The pain trade is higher The pain trade is higher\images\insights\article\laser-cutting-metal-small.jpg January 21 2020 December 4 2019

The pain trade is higher

We view pullbacks as opportunities to add.
Published December 4 2019
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After a near-vertical climb off early October lows, stocks appear to be in an overdue and very natural consolidation phase. It’s never a one-way trip. But our view that the S&P 500 will end the year above our longstanding 3,100 target for 2019 still holds, as does our 3,500 year-end target for 2020. Our equity team continues to recommend that investors add to positions on dips, which in this environment are unlikely to last long. We suggest a particular focus on cyclical “value” sectors such as industrials, tech hardware/computer chips, financials and if China also begins to rebound, maybe materials/energy.

To be sure, among the value pile are plenty of melting ice cubes that will struggle to sustain even current levels of revenue and cash flow, so stock picking will be key. But generally, for reasons we lay out below, the economy is expected to perk up and the yield curve to steepen a bit more in the months and year ahead. This should help underperforming value stocks have their day, with the recent pullback adding to the attractiveness of some of these names. Key catalysts include:

  • A manufacturing sector that is about to turn up The downturn that started a year ago appears to be bottoming as it laps weak year-ago numbers, and there are signs the same may be true in Europe and Asia. If the skinny “Phase One” deal gets signed this month as we anticipate, this could provide the confidence spark to reignite activity. Federated’s macro team is forecasting real GDP to grow a well above-consensus 2.4% next year, with a bias to the upside. The services sector as suggested by today’s nonmanufacturing ISM remains pretty healthy in our view and, remember, services represent by far the largest part of the U.S. economy.
  • A U.S. consumer who is confident and spending Early indicators suggest a very strong holiday sales season, with consumers bolstered by the best labor market in 50 years, rising real wages, low inflation and elevated sentiment that seems to be unaffected by all the D.C. noise. Indeed, the strength of this consumer has been powering the economy through all of this year’s geopolitical messiness and trade worries. With employment strong, there’s little reason to expect this to suddenly stop on a dime.
  • The Fed is on hold for at least a year.  After the recent reversal on policy (again), Chair Powell cannot afford to get cute. And once we get into midyear, the election year cycle is likely to prevent him politically from acting on rates. So we have a hall pass from the Fed to buy stocks, with all the liquidity Powell and his compatriot Christine Lagarde at the European Central Bank are pouring into the markets serving to continue to provide a bid for financial assets.

While tweets and comments from President Trump out of the NATO summit unnerved markets about a trade deal, both he and China President Xi need a truce. China is suffering more economically for sure, but a skinny deal would help keep the U.S. economy and markets buoyant, too. Without this, Trump could face a difficult campaign in 2020.

As evidenced by equity fund outflows and heavy short positions for much of this year, most investors remain on the wrong side of the stock trade. It was fascinating to us to see how many bears came roaring out to the closet yesterday calling for a market top. They are clearly mispositioned and keep jumping on any possible rationale to sell. We think this—along with the reasons above—creates a market-supportive Wall of Worry not just through year-end but well into 2020. The pain trade is higher.

Tags Equity . Markets/Economy . Volatility .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

Federated Global Investment Management Corp.