January 14, 2020

Gulf War III was certainly not part of any econometric models, but it came close – with a predator drone strike and an Iranian retaliation. Who knows what Shiite militias on the ground in Iraq will cook up in the coming months, but the situation is not as bad for Iran as it seems at first glance, despite its unfortunate downing of a Ukranian airliner. Iraq is now firmly on their side with the Iraqi parliament voting on a resolution to have U.S. troops leave the country, and the Iraqi prime minister asking the American side for a timetable for this withdrawal. If that does not help Iran’s influence in the region, I don’t know what will.

If Gulf War III is ultimately averted in 2020, the U.S. economy should reward us with re-accelerating earnings growth, an election cycle, and unemployment at 50-year lows, which in theory should be good for the incumbent in the White House. In the last year, the stock market has largely followed seasonal patterns in effect since 1926 (see chart, below), and if no Iranian wild cards surface, it may do so in 2020.

Standard and Poor's 500 Total Return Index Average Monthly Returns Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Right now, stocks are “overbought,” as traders like to say, both from a weekly and daily readings on indicators like RSI, but it is my experience that “overbought” and “oversold” are rather nebulous terms that can mean different things to different people. In other words, they are not precise terms.

Standard and Poor's 500 Large Cap Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

“Overbought” can be bullish when an overbought market stays overbought, and “oversold” can be bearish when an oversold market stays oversold. The weekly RSI readings are certainly not as extreme as they were in January 2018, even though those extremes have not been seen for decades for some indexes.

The market is not up as much as it may seem in the last two years, as the weekly close on the S&P 500 in January 2018 was 2872. Last week, the index closed at 3265, so it’s up less than 400 points in two years. There were big selloffs and rebounds, and it feels that we have made a lot of progress but, in reality, the advance on average has been “normal” (if there is such a thing with the current White House occupant).

Since 1950, the U.S. stock market has seen its best performance in the November-May period. Despite February being one of the weaker months, historical averages are by no means guarantees. It is important to remember that the present Phase I deal with China has not yet been signed, even though there are indications that the Chinese will sign it. I think the Chinese dragged the negotiation on purpose into the election cycle in hopes to get a better deal if a new occupant ends up in the White House. In that regard, I doubt there will be a Phase II deal before the November 2020 elections. China would have made a big miscalculation, as many tariffs remain in place and the Chinese economy is in a precarious situation.

A Bull Market in Central Bank Balance Sheets

As the Federal Reserve balance sheet has expanded by over $400 billion in four months, is it any wonder that the stock market is at an all-time high and that credit spreads have contracted. The ICE BofA Merrill Lynch High Yield Master II Option-Adjusted Spread is at 349 basis points at last count (anything under 400 bps is considered a tight spread).

Bank of America Merrill Lynch High Yield Credit Spread Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Quantitative easing (QE, or central bank balance sheet growth) is like printing money, but for financial institutions only. In that regard, it does affect the prices of both stocks and bonds, without (yet) producing hyperinflation, as it does not result in broad money supply growth. I don’t like it, as to a degree involves the perverse central banking maneuver of “fundamentals in reverse.” It first affects the prices of stocks and bonds, which help the economy to recover via refinancing at lower rates, avoiding corporate defaults.

Japan Central Bank Balance Sheet versus European Union Central Bank Balance Sheet Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Still, QE has its limits and even central bankers don’t necessarily know what they are. While QE in Europe and Japan has caused government bond yields there to turn negative, it has not necessarily resulted in better economic performance. Still, QE sure seems to be approaching its limits.

Japan's Shrinking Population Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Japan is a case in point, as it has a shrinking population, which is terrible for long-term GDP growth. The Bank of Japan can print a lot of yen; it can buy all the Japanese government bonds (JGBs) it wants and even cancel those bonds (making debt evaporate), but there is one thing the Bank of Japan cannot do.

It cannot print babies.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

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About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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