Weekly Investment Strategy

Key Takeaways

• Activity levels continue to point to economic strength.
• Negative seasonality and heightened valuations are risks to the market.
• We caution investors from becoming overly complacent.

“Traffic” is the dreaded price we all pay every year as we make our way to the beach for summer vacations. This past week, as my family was making a trip to the Jersey shore, we got stuck in what seemed like never-ending traffic which got me thinking. With all the time I had looking at overhead traffic lights and the brake lights of the cars ahead of me, never have three colors so clearly matched my mood (from “happy” green to “frustrating” red) to our views of the economy and financial markets.

• Green Means Go | The US economy is likely to keep “moving” with limited risk of recession over the next 12 months. Although it can be incredibly frustrating at times, believe it or not, traffic can provide a solid read on the health of the economy and is one of our favorite real-time indicators of economic activity. The thought process is that the more confident consumers are, the more they drive and take vacations. With total miles driven in the US at a record high, it is consistent with this week’s elevated consumer confidence (as the expectations component rose to the second highest level since 2000) and strong personal consumption (2Q19 posted the second strongest quarter over the past five years.) Our other real time indicators similarly suggest the US economy remains on solid footing. Withholding taxes, which is a daily statement released by the Treasury Department that reflects the amount of taxes withheld from employees’ paychecks, has moved to record highs and is growing ~9% on a six month annualized basis, which is in the 90th percentile relative to all other time periods. Continued strength in the labor market should support consumer spending and economic growth going forward. Activity levels remain healthy with truckloads at record highs and air freight cargo nearing record highs. With the Fed cutting interest rates 25 bps this week for the first time in 11 years (and likely to cut one more time in October), the economy should be able to maintain its momentum and keep growing (our 2019 GDP growth estimate is +2.1%).
• Yellow Means Caution | The S&P 500 is currently up 19.2% year-to-date (YTD), which is the second best start to a year in over 20 years. Recent catalysts for the S&P 500 have been a better than expected 2Q19 earnings season and the dovish shift in global central bank policy. However, given the recent rally, valuations have moved higher and the S&P 500 is trading at its highest P/E since March 2018. While fundamentals support a move higher longer term, some near-term volatility may be warranted to digest the recent gains. It is important to note that despite 2Q19 earnings season likely to land in positive territory (at ~1-2%), 3Q19 EPS estimates have shifted into negative territory (-1.3% year-over-year (YoY)) and full-year 2019 and 2020 EPS estimates have each been revised down 5% year to date. The continued move lower in forward earnings expectations, in conjunction with negative seasonality (August and September are historically two of the weakest months for equities) could lead to near-term weakness for the equity market. With the equity market flashing yellow, precaution is warranted in deploying new capital.
• Red Means ‘Stop’ and Be Aware | In addition to stopping at red lights, investors also need to watch the brake lights of the car (and risks) in front of them and not get too close so they can safely stop, if needed. The rally in equity markets have led to the market being priced to perfection and investors becoming complacent around many upcoming risks. As an example, increased optimism around aggressive central bank actions has been met by disappointment (and sell-offs) the last two weeks. The ECB not cutting rates immediately last week and the Fed not committing to more rate cuts in the near term has led to modest equity declines. This week’s tweet by President Trump announcing that a 10% tariff would be applied to the remaining $300 billion of Chinese imports starting on September 1 reminded the markets that trade frictions have not vanished. Other risks on the horizon include Brexit concerns with new Prime Minister Boris Johnson threatening a no deal Brexit and political rhetoric as we head into the 2020 election. Elevated valuations, low volatility, and rising equity investor sentiment serve as warning ‘brake’ signs of the potential of an uptick in volatility and the reason for our recent cautiousness on the equity markets.

Additional information is available on request. This document may not be reprinted without permission.

Raymond James & Associates may make a market in stocks mentioned in this report and may have managed/co-managed a public/follow-on offering of these shares or otherwise provided investment banking services to companies mentioned in this report in the past three years.

RJ&A or its officers, employees, or affiliates may 1) currently own shares, options, rights or warrants and/or 2) execute transactions in the securities mentioned in this report that may or may not be consistent with this report’s conclusions.

All expressions of opinion reflect the judgment of the Equity Research Department of Raymond James & Associates at this time and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Other Raymond James departments may have information that is not available to the Equity Research Department about companies mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this presentation’s conclusions. We may perform investment banking or other services for, or solicit investment banking business from, any company mentioned. Investments mentioned are subject to availability and market conditions. All yields represent past performance and may not be indicative of future results. Raymond James & Associates, Raymond James Financial Services and Raymond James Ltd. are wholly-owned subsidiaries of Raymond James Financial.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Investors should consider the investment objectives, risks, and charges and expenses of mutual funds carefully before investing. The prospectus contains this and other information about mutual funds. The prospectus is available from your financial advisor and should be read carefully before investing.