The Message Of The Markets: Dazed And Confused, But Recent Lows Hold

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Includes: DIA, IYE, QQQ, SPY, XLE
by: Brian Gilmartin, CFA

Leon Cooperman phoned in to CNBC's Halftime "Fast Money" show about 3-4 weeks ago, and the one comment that stuck with me was "This isn't my Father's stock market".

It was a telling comment from one of the Street's great long-time investors, and a man who has seen many markets.

Here is a quick summary of all the reasons being discussed for the stock and bond market's action this year:

  1. Recession is coming - maybe that had a little bit of credence until yesterday's jobless claims number. Over the years, reading Jeff Miller, Bespoke and even Brian Wesbury at First Trust, jobless claims are some of the most reliable, pristine and accurate economic data we get on a real-time basis. Seems unlikely a deep recession is headed our way, with the exception of possibly the oil patch, which leads us to #2;
  2. The withdrawal of liquidity (i.e. Fed rate hikes and ECB stopping QE) may be having its intended impact. As the training wheels are removed from the economy, the uber-sensitive markets might be reacting in kind, as the junk is withdrawn from the liquidity addicts. This could be like 1994, without the earnings growth. The thought of negative rates in the USA is somewhat frightening. It would be interesting to see how Americans might react to that policy. Personally, I don't think it will ever happen. QE 1-QE 3 showed that the Fed has and will use other options.
  3. Core S&P 500 earnings growth is just 2% as of last week (see here) down from 10% in Q1 '15 and 5% in Q3 '15. Everybody not living in a cave knows that Energy and Basic Materials have been a drag on S&P 500 earnings since Q4 '14, but the other sectors were holding up until Q4 '15. Revenue growth is just barely positive too.
  4. China slowing? I didn't know a bunch of ex-Commies masquerading as capitalists with all the sophistication of two teenagers trying to procreate for the first time could send the global stock and bond markets into such a convulsion. Certainly the currency markets could be impacted, but a global, synchronized bear market?
  5. Maybe this is simply a long overdue 20% correction for the S&P 500 - one not seen since 2011?
  6. European banks with large derivative books coming home to roost. The damage to Deutsche Bank (NYSE:DB) and Credit Suisse (NYSE:CS) is talked about nightly on CNBC, but what about Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS), and Morgan Stanley (NYSE:MS)? Was or is counter-party risk still an issue? Wasn't the counter-party risk the issue in 2008? What good then was Dodd-Frank, CCAR (Comprehensive Capital Analysis and Review) and the complete stifling of the US financial system if European banks can dent the whole structure all over again? Bank of America has been sold from client accounts - what good is it to own a value stock like BAC if it only goes up 25% in a good market, and then corrects 40% in a correction? Really, I'd rather own GS and have been picking away at the brokerage giant.
  7. The collapse in the Energy sector is driving deleveraging at sovereign wealth funds and hedge funds, and the talk is that some book is unwinding painfully.
  8. Management turmoil at Bridgewater Associates, Ray Dalio's labor of love and the largest hedge fund in the world.
  9. A brutal sector rotation from 2015's winners to 2015's losers. Large-cap Technology and FANG pounded, the worst sectors of last year starting to stabilize.
  10. Strong yen - the carry trade in Japan unwinding after 25 years? Check the strength of the yen from 125 to 112. Per one technician I follow, that isn't good. Kuroda hinted that he might need to continue to devlaue the yen, but the yen didn't drop after the comments.

Conclusion: The weekly earnings update will be out tomorrow, although as Led Zeppelin once crooned, "The Song Remains the Same". S&P 500 earnings are still positive as is revenue growth, but the core is weakening. The "value versus growth" theme within the S&P 500 is being watched carefully. That being said, S&P 500 earnings growth is looking like it did in 2011 and 2012, very slow but not negative. Some trends we are looking for to reverse:

  1. The US dollar, if it continued to weaken slowly, would definitely be a plus for S&P 500 revenue growth. A strong yen wouldn't be good.
  2. Crude oil and commodity metals stabilizing. Look at this link here posted to this blog Wednesday night. Note how Energy sector earnings are expected to decline 87% (!) for Q1 '16, and for full-year 2016 the decline is already for 50%, a much faster rate than last year at this time. The world is awash in crude and it could get worse, but expectations are as negative as I've ever seen, as bad as 1998 when crude dropped to $10 per barrel after the Malaysian Ringghit-Thai bhat devaluation. In 1998, crude didn't fall from the heights it did in 2014, though.
  3. Value has a small performance lead over Growth YTD in 2016. It was a 900 bp laggard in 2015. Some XLE, IYE, and Emerging Markets were added to client accounts in September-October 2015. Some of the sectors that really got trashed last year could be in the early stages of bottoming. (More this weekend.)
  4. The 1,812 January 20th low for the S&P 500 held yesterday. That is a very good sign. The low coincided almost exactly with the Reuters headline that OPEC would cooperate on a supply cut.
  5. Technicians remain very bearish. Not one talked about the S&P 500 holding the January 20th lows of 1,812.