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Second Quarter 2019 Forecast and Opinion

The first quarter of 2019 was the best for stock prices since 1998, to such an extent that some caution may be advised in the short term. While the stock market has been climbing, Wall Street analysts have been lowering earnings estimates for the first quarter. In fact median EPS estimates have fallen by 7.2%, which are some of the largest cuts to S&P 500 earnings estimates in years. This is a source of concern.


It’s often a good exercise to be mindful of “the dark side”, even when the market is rising. Fully 1/4 of all the Russell 3000 index, which represents 98% of all US stocks, operate at a loss. Last year, 83% of all IPOs came to the market with negative earnings. Real GDP growth in the US was 4.2% in Q2 18, 3.4% in Q3 18, 2.2% in Q4 18, and is now predicted to come in at 1% for Q1 19. The New York Fed manufacturing index slipped to a two-year low in February, while core capital expenditure orders have slipped in four out of the past five months. Durable goods orders are soft. Consumer spending is slumping, and every automaker reported weak U.S. sales in the first quarter. Consumer confidence appears to be moderating, and small business optimism was down in the first quarter as well.
There are some mixed signals on the economy now, despite the robust employment numbers, which have been primarily boosted by workers over 55 years of age, suggesting that people may be coming out of retirement to support themselves. Real, inflation adjusted wages, after all, have not increased in 25 years.


We are in new territory when it comes to the absolute amount of corporate debt. Companies have taken advantage of low rates over the past 10 years to borrow in order to buy back their own stock and to increase dividends. Now, these companies are increasingly aware that they need to de-leverage, or pay down debt, before they face downgraded credit ratings. This process of pairing down debt will benefit corporate bond holders at the expense of stockholders. The credit quality of corporate bonds is much weaker than at previous credit cycle peaks such as 2000 and 2007. Fifty-six percent of all corporate bond issuers are speculative grade (junk), compared with 49% in 2009. And of the remaining bonds that are considered “investment grade”, nearly 50% of them are rated Baa, the level right before junk. This means that we are one “credit event” away from potentially having $3 trillion of corporate debt downgraded to junk status, which would cast quite a pall on the debt-binge party, as well as increasing borrowing costs for corporations which would in turn impact their profits.


But the real “elephant in the room“ is the size of our national debt. In fiscal 2018 there was a $780 billion federal deficit. Add to that another $420 billion of natural disaster relief, certain military operations, and loans from the Social Security trust, and the federal debt increased by $1.2 trillion.
Out of the $21.5 trillion annual US economy, $1.2 trillion amounts to nearly 6 percent (!)
The tax package and more government spending stimulated the economy at the cost of more debt, just at a time when the Federal Reserve has raised interest rates. On top of the federal debt are the numerous obligations the government has, like Social Security, Medicaid, Medicare, unfunded pensions on a state and local level, etc. For a truly terrifying look at “big picture“ debt levels, check out www.usdebtclock.org, where the unfunded liabilities of the US amounts to $122 trillion, or six times the US annual GDP. If the US spent 10% of its national annual output on debt repayment it would take over 60 years.

But for now, no one foresees any near term triggers for a debt crisis.


For now, the US government spends 1 1/4% of GDP on interest payments.


In the not distant future, the Congressional Budget Office plans on spending 3% of GDP on interest payments by 2025. If there is a recession, this number could be higher. Long-term thinkers might want to consider how this may weigh on both of the stock and bond markets in the future.


The Fed has announced a pause in higher rates, and a pause on the reduction of their balance sheet, which the market welcomed in the first quarter. On March 21st, the Fed forecast a slowing of U.S. growth to 2.1% in 2019, 1.9% in 2020, and 1.8% in 2021.


A trade deal with China should be announced shortly. When it is, it will provide not only another boost for stocks, but an opportunity to lighten up on risky assets in managed portfolios. There is little upside left for stock indices in the short term, given slower growth, higher inflation, and tighter Federal policy. Defensive and value stocks should begin to outperform growth stocks,


As for the bond market, shorter maturities of less than five years are advisable.


The Dow rose 11.6% during the first half, while the S&P 500 was up 13%.

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This report has been prepared by Metis Capital Management LLC. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst responsible for the preparation of this report may interact with trading desk personnel, sales personnel, other analysts, journalists, and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Metis Capital Management LLC is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Metis Capital Management LLC accepts no liability for any loss or damage arising out of the use of all or any part of this report. Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Metis believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

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