Welcome to Real Vision's Trade Ideas.
Today, we're sitting down with Art Hogan of National Securities.
Great to have you back.
Thanks so much for having me.
So, you've been on twice recently.
Once in January, once in March, bullish on the market both times.
And rightly so, we've seen a pretty big run up in the market since the beginning of the
year.
Recently, we've had a little bit of headwinds, especially with the trade war.
We've seen a lot of volatility in the market recently.
How has that impacted your bullish thesis?
That's a great question.
So, just take a step back, the three reasons the markets really turned this year I think
are- in no particular order- I think the Fed has made a pivot.
They've become less hawkish and more dovish.
In December, they sounded like they were on autopilot and they were going to raise rates
agnostic to what was going on in the world.
And they changed that tune.
They changed it in December, changed it again in March.
So, I think the earnings season has been much better than we feared that it would be.
So, coming into the year, we thought we'd have negative earnings growth in the first
quarter of anywhere between 2% and 4%.
Looks like we're going to be positive by 2% or 3%.
So, that's great news.
The third thing was most of the information we've been getting about the US-China trade
talks have been pretty constructive.
Every week, or every month or a couple of times a month, you'd hear somebody in the
administration come out and say things are going well.
And we're almost there.
And we could have a deal in a couple of weeks.
And that all changed over the weekend.
So, Donald Trump came out and said, we're raising tariffs, we're escalating.
And that's the worst-case scenario right now.
And the last thing we want to do is escalate.
We want to get to the end of this trade negotiation process, because it's slowing the global economy
down.
And if we can get this US-China trade deal done and in the rearview mirror, I think that
unleashes a lot of economic energy into the global economy.
And unfortunately, right now, where we thought things were going well, it seems like there's
some slippage in that process.
And I think that's why markets are taking a bit of a pullback.
And in terms of having any resolution to this trade war, is that really dependent on what
the US does?
Or do you see China potentially coming to the table and taking a hit in some way?
That's such a great question.
So, we look at it like this.
First and foremost, both parties feel a little more emboldened by what's been going on in
their economies.
So, for the Chinese, they've put a massive amount of stimulus in their economy and their
economy is actually stabilizing in the first quarter of this year.
And that's good.
And so, they feel stronger.
Their equity markets actually went down significantly last year to the tune of 34%.
And they've rallied this year.
So, they feel like okay, our markets have recovered.
Our economy is stabilizing.
We can probably play the long game here.
On the other hand, the United States feels the same way.
So, we just had a 3% GDP print, we've got 3.6% unemployment.
Markets are at all-time highs last week.
So, we feel empowered or emboldened to both sides are feeling more confident, which unfortunately
means they're going to work harder for themselves in this deal process.
And I think that's exactly what's happening this week.
It's almost like when we think about how the Yankees felt in 2004 in the ALCS, right?
They just won three games and scored 32 runs in three games, 16 or 19 the night before.
So, going into game fourth, they both felt like the Red Sox need this much more than
we do.
I think both sides of this argument feel like the other side needs it more than they do.
And that's what slows things down in negotiations.
Now, at the same time, both sides need to get this done.
They really do.
For China, they need to get it done because it's going to help their economy.
They want to remove most if not all of the tariffs to stimulate economic activity.
And I think that that's- they're desperate to get this done, but they don't want to show
that.
On our side, Donald Trump would love to have this behind him heading into the 2020 election
cycle.
This is something that will help him.
It's also going to help to put this in the rearview mirror because he's hurting farmers
and put costs are higher so builders that need building materials have to pay more.
So, it's inflation with no positive benefit to it.
So, when you fixed prices, you set them at an unnaturally high place.
And it doesn't help at all.
There's no economic benefit whatsoever, and nobody wants a trade war.
So, I think both sides are motivated to get this done.
Unfortunately, both sides are feeling confident right now.
Do you see China potentially waiting until 2020, until there is an election and possibly
some turnover to actually further the trade war negotiations?
Yeah, that's an interesting concept.
It's a long time to wait.
But China works in long timeframes.
They've got a plan that they started 15 years ago that's called China 2025, right?
And by then, they want to have 70% of things that they produced made in China, all of the
parts that everything.
And they want to start selling things.
They don't want to be the purveyor of cheap goods to Walmart.
They want to be the leader in the economy for things like the Internet of Things.
So, they've got a very long-term plan.
At the same time, they've got an economy they have to run.
So, they've got a bit of a tug of war going on.
Do they actually want to wait?
And do they believe Donald Trump won't be around in 2020?
And can they play that long game?
I don't think so.
But it's an interesting concept to think about, especially when there's a lot of domestic
things that are going on that perhaps weaken Donald Trump, and it seems like he's on an
upward trajectory.
It seems like some of the things that China might have been waiting for domestically to
play out have played out and it's time for them to get to the table and make a deal,
I think.
How big of an impact do you see this having on the market going forward in terms of other
things in the markets right now?
As you mentioned, the Fed is fairly dovish, earnings have been decent, or at least better
than expected.
How big of a headwind is this trade were going to be?
Well, I think it's the number one headwind that the markets face right now.
But the thing to think about is, as soon as this is gone, a couple things could happen.
We could start a new trade war with Europe or the eurozone, and the US could start having
tariffs on autos.
And I think that would be going from the frying pan into the fire.
I think that's the wrong thing to do.
And I'm hoping and I'm glad you brought this up.
I'm hoping that the administration looks at this as if that's something we can put off
until after the election cycle, very much like they've punted on health care and saying,
okay, we'll deal with that after 2020.
I think that any new trade wars will probably get put off until.
So, that's this good thing.
The problem with saying, okay, this headwind's out of the way and it's become a tailwind.
What's next is all the things that we've ignored or kept them back burner, come to the fore.
So, what is that?
Venezuela, still going on.
There's a queue there.
The people on either side of that disagreement are pretty big nations like the US and Russia,
and China.
So, that could that could heat up and become an issue.
Iran, we just deployed a lot of military assets to that region.
It wouldn't take much to spark a confrontation.
And right now, we're not talking about that because we're really hyper focused on the
US-China trade war, but you put this behind us and unfortunately, the markets have other
things to contemplate.
But I think it'd be a very good thing.
I think getting the trade war accomplished and removed is going to unleash a lot of economic
energy in the global economy.
I think that helps everybody.
Do you see that once that's resolved, there potentially being another rally in the markets?
Yeah, there's a little bit of a lag time between removing tariffs and actually seeing better
economic data.
It's not going to be immediately.
So, let's say we get a trade deal done on the first half, we're probably start seeing
that manifest itself in better economic data in the first half of next year.
But that's a good thing, right?
And a stronger China economically is better for the eurozone.
So, this helps everybody.
It's very intertwined.
And putting this behind us, helps businessmen make decisions about complex supply chains
and thinking about where they're going to source things and making decisions and not
having to leave a lot of capital that they've already spent on supply chains out of China
and the Asia Pacific region in general.
So, I think it just unleashes a lot of economic activity, but there will be a lag.
It's a couple of quarters before we say wow, the global economy has picked up significantly.
That's probably the frontend of 2020 before that happens.
If we do you end up getting a trade deal with China, do you see it being a full on trade
deal, or do you see there being still issues with IP?
We'll get to that point where the hard part of getting this done is just that, the structural
issues.
So, it's not that we really need China to buy more of our stuff and tighten up that
trade imbalance.
It's really we need to have them play fair.
And by playing fair, we need to have them stop stealing our technology, having forced
technology transfer, stealing our intellectual property, forcing companies to join joint
ventures when they come into China versus being able to run their businesses.
Those are the sticking points.
And the biggest sticking point is how do we make sure this is happening?
So, what's happening right now is, at least the hawks that are at the table like Lighthiser,
are making sure that we don't walk away with the deals that doesn't enforce intellectual
property theft, forced technology transfer and some way to enforce that.
So, I don't see a deal happening.
I think we'd walk away and have no deal before we'd walk away and say, okay, everything's
fine.
You can keep stealing our stuff.
Are you concerned at all about near-term earnings at least earnings for 2019 especially since
comps are going to be tough?
Comps are really difficult.
It's so amazing.
I'm glad you phrased it like that, because we forget that last year was spectacular,
right.
Nearly 24% every quarter in earnings growth, a lot of that had to do with the change in
corporate tax rate.
So, that was the reason we heard so much about an earnings recession this year.
And the problem with that is we tried to extrapolate from estimates and as sad as it is to say,
we're really bad at estimates.
Every year, every quarter, about 70% of companies beat their estimates, right?
We always give conservative estimates and they tend to get beat.
So, the first quarter is going to be positive and the second quarter will be positive.
Not great, but positive, 1.5%, 2%.
The second half comes into question, because if we're still fighting a trade war with China,
the numbers for the second half have to come down.
I think the second half estimates are predicated on getting this deal done.
They certainly are for us.
And if this drags out through the summer and into the fall, the third or fourth quarter
I think probably will look worse, but still positive.
The comps are really difficult.
We're growing, but not as rapidly as we could if we weren't fighting a couple of wars.
What do you suggest traders do in this environment?
Well, it's interesting.
So, one thing you have to do is try to ignore a lot of the noise, right?
And that's really hard, because there's a lot of it.
And we got a bit complacent in the market.
So, the volatility index, the VIX was pinned for about 90 days at 13.
And then all of a sudden, it went up 30% in a day and it's been closed yesterday at 19.
It's important remember back in December, it's at 36, right?
So, we've gone like this and flatlined, and then volatility has picked up.
In volatility, there's opportunity, but you have to really watch your position sizing.
And I think that's the most important thing.
It's like, if there's going to be volatile markets, you need to pare back on the size
bets that you make.
If you're making tactical investments, that volatility gives you opportunities, but you
really have to be careful about your position sizing.
Are there any specific sectors that you're looking at or especially since I guess you're
still bullish overall, but a little bit, I guess, hesitant or cautious in the current
market situation?
What do you suggest investors do in terms of get into cash, bonds, or just stay long
the market?
Now, all that is dependent on your investment time horizon.
But let's say, it's you and I, and this is our retirement money, and you're going to
be retiring in 50 years.
So, you've got plenty of time to think about that.
We wouldn't have you adjust a whole lot.
We'd make sure you rebalanced.
And that just means if you've got a 70-30 portfolio or 70% equities, which is probably
the right place for you to be, make sure you're rebalancing every quarter because as the market
does better, you're overallocated equities and probably under-allocated in fixed income.
I think that that makes sense pretty much throughout all of your investment, the time
horizon and that probably doesn't change a lot.
For us, we think our base case is that the S&P 500 can get to 2900, which went through-
we got a size 2945.
We didn't change our targets because we were afraid of things like what's happening right
now.
The two things we thought might happen is either A, we get a deal done with China, and
that's already perceived to have been baked into the market.
And you get a sell on the news, and then have an opportunity, but more new money to work.
Unfortunately, what happened was, we hit a bump in the road, and we still got that selloff.
I think that if in fact, we get a deal done in the front half of this year, our estimates
are too low for the back half of this year.
So, our $170 estimate for the S&P 500 probably has to go up.
Using the same multiple, we can probably get to 3000.
We're not doing that yet.
But that's the upside risk.
The downside risk is, this drags on for a while, then you're looking at a $2700 target.
And that's just using the same multiple but taking about $10 out of our estimate for this
year.
And that's just if we fully escalate and put 25% tariffs up everything that China exports
to us.
That's the worst-case scenario.
That's where we are right now.
In terms of sectors, I would tell you this, when you make that breakdown, I think that
the two sectors that I think look the most attractively valued are financials.
They've never really recovered from 2007 and of the 11 sectors in the S&P 500, they're
probably trading at the lowest multiple.
And the other is energy.
And it's funny because I think investors have this PTSD with energy.
They get so burned in 2015 when the commodity price went from $100 to $30.
And the sector just got completely wiped out that they've said I've got other things to
do.
I'm never getting back in.
And quietly, the commodity has moved up some 35% on a year to date basis and the sector
itself is only 15%.
So, I think that will see some mean reversion there.
It's trading at less than the multiple of the S&P 500.
So, I think there's value there.
Rate concerned is where you and I say well, I'm concerned about volatility, so I'm going
to play defensive and unfortunately, so many people have done that for the last three years
at the multiples on consumer staple stocks are really high.
The multiples and utilities are ultra-high and their yields are ultra-low for what you
should be getting.
So, on a low interest rate environment, people have chased that dividend only trade.
I just think it looks expensive right now.
What upside potential do you see for both energy and financials?
That's a great question.
So, when we look at that, it's much more of a where they're trading compared to the broader
market, right?
So, I think that if you've got a market that's trading at 17 times, I think both those groups
should certainly trade at that.
And they're not.
So, you have two multiple turns.
So, that's probably about 10% upside for both groups this year.
I think that's a safe bet.
And the same thing is true on the downside.
I think if you look at the staples and the utilities, a couple multiple turns there,
you can watch out about 10% in each group pretty quickly.
So, if you're looking at pairing those together, it might be a way to trade that.
So, you'd get that more symmetric risk.
But I will tell you, I think the upside in both energy and financials is significant
as compared to the broader market.
Can you summarize your market outlook for 2019 in 30 seconds?
Yeah.
Our outlook for 2019 is that the- our base case is that the US and China will come to
a deal- probably sometime in the first half.
I think the earnings estimates have upside risk to them.
We were at $170 for the S&P 500 for 2019.
And we think that that gets you to 2900.
And the upside risk of that would be earnings are probably better in the back half.
And we could actually get to 3000 without doing too much math.
Great.
Art, thank you so much.
Thanks for having me.
So, even though Art is nervous due to the trade war, he's still bullish on the stock
market.
Specifically, he thinks the financial sector has 10% upside potential by the end of the
year.
In addition, he likes the energy sector.
He thinks it also has 10% upside by the end of the year.
In contrast to his bullish theses, Art sees 10% downside in the stable sector.
He also sees 10% downside in utilities by the end of the year.
That was Art Hogan of National Securities.
For Real Vision, I'm Justine Underhill.