in the Democratic primary and another who wants to mount a tax campaign against the rich. And the market keeps going up and up.
How is all of this possible?
Let me take a stab at what's going on here.
First, the year got off to a start that was severely depressed by the Federal Reserve's decision to tighten when it should have been loosening. That's the single most important part of the equation for most people.
The S&P 500, after getting blasted in October by the Fed with Jerome Powell talking about the need for four Fed hikes - one in December of 2018 and three in 2019 - collapsed from 2931 to 2343. When the Fed reversed that pummeling reversed like a coiled spring to where we are now at 3158.
I don't want to blame it all on the Fed. At the same time the Fed got hawkish, Vice President Pence blasted China for everything from economic to human rights violations that turned out to be one of the most important speeches of the Trump era. Pence staked out the position that China could be the new Soviet Union and it, and its hegemonic initiatives, had to be curtailed. The speech seemed so harsh that it was unprecedented, a full-scale doctrine that has never been ameliorated by the Chinese or repudiated by the president.
It wasn't just politics or the Fed that caused the market to get crushed. Apple (AAPL) preannounced a very weak quarter right when the year began. The stock had already been beaten up after it hit a high of $231 at the beginning of October, but it traded down to $142 on the preannouncement. That's a staggering decline.
So earnings, Fed policy, and trade were all dead set against the bulls coming into the year. That allowed the Armageddonists, as Michael Cembalest, an incredibly important markets commentator over at JP Morgan (JPM) , to take the microphone and predict the trendlines.
Apple, we heard, was the forerunner to the most important cohort: tech. The December hike was merely a prelude to the coming disastrous short-term increases that would invert the yield curve, a sure sign of a coming recession. The Pence speech meant there would be no trade deal, just the opposite.
And what happened?
First, Apple turned out not to be a forerunner at all: not even for Apple. In fact the preannouncement served as the bottom in the stock and in a remarkable, Lazarus like resurrection, the stock rallied on the strengths of its iPhone numbers, but, more important, its ecosystem. At the end of 2018 Apple decided not to breakout the number of cellphones that it sold because it felt that the number was not representative of how the company was doing. The Apple Armageddonists, incorrectly, took it a as a sign that Apple's growth was over. But it turned out that was the beginning of Apple as a consumer product company, with a host of subscription services augmenting the total earnings.
As someone who had pushed, endlessly, for the breakout of the service revenues, this preannouncement set the year up nicely for the recognition that Apple could make a ton of money away from cellphones. The next frontier? Apple has tremendous customer satisfaction. That means the accouterments of Apple, the watch, the airpods are necessities. With a 99% customer satisfaction you can pretty much figure out the lifetime value of a customer. The market ALWAYS pays more for a sticky subscription growth model than an episodic model so watch the price-to-earnings multiple increase.
Tech wasn't done with just Apple. This was a year that saw continued growth of the data center at the beginning of the year and then 5G at the end of the year. Given that so many tech companies straddle both worlds, it was a natural that tech left the cyclical and joined the secular in growth.
I don't like to emphasize the Fed too much but given how many firms seem uniquely focused on what the Fed does and how it phrases its actions - something we are going to see Wednesday when the Federal Open Market Committee releases its next move - you can only consider 2019 a tour de force, you your face beatdown of the rate armageddonists. Powell, seeing the err of his ways, switched direction and started a cutting cycle. Of course, it wasn't called a cutting cycle. Each time it was called something new, like a mid-course correction. That's fine, what matters is so few saw it coming. The thesis had been we had to have a recession, we just had to, because we caught an inverted yield curve. But with the Fed now on the side of the bulls, Powell could determine if there was an inverted yield curve or not. The big news for most of the year, then, was that there would be no recession, something aided by the fact that employment stayed strong all year right down to last week's number. Robust growth made the inverted yield curve a false tell, forcing new money into the market.
That leaves the last imperative that crushed the market last year: trade. This is the one I worry about. The President seems consumed by the impeachment hearings while at the same time recognizing that the Democratic frontrunners are, in his mind, beatable. The President likes to win. I think the market believes a win is a trade deal. I believe the President thinks a win is no deal or at least no deal until the election.
What's the President thinking? It is always hard to gauge but two weeks ago the Communist Party adopted a cybersecutiy stance that no foreign company can encrypt so that it cannot be read by the government. Then this weekend the Beijing ordered government entities to rip out foreign PCs, including those by Dell (DELL) and HP (HPQ) . Of course, Microsoft (MSFT) would be ripped out, too.
Does this sound like the kind of country that wants to make a deal with Trump? Or do these kinds of edicts smack of insults to the President and an embarrassment to the softer wing of the White House: the Secretary Mnuchin wing. For the life of me I can't believe the President is even debating holding off on the December 15th tariffs after our employment number on Friday showed that the economy was more robust than ever and that - get this - the tariffs in his eyes may actually be making America stronger not weaker. So an agreement to roll back tariffs is an anathema.
And here is . On Wednesday Powell says something about how he doesn't know if he is going to cut or hike next year, a really stupid statement that could be in the offing. Then the President walks away from the China table and we come in Monday with the Armageddonists screaming sell, sell, sell!
I want to make it my mission to prepare you for that combination. If neither occurs we soar. If one does we are muted. If both occur - Powell says something silly about maybe raising rates and Trump say something smart about waiting to do a deal in 2020 - then the market declines and you have to be ready to buy.