One of the main reasons stocks hit such a bumpy patch was that the economy had, by many metrics, heated up to an unsustainable degree. Readings of measures like core producer price inflation and wage inflation hit their highest levels of the current cycle.
Such economic fervor was expected to prompt the Federal Reserve to hike interest rates, lessening the appeal of equities versus their fixed-income peers. And investors didn’t wait for the hikes to come. They sold stocks and asked questions later.
But at least one Wall Street expert is ready to call off the dogs. That would be Jim Paulsen, the chief investment strategist at Leuthold Group, who recently argued that a “recession will be avoided in the foreseeable future.”
For one, he doesn’t buy a flattening yield curve as a recession signal. Paulsen notes that while junk yield spreads have widened, they’re still tight compared with the periods before previous recessions.
Beyond that — and perhaps most important — Paulsen says private balance sheets are “remarkably healthy” for an economic recovery that has lasted almost a decade. He cites US household net worth, which is now 60% above its previous all-time high, and falling household debt relative to disposable income.
And then there’s the matter of consumer and business confidence. Paulsen says the latest financial crisis left people so scarred that they only recently regained their old level of conviction.
“Consequently, it is difficult to find ‘extremes or excesses’ today which would normally be more obvious in a recovery this old,” he wrote in a recent client note. “Lending and borrowing have not been excessive, consumers have not overused their credit cards or over-stretched into mortgages, and they have not run through their savings.”
These developments have Paulsen looking ahead at a potential stock-market rally — and a sharp one at that. He’s even gone to the extra length of declaring that the market has bottomed.
One big reason for that is the arrival of investor panic. While it may seem counterintuitive to view this as a positive, a healthy dose of skepticism can benefit the market in the longer term and keep traders from being blindsided by sudden selling.
In terms of the Fed — which is always the elephant in the room when discussing the stock market in 2019 — Paulsen says it’s been “almost ensured” the central bank will not raise rates further anytime soon. He notes that overheating conditions have cooled off considerably, which has been coupled by a large decline in 10-year Treasury yields.
So the path has been cleared for a stock-market rebound. Paulsen has made that much clear. As for how much he thinks the S&P 500 can rally, he says it will most likely reach anywhere from 2,800 (a 9% increase) to 3,000 (17%).
With all of that established, Paulsen has five distinct stock-trading strategies to help investors take advantage of a 2019 rally. They are as follows. All quotes attributable to Paulsen.
1) Favor international markets over their US counterparts
“Both international developed and emerging stock markets are a better relative value compared to the US stock market. Overseas stock markets are under-owned in most portfolios. While US economic growth may be slowing, growth may already be accelerating again abroad. And finally, a weak US dollar would augment foreign investment returns.”
2) Buy weak US dollar beneficiaries
“Materials, energy, and industrials sectors should be bolstered by dollar weakness. It would not only raise commodity prices but also improve the competitiveness of US industrial activities.”
3) Buy financials
“Last year, financials were pounded by Fed tightening, a flatter yield curve, wider credit spreads, and rising recession anxieties. If the recovery slows, but persists, all of these negative influences should pause, if not reverse.”
4) Buy small-cap stocks, which should outperform this year
“They significantly underperformed the S&P 500 in 2018 and should have greater upside leverage to a period of renewed optimism.”
5) Reestablish an overweight in tech, but focus on small caps
“The FAANGs remain too popular and widely owned as most investors still hope for a sharp recovery once the stock market improves. Small-cap tech stocks have been matching the performance of their larger brethren, many without facing the thorny and unresolved issues which currently challenge the FAANGs.”