2019 Yearly Forecast

 Random Predictions For 2019

1) Early last year we predicted that the US stock market would experience greater-than-average volatility over the year ahead. This obviously happened, as there were more 2%+ single-day moves in the SPX during 2018 than in an average year.

We expect the same for this year, that is, we expect price volatility to remain elevated. The reason is that the two most likely scenarios involve abnormally-high price volatility. One of these scenarios is that a cyclical bear market began last October, and bear markets are characterised by periods of substantial weakness followed by rapid rebounds. The other scenario is that a very long-in-the-tooth cyclical bull market is about to embark on its final fling to the upside.

2) When attempting to predict when a period of economic growth will end it is futile to look more than 6-12 months into the future, because there are no leading recession indicators that can predict that far ahead with acceptable reliability. There are, however, leading indicators that can be used to determine the probability of a recession beginning within the next few quarters.

Early last year these indicators told us that a US recession would not begin during the first half of the year. They currently tell us that the US economy stands a good chance of commencing a recession this year, most likely during the second half of the year. Note, though, that if a recession does get underway this year it won't become official until 2020, because recessions usually aren't confirmed by the National Bureau of Economic Research until about 12 months after they start.

3) Regarding 'cryptoassets', at around this time last year we wrote:

"...it's a good bet that the Bitcoin bubble reached its maximum level of inflation late last year. Also, the broader bubble in cryptoassets is set to burst during the first quarter of this year."

And:

"By the end of 2018 it will be apparent that the public's enthusiasm for Bitcoin and the "alt-coins" was one of history's great speculative manias."

This assessment looks correct.

We don't have a strong opinion about what will happen to 'cryptoassets' in 2019. This is partly because there is no reasonable way to determine the fair value of these assets. For Bitcoin, for example, a price of $3,000 is no more or less sensible than a price of $30,000 or a price of $300.

Distributed ledgers can be very useful, but there should be ways to implement them without consuming a lot of resources. If so, the price of Bitcoin eventually will drop to almost zero.

A year ago we also predicted:

"Despite spectacular collapses in the prices of the popular 'cryptoassets' during 2018, central banks including the Fed and the ECB will firm-up plans to introduce their own blockchain-based currencies. This will be driven by a desire to eliminate physical cash, the thinking being that if there is no physical money it will be more difficult for the average person to make/receive unreported payments and escape a negative interest rate."

As far as we know the major central banks didn't firm-up plans to introduce their own blockchain-based currencies last year, but we continue to expect that they will -- for the reasons mentioned above.

4) Regarding the Fed's expected actions in 2018, early last year we wrote:

"Due to rising commodity prices it's a good bet that "price inflation" will become a higher-profile issue during the first half of 2018, prompting the Fed to move ahead with its quantitative tightening (QT) and make two more rate hikes. However, both the QT and the rate-hiking will be put on hold during the second half of the year in reaction to increasing downside volatility in the stock market."

We got the anticipated rate hikes during the first half and the increasing downside stock-market volatility during the second half of last year, but the Fed stuck to its guns. However, over the past three weeks the Fed Chairman has made it clear that the Fed will be quick to change direction if the stock market continues to decline and/or the economic numbers point to significant weakness.

For 2019 we expect one Fed rate hike, most likely in June. Also, we expect that people 'in the know' will explain to senior Fed members that it's the balance-sheet reduction program (QT) that really counts, prompting the Fed to slow the pace of QT during the first half and conclude the QT program before year-end.

5) The ECB has just ended its QE program and has a tentative plan to implement its first rate hike during the third quarter of 2019. Given that nothing has been learned from the failed monetary experiments of the past few years, it's a good bet that evidence of declining economic activity in the future will be met by the ramping-up or reintroduction of policies that failed in the past. Therefore, we predict that the ECB will not increase its targeted interest rates this year and will restart QE during the second half of the year.

6) This is not a prediction for 2019, but rather an observation that could apply for decades to come. We suspect that the age of real estate has ended.

We don't mean that from now on it will be impossible to achieve good returns by investing in real estate, but that gone are the days when anyone could buy a house almost anywhere and likely end up with a sizable profit as long as they held for 10 years or more. From now on only astute investors will consistently make good returns from real estate, where "astute" means able to time the cyclical swings in the broad market or able to correctly anticipate future supply-demand imbalances in specific areas.

For the average person, residential property will transition from an investment to what it was prior to the 1970s: a consumer good (something bought solely for its use value).

The reason for the change is the interest-rate trend. The 3-4 decade downward trend in interest rates resulted in a 3-4 decade upward trend in housing affordability for buyers using debt-based leverage (that is, for the vast majority of buyers). There were corrections along the way, but provided that long-term interest rates continued to make lower lows there would eventually be a pool of new debt-financed buyers able to pay a much higher price.

There's a good chance that the secular interest-rate trend reversed from down to up during 2016-2018. If so, future house buyers that don't have good timing and/or substantial area-specific knowledge generally won't make long-term capital gains on their residential property purchases.

 The US Stock Market

This was our 2018 stock market forecast, penned at around this time last year:

"...the monetary backdrop only turned negative about three months ago and it can take 6-12 months for the effects of such a shift to become apparent in the financial markets and the economy. Also, there is not yet any evidence in the yield curve or credit spreads that the tightening of monetary conditions has become critical. We therefore expect that the stock market will work its way upward during the first half of 2018, although we also expect that the advance will be 'choppy' and include a Q1 correction of 5%-10%.

At some point during the second half of 2018 the tightening of monetary conditions should become critical, with a 15%-25% SPX decline being one of the most obvious consequences. Whether or not this decline marks an end to the bull market will depend on the central-bank reaction at the time, in that a rapid policy shift from monetary tightening to loosening could extend the long-term advance.

We expect that commodity-related stocks will be among the best performers during the first half of the year, but that all sectors of the stock market will suffer large declines during the second half with the possible exception of the gold-mining sector."

The annual forecast (educated guess) we made in early-2018 turned out to be very close to the mark.

Here is this year's educated guess:

It isn't yet certain that the stock market decline that unfolded during the final quarter of last year was the first leg of a bear market, but arguing in favour of a bear market is:

a) The fact that the G2 monetary inflation rate has been in 'bust territory' since September-2017.

We noted a year ago that it can take 6-12 months for the effects of a substantial negative shift in the monetary backdrop to become apparent in the financial markets and the economy. It is now 15 months since the negative shift and the effects are readily apparent. Moreover, with the Fed still intent on withdrawing money from the economy via its balance-sheet 'normalisation' program there is no reason to expect a meaningful up-turn in the 'liquidity' situation in the near future. 

b) The widening of credit spreads that began last October.

c) The pronounced reversal in NYSE Margin Debt from expansion to contraction.

d) The SPX/euro ratio's monthly close below its 20-month MA in December-2018.

However, some early-warning signs of a bear market are still missing, chief among them being a yield curve reversal from flattening to steepening.

In any case, there is no requirement to make the big forecast (bear market or not). This is because there is a high probability of the December-2018 lows being decisively breached during 2019 regardless of whether or not a bear market has begun.

Getting more specific, over the past three weeks we have written that the SPX probably would form a multi-month 'W' bottom, involving an initial rally from the December low followed by a decline to test the low and then a longer/larger rally. We continue to expect something along these lines to materialise during the first half of the year, with reduced US-China trade friction being one of the 'justifications' for the rally. If it does it will set the stage for a multi-month decline to well below the December-2018 low.

Our guess is that the SPX will end the year with only a single-digit percentage loss, but that there will be a 15%-25% decline from the first-half peak to the second-half trough. We expect the large decline from the first-half peak to be driven, in part, by rising long-term interest rates.

    The Currency Market

Last year's annual forecast for the currency market was more wrong than right. We expected US$ weakness during the first half and US$ strength during the second half of the year, but the Dollar Index (DX) trended upward from a February low to a November high. However, our US$ True Fundamentals Model (UTFM) was correct. The UTFM was bullish all year, apart from a single week in April when it was whipsawed.

The DX is dominated by the USD/EUR exchange rate, so the fundamental drivers of the DX are the same as the fundamental drivers of the euro. Of these drivers, one of the two most important is the interest-rate differential.

Now, there are many interest-rate differentials, but we've found that the spread between Germany and US 10-year government bond yields is the one with the strongest and most consistent relationship with the euro/US$ exchange rate. The following chart compares this interest-rate spread with the euro. Note that on this chart as well as on the next two charts it's the direction of the fundamental driver that matters, not the absolute level.



The other main driver of the EUR/USD exchange rate is relative equity-market performance. For this we use the EZU/SPY ratio (the iShares MSCI Eurozone ETF versus the S&P500 ETF). The following chart compares this ratio with the euro.



The Germany-US 10-year interest-rate spread and the EZU/SPY ratio are the only inputs to the UTFM. It's a simple model. However, we also pay attention to how European bank stocks are performing relative to their US counterparts by using the EUFN/KBE ratio (iShares MSCI Europe Financials ETF versus the US S&P Bank ETF). Here's the chart:



With reference to the above charts, notice that the sharp upward move in the euro from early-November of 2017 to late-January of 2018 was counter to the fundamentals. This is not uncommon in the currency market. The fundamentals are a form of pressure and if the fundamental pressure persists it eventually will force the price into line, but the price can diverge from the fundamentals for up to 6 months.

There are tentative signs in the above charts that a fundamental shift in the euro's favour is underway. Due to the relatively attractive equity valuations and the ridiculously low interest rates (both relatively and absolutely) in Europe, our guess is that the shift in the euro's favour will continue. Therefore, we expect that the euro will trend upward, and by extension that the DX will trend downward, for the bulk of this year.

Apart from that, we expect that the major commodity currencies (the A$ and the C$) will perform well during the first half of the year in response to rising prices for industrial and agricultural commodities, and that the British Pound will have a good year despite the Brexit mess.

   T-Bonds

Here's how we summed up our 2018 T-Bond forecast:

"We expect that...major support [as defined by the 84-month MA] will hold if tested during the first quarter but will be breached during the second quarter in response to rising fear of "inflation". 

In the second half of the year we expect to encounter substantial 2-way bond-market volatility, with a strong 2-3 month rally at some point in reaction to falling equity and commodity prices.

Overall, we are anticipating a down year for the T-Bond (an up year for long-term interest rates), but not a large decline. We expect that major weakness in 'risk free' government bonds will be one of the next decade's big stories."

Last year's guess was excellent for government work and still OK for the private sector. We got the expected breach of major support during the first half of 2018 and the strong 2-3 month rally in reaction to falling equity and commodity prices late in the year. Also, it was a down year for the T-Bond, but not a large decline (the T-Bond price was down by about 4%). The only 'miss' was that we expected the T-Bond's break below major support to happen in Q2, but it happened in Q1.

This year's forecast (guess) is for an extension of the rebound that began late last year to a top within the first four months of the year, followed by a decline to a new 5-year low. Whereas last year's T-Bond price weakness was driven by the Fed's tightening campaign and a small increase in inflation expectations, this year's weakness will be driven by fear of the veritable explosion in US federal debt that is bound to occur during the next recession. It's likely that within the next three years there will be a 12-month period during which the US government increases its debt by more than $2 trillion, and that will be just the beginning of a self-reinforcing debt spiral as rising interest rates lead to greater deficits.

As was the case a year ago, we are anticipating a down year for the T-Bond (an up year for long-term interest rates), but not a large decline. Our bearishness regarding the T-Bond's prospects over the coming 12 months is lessened by the likelihood that after the senior US stock indices break well below their December-2018 lows there will be another flight towards the perceived relative safety offered by Treasury debt. This should mitigate the T-Bond's annual loss.

Also, we expect that the T-Bond's 84-month MA, which acted as support for three decades prior to last year, will now act as resistance during counter-trend rallies. As illustrated below, this MA is presently in the high-140s. We won't be surprised if there is an intra-month spike into the 150s within the first few months of this year, but on a monthly closing basis the T-Bond's upside should be capped at 148-149.

 

Due to the fear of future bond supply and an increasing general desire to hold only the most liquid debt securities, the demand for short-term Treasury debt should rise relative to the demand for long-term Treasury debt during 2019. This will cause a pronounced steepening of the US yield curve.

Lastly, we reiterate that major weakness in 'risk free' government bonds will be one of the NEXT decade's big stories. Secular interest-rate trends turn around like fully-laden supertankers.

   Gold and the Gold Mining Sector

There were hits and misses in our 2018 gold market forecast. We were right that during the first half of 2018 gold would lose ground relative to commodities in general. We were also right to mention the potential for gold to be boosted during the second half of 2018 in both nominal dollar terms and relative to commodities by serious stock market weakness and a strong rebound in the T-Bond. However, we were wrong to expect gold to make a significant first-half gain in US$ terms.

We usually find it easier to come up with a prediction for what gold will do relative to commodities (as represented by a broad commodity index such as GNX) than to predict what gold will do in US$ terms. The main reason is that whereas there are several strong influences on the US$ gold price, the gold/commodity ratio consistently trends in the same direction as the 30-year T-Bond.

The strong positive correlation between the T-Bond and the gold/commodity ratio (gold/GNX) is depicted below.



Our 2019 T-Bond forecast is for a price top during the first three months of the year at not far above the early-January high, followed by a 1-2 quarter decline to new multi-year lows and then a rebound in response to stock market weakness. This leads us to expect that the gold/commodity ratio will top-out during the first quarter of this year (if it didn't already peak near the end of last year), trend downwards for 1-2 quarters and then rebound strongly into year-end.

What happens to the US$ gold price will depend to a large extent on what happens to the Dollar Index (DX). In this regard it is significant that the fundamental backdrop has begun to shift in the euro's favour. If this shift continues then the US$ gold price will be boosted by US$ weakness over the next several months. In fact, this is the most likely outcome.

We expect that the US$ gold price will rise during the first 3-6 months of 2019, but that the advance will be 'choppy' for two reasons. The first reason is that the market began the year in an 'overbought' condition. The second reason is that a continuing recovery in the stock market during the first half of the year will reduce the demand for 'safe havens'. 

During the second half of the year, a downside breakout in the stock market could lead to substantial strength in the US$ gold price. Our guess is that gold will trade near US$1500/oz before year-end. 

Turning to the gold-mining sector, if the stock market was always rational then gold-mining stocks would always trend with the gold/commodity ratio. This is because the trend of the gold/commodity ratio indicates the trend of gold-mining profit margins. On a long-term basis the gold/commodity ratio does exert considerable influence on the gold-mining indices, but in the short-term the US$ gold price tends to dominate.

Therefore, we expect that the gold-mining indices will do something similar to the US$ gold price in 2019. This means that we are anticipating a 'choppy' advance during the first 3-6 months and a substantial multi-month rally at some point during the second half. The difference is that the gold-mining indices likely will be much more volatile than the bullion price. In particular, gold-mining stocks could be pulled down by a large stock-market decline and then rebound ferociously after the Fed makes a rescue attempt.

There's the potential for the gold-mining sector to make a big catch-up move this year, that is, to greatly outperform gold in 2019. However, at the time of writing there is no evidence that such a catch-up move has begun.

   Commodities

Early last year we wrote that the basket of commodity prices that constitutes the GSCI Spot Commodity Index (GNX) was set to trend upward during the first half of 2018. We also wrote: "If the first half pans out roughly as expected then the second half should contain a lot more downside volatility. In particular, we expect that a substantial decline in the broad stock market during the second half will lead to pronounced weakness in the prices of industrial commodities as the dominant concern temporarily shifts from "inflation" to "deflation"."

The following chart shows that this forecast was close to the mark, although not all of our reasoning was correct.



We suspect that this year will be similar to last year, with strength in the industrial commodity markets during the first half and a multi-month period of substantial weakness during the second half in response to stock-market turmoil.

With regard to oil, there are three reasons to expect an upward trend during the first 5-7 months of the year. The first is oil's strong positive correlation with the stock market and the likelihood of the stock market having an upward bias for a few months before resuming its longer-term downward trend. The second is the extent to which oil and oil service stocks were 'oversold' at the December-2018 bottom. The third is the 10-year cycle, which projected an important low late in 2018. The 10-year cycle actually points to the oil-price upward trend extending throughout 2019, but at this time all we are anticipating is a first-half rally.

For the base metals, a strong first half should result from the combination of low inventory levels, a stock market recovery, the temporary winding-down of the US-China trade conflict and US$ weakness. There is more uncertainty in our second-half outlook, but if the stock market does what expect then base metal prices could suffer large declines.

The only other commodities we will single out are uranium and platinum.

We doubt that uranium has commenced a bull market, but, as mentioned in the past, we do think that it made a long-term price bottom near $18/pound in late-2016. We think that it is in the process of building a long-term base in the $20-$40 range and that the top of the base ($35-$40) will be tested in 2019.

Of the commodities we follow, in 2018 platinum was one of the two that deviated the most from our expectations in a bearish way. The other was cobalt. We wrote a year ago that the shift to a platinum/gold ratio of less than 1 was permanent, with gold benefiting from the increasingly manipulative/counter-productive efforts of central banks and platinum being hurt by the trend towards an all-EV world. However, despite expectations that weren't over-the-moon bullish, last year platinum still managed to disappoint.

Looking forward, there are signs in platinum's price action that a major bottom was put in place last August near $760/oz and we expect the recovery to continue over the months ahead. At a minimum, the platinum price should return to the $900s during the first half of this year.