If you walk peacefully on the beach; our feet sink a bit before we can take the next step forward, rinse and repeat. So goes the market at times.”
At some point, even this bull market will tire, but as long as the internals keep holding up, earnings continue to show steady growth, or historical trends suggest otherwise, it won’t be profitable to keep doubting this bull market. That has been the message now for not months, but years.
This year has been no different from the past. There have been any number of well reasoned arguments about why the market should pull back. Whether it was the chaos in Washington, likely war with North Korea, a run of weak economic data, a potentially more hawkish Fed, excessive valuations, being overdue for a pullback, weak seasonal patterns, or something else. The reasoning behind the cautious arguments has sounded good in theory.
They always sound smarter to the human mind because they dovetail with our own worries. Sounding smarter doesn't necessarily produce the desired results. Investors always have to be ever mindful of letting emotion creep into the equation. All of these issues and many others that have come before them have been shattered. Most of the time they never even surfaced. It is why when an issue arises, it needs to be listened to, then assigned a probability of it actually happening. It should never just be accepted as a black and white, has to happen event.
The fine line then becomes we can also never be complacent, and with that the thought of what to do when the market does change course. First, let me be clear that this is not a call that the market has topped. Nor is it a time to believe that we are about to see a reversal of the long-term trend anytime soon.
The fact of the matter is many are asking questions on how they should proceed when that day eventually comes. Ironically, I put my thoughts in writing on this topic back in July of 2013 when I was repeatedly asked the same question. Yes, many believed the market had topped back then when the index broke above the 2007 high. Those queries came way too early and it is my opinion these recent concerns are also premature.
For someone that has stayed invested in the last few years, it’s human nature to have the fear of losing the lion's share of the gains achieved. The best way to control that emotion is to gain the confidence that you will first, have a plan, and then calmly execute that strategy.
The key to my strategy is the long-term trend, and taking action only when it is changing. Any change of strategy before that occurs is premature. Those that we have seen calling a top before then is simply guessing, despite whatever evidence they throw at investors.
The monthly chart of the S&P clearly points out what I am referring to. Look at the long-term chart below. Market tops could have been called anywhere from 1995 all the way to 2000. And each one was wrong. Move to the time period of 2003 to 2007. Many predictions for a market top were made in 2004, 2005, and 2006, and anyone selling during any of those calls was dead wrong. What has to stand out in each case is that the primary long-term trend in those examples was never broken.
Chart courtesy of FreeStockCharts.com
The picture also shows that the trend line remained firmly in place from 2009 to August of 2015. The reason that all of the calls for a market top in that 6-year time frame turned out to bad advice. It is also why it was necessary to stay invested in equities.
The yellow arrows show when the trend (green line) was broken back in 2000 and in 2007. Those events signaled caution. The time to start being defensive and outright bearish comes when the index fails to retake that moving average (red arrows) in short order. This concept is clearly illustrated when we look at the last two bear markets.
Note in the insert below, there was a failure (red arrows) when the index tried to recapture the long-term support line. It became obvious that trend was broken decisively after those failures.
Chart courtesy of FreeStockCharts.com
Please do not lose sight of the fact that the chart displays all of the action contained in a month’s time frame. Plenty will occur to sway an investor in that amount of time. We saw that play out recently in January/February 2016. One has to exercise patience and wait for the process to unfold.
So the first myth that needs to be abolished is that one won’t have the time to get out before the next crash. Not true, the 2007/2008 financial crisis is the first example showing that to be the case. Anyone care to point out a more dire time in equity market history?
In October 2007, the S&P closed at 1,549. The first break in trend (green line) occurs in January 2008 (yellow arrow) with a close that month of 1,378, an 11% drop. Caution flags were raised to stop buying and sit tight. The retest and failure came in May 2008, with a close of 1,400, some 10% from the highs, a time to get defensive, raise cash and start to hedge, all dependent on an investor's risk tolerance. A market participant had 4 months to start taking some defensive and contemplate material changes to portfolio positioning.
Of course, no one can make guarantees about how the market will react the next time. However, allow me to post more evidence for the non-believers. The same scenario played out in 2000. The S&P had a closing high of 1,517 in August of 2000. The first break of that trend was in October at 1,392, an 8% pullback. Then in December of 2000, the index rallied back and closed at 1,320 (13% lower), but failed to retake the trend line. Caution flag at 8%, failed rally and warnings flashed at 13%. One could have acted cautiously, then prepare to roll into their bearish strategy during that 4-month period.
Chart courtesy of FreeStockCharts.com
The second myth is that an investor will get crushed if they sit around waiting for signals. Of course, that depends on the definition of getting crushed. In both cases (2000 & 2008), an investor was cautioned that it was time to lighten up and raise considerable cash anywhere between 8 and 14% of THE TOP. So unless one firmly believes they can make material strategic portfolio changes at the exact top, they need not have a strategy when the trend changes. This refutes the theories that defensive action can’t be deployed, investors will be trapped, and all the gains will disappear. Caution flags were raised. Following some simple signals, deploying the proper strategy would have saved a lot of pain.
Another part of this investment strategy that cannot be dismissed revolves around the ensuing bear market. Anyone who lived through the last two bear markets realizes that stocks went down, and went down hard. Investors not only need to protect their portfolios, they need to profit from the new trend that is now established. Once that becomes part of an investor's toolbox, riding a bull market, then getting defensive when conditions warrant is only the first part.
Profiting from a bear market trend has to also be a goal of a market participant. This isn’t being presented in hindsight, please look at the chart again. Once a trend is established, up or down, it will run until broken. There is no law that says a once bullish investor can’t purchase an index ETF that profits from a market decline. There are plenty of instruments at an investor's disposal today that simplifies what was once a difficult task of shorting, etc.
It is patience and the ability to control emotion and remove the noise that is required while a down market tugs at our minds. Let’s fast forward to the late 2015 and early 2016 time frame, and review why so many analysts and pundits got the story wrong. The trend was broken in August 2015, and again in January 2016 (yellow arrows).
A break in the trend, first sign to get cautious and somewhat defensive depending on your risk tolerance. I will add that the word defensive means different things to different people. But it does not mean sell and hide. That is THE takeaway. Those that played some defense when the caution flag was raised are far ahead of those who prematurely sold in 2016. Patience was rewarded in both cases when the retest of the trend line resulted in a quick retake of the moving average just two months later.
Chart courtesy of FreeStockCharts.com
That rebound negated any sell signal and the reason to make material changes to equity posturing. It was at that time when many were calling for the end of the bull market, the headlines were terrible, a new bear market was about to begin. I simply stated to stay the course. I’m not clairvoyant, the index recaptured the long-term trend and in doing so remained in play.
It was simple, there was NO change in trend. No sell signal. Now anyone believing that this is all done in hindsight to make a point should reconsider their argument. Here are the articles that defined that moment. In February 2016, it was a time to be concerned but not panic. When the S&P rallied back in March, my view when speaking to the trend line signal was:
"A failure there would suggest a "possible" replay of the 2000 and 2007 market "tops." A successful retake of the MA and the probability for new highs increase dramatically.”
The rest is history, many sold their stocks when it was evident the trend was still in play and new highs would come next. By the end of March, the S&P recaptured the 20-month moving average, and all indices had made new uptrend highs off the lows with strong breadth.
Coincidence, voodoo, magic? Not really. It is following what drives markets over time, and that is trends. There is no absolute tool, no holy Grail. There is no single technical approach that works every time. It is always a process that needs to be refined. However, following technical analysis of long-term trends is a necessity, and should not be dismissed as some would have us believe. Adding indicators such as market breadth and others can only enhance the process. For me, it's best to keep it simple, what was just described is the way I approach identifying potential market tops.
Now that I have laid out the strategy, the specifics for my personal situation are as follows. A yellow caution with a break in trend, no new market positions, possibly take some profits in overextended positions. A red flag, raise more cash, buy hedges on core positions I may wish to hold. As the downtrend becomes firm, use index ETFs that take advantage of a falling market. That includes the leveraged ETFs which will offer more protection for less invested.
It is all about confidence. I do not fear a downturn, therefore I can attempt to remain in control when the issue gets murky like it did in all three examples posted today. If a market participant fears an issue, they will not be in control. Instead, the situation will be in control of them. A recipe for mistakes and portfolio losses.
Dallas Fed's Manufacturing Index surged 6.3 points to 27.6 in October after climbing 4.3 points to 21.3 in September, which followed a 0.2 point gain to 17.0 in August. This is the highest reading since March 2006.
October Chicago PMI Business Barometer Index rolls in at 66.2 versus consensus of 62, the highest level since March 2011. Jamie Satchi, Economist at MNI Indicators:
“Firms kicked off Q4 in a buoyant mood with only 12% expecting activity to decline between now and the close of the year. Despite the MNI Chicago Business Barometer hitting a six-and a-half year high, and output and demand in seemingly strong health, concerns remain over firm’s inability to attract and retain skilled workers.”
Consumer Confidence for October was reported at 125.9 versus consensus of 121, the highest level in almost 17 years. Lynn Franco, Director of Economic Indicators at The Conference Board:
“Consumer’s assessment of current conditions improved, boosted by the job market which had not received such favorable ratings since the summer of 2001. Consumers were also considerably more upbeat about the short term outlook, with the prospect of improving business conditions as the primary driver. Confidence remains high among consumers, and their expectations suggest the economy will continue expanding at a solid pace for the remainder of the year.”
The latest ISM Manufacturing report for the month of October registered a reading of 54.2, that is up from the 53.1 result reported in September. Chris Williamson, Chief Business Economist at IHS Markit:
“US manufacturing stepped up a gear at the start of the fourth quarter, boding well for higher factory production to support robust economic growth in the closing months of 2017.”
More solid economic data as ISM Non-Manufacturing report blew away estimates with a reading of 60.1, above the September reading of 59.8.
ISM Services remained robust while unchanged from the prior month’s reading of 55.3.
The JPMorgan Global Manufacturing PMI continues to signal the synchronized global recovery in progress. The index resides at a 78-month high with a reading of 53.5. That is up from the September report of 53.3. David Hensley, Director of Global Economic Coordination at JPMorgan:
“The global manufacturing PMI points to continued robust gains in production. The output PMI was little changed at an elevated level while the index of new orders moved up. Furthermore, the PMI indicates that output growth remains broad-based across the consumer, intermediate and investment goods sectors.”
Eurozone economic confidence rolled in at a 16-year high. The economic sentiment index improved more than expected to 114.0 in October from 113.1 in September. Unemployment data for the Eurozone was stronger than expected in September, dropping 0.1 percentage point to a new post crisis low of 8.9% and getting a 0.1 percentage point revision to August data.
GDP in the Eurozone beat expectations coming in at 2.5%, the fastest pace since 2011. The headlines also noted that in the same time period the United Kingdom grew at a 1.5% pace.
Manufacturing PMI is now at an 80-month high with a reading of 58.6. Chris Williamson, Chief Business Economist at IHS Markit:
“Eurozone factories started the fourth quarter with increased vigour, with the sector’s growth spurt showing no sign of abating. October’s PMI was the highest since February 2011 and the second highest in over 17 years. The overall performance of the manufacturing sector so far this year has been the strongest since 2000.”
Caixin China Manufacturing PMI remained in a sideways trend. Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group:
“The Caixin China General Manufacturing PMI was 51 in October, unchanged from September and remaining in expansionary territory.”
Chinese Services PMI rose to 51.2, rebounding from the disappointing September lows of 50.6.
Japan retail sales spending data rose 2.2% in September, indicating the strong run for consumption in that country continues. Consumer Confidence continues to show solid results with a reading of 43.9, the highest level since March. That is more than likely supporting the spending growth.
Manufacturing PMI remained steady, dropping to 52.8 from the prior month reading of 52.9.
Positive economic data has been difficult to achieve out of the United Kingdom lately. Here is one report that bucked the trend. Services PMI rebounded nicely to post the strongest growth in six months. The index was reported at 55.6, up from the September read of 53.6.
IHS Markit Canada Manufacturing Purchasing Managers’ Index dipped to 54.3 in October from 55.0 in September. Tim Moore, Associate Director at survey compilers IHS Markit:
“Business conditions improved at a slower pace in the manufacturing sector at the start of the fourth quarter, as softer rises in output and new order volumes dragged down the headline PMI figure. Weaker growth in manufacturing workloads in part reflected a dip in export sales for the first time since October 2016.”
Earnings headlines continue to impress. Overall, the growth rate for Q3 is roughly 5.9%, which is a nice pickup compared to the 1.7% estimate for the quarter going into this earnings season.
For what it is worth, Strategas Research sees no evidence that tax reform has been priced into the market. They note as the S&P has been rising, the company's most levered to tax reform have been under performing, suggesting the equity market is being driven by other factors such as stronger global growth, higher earnings and possibly less regulation.
As shown below, the spread now between the % of companies raising guidance versus those lowering guidance is at +3 points, which is slightly higher than we saw last season.
That is a big positive. Not many CEOs will go and stick their neck out on an earnings forecast if they don't have to.
Utilities lead the way in terms of surpassing earnings forecasts. Technology earnings continue to confirm why prices have appreciated to the level they are at.
FactSet Research weekly report:
For Q3 2017, with 81% of the companies in the S&P 500 reporting actual results for the quarter, 74% of S&P 500 companies have reported positive EPS surprises and 66% have reported positive sales surprises.
For Q3 2017, the blended earnings growth rate for the S&P 500 is 5.9%. Six sectors are reporting earnings growth for the quarter, led by the Energy sector.
The forward 12-month P/E ratio for the S&P 500 is 18.0. This P/E ratio is above the 5 year average (15.7) and above the 10-year average (14.1).
Ned Davis Research reports:
“Growth finally reached its cyclical potential but is not enough to suggest high inflationary pressures and a need for the Fed to tighten. It notes core PCE inflation remains well below the Fed’s target."
The Fed released its FOMC statement this past week, and there were no surprises in the report. It was also no surprise to hear that Jerome Powell was announced as the next Fed chair. The announcement was telegraphed all week and the stock market took the news in stride.
Bullish sentiment on the part of individual investors is currently at its highest level since the start of the year. In this week’s sentiment survey from AAII, bullish sentiment increased from 39.6% up to 45.1%. That’s the first 40%+ reading in six weeks and the highest level since the first week of January. Even with the increase, though, bullish sentiment has now still been below 50% for a record 148 straight weeks.
Have we entered into the acceptance stage as I mentioned in October? We’ll know in the next few weeks.
The latest inventory report showed a slight draw in inventories of 2.4 million barrels. Gasoline stockpiles decreased for the second straight week, this time it was a 4 million barrel draw down.
WTI finally broke above the $52-$53 resistance level this week, trading at an eight-month high. The price of WTI closed Friday at $55.70, up $1.80 for the week. Perhaps traders are buying into the global growth story which should bring demand in focus.
The Technical Picture
A notable divergence last week that deserves to be watched. Both the Russell 2000 and Dow Transports turned in weak performances relative to how the Nasdaq, Dow 30 and S&P traded all week. Both the Nasdaq and the Dow industrial posted new closing highs. In the meantime, the S&P tagged a new intraday high at 2,588. It’s a divergence in its early stages that needs to be watched.
The S&P rides along the very short-term 20-day moving average (green line). No change from what was reported last week. There can be no discussion of a pullback until that initial support breaks. This relentless move higher continues.
Chart courtesy of FreeStockCharts.com
Short-term support is at the 2,575 pivot and SPX 2,544, with resistance at the 2,594 pivot. For those that are interested where the 20-month moving average is today, it sits at 2,309. That of course will continue to rise until we do get a material pullback. Based on what was presented earlier, one can now see why I don't fear a bear market starting in the near term.
It’s all about the Fed, or is it? Plenty of people still around that believe that.
Anyone still hanging on to that idea to form an investment strategy has been left behind. For those that were telling us the bull market was over as the Fed balance sheet wasn’t increasing and the market sold off in early 2016, forgot that energy earnings were the real culprit for that decline.
Worse yet for those that continued to believe it was all about the Fed, convinced that stocks would drop amid the lack of QE, found themselves trapped. So while the balance sheet remained stable, the bull market in equities has seen a new leg higher and rallied over 35% from its early 2016 lows.
The word that is never mentioned in any bearish article recently, Earnings.
It isn't mentioned because it doesn't fit the bearish stories being told to investors. Urban Carmel posted this comment and chart last week:
“This has been a mostly fundamentals driven bull market: 69% of the change in the S&P is explained by EPS growth.
Chart courtesy of Urban Carmel
Individual Stocks and Sectors
Apple hasn’t been mentioned here in awhile. Share owners have been treated to the usual rhetoric in the last two weeks. How many of these units will they sell? What is next? Can there be any innovation? Should investors sell the stock before earnings? After earnings? And on and on. The ONLY point that mattered was the new high put in by the stock on Monday. Investors apparently sniffed out a positive earnings result reported later in the week and the company reported a great quarter. The numbers being reported by this company are in one word, astonishing.
Facebook (FB) and Alibaba (BABA) both pegged new highs as well. Facebook's earnings were a thing of beauty as revenues are still growing at a phenomenal rate of 47%. Operating margins at 50%. The shares did not react on that news. Instead, traders reacted to the increased expense of providing better security on their platform, and hit the sell button. In my view, the aggressive expense guidance also signals confidence in Facebook's 2018 revenue growth.
Alibaba did not disappoint, reporting a 63% increase in core commerce revenue. This growth machine continues to produce phenomenal results. The entire FAANG group and Alibaba are a buy on any weakness. Maybe it now needs to be called FAAANG. My view that these stocks will outperform in this quarter appears to be on track as the fundamental story on all of these companies continues to improve. It is very simple, in each case, the respective stock price is following a strong fundamental story.
October is in the books and it was a good month for the bulls. Another 2.2% gain for the S&P, while the Dow tacked on 4.3% and the Nasdaq added 3.5%. Of those three, the Nasdaq posted a new high. Plenty of investors are wondering what can this market possibly do for an encore. Earnings are leading the way, no need to question or ponder that issue, continue to go with the flow.
Stock markets around the globe have broken out of multi-year trading ranges confirming the global growth story. Japan has been strong so far this quarter, with a gain of well over 4%. Not only have returns been positive, but they have been extremely consistent. In the latter part of October, the Nikkei ended a run of 16 straight trading days without a decline.
Chinese equities have also been very strong as the Shanghai Composite keeps marching higher. After a nearly two-month period of consolidation, this week’s rally served as a continuation of the late August breakout.
It’s not just these two countries, major indexes all across the eurozone have broken above multi-year trading highs. Ask yourself, is everyone in the world euphoric? Are all in the investment world in an ecstatic state with the global issues that confront them? Or is it the change that the equity markets can see taking place after years of poor growth that is propelling prices higher? It is also a fact that these higher prices are justified as the fundamental story improves.
What the markets are telling us is that the solid growth of global trade and output is likely to continue in Q4 as indicated by strong economic reports. The global economic cycle has not started to moderate and mean revert yet.
Looking ahead, the month of November isn't the chart buster for the bulls that many perceive it to be.
Over the years, the S&P has eked out a small gain during November. Given the robust gains in October, that may come to pass this year as well while the gains are consolidated. Based on the chart, Technology stocks may also take a well deserved breather as well. Then again, it is entirely possible that the strength continues. Better not to try and outguess the markets.
Ryan Detrick comes up with data that indicates we are entering into one of the strongest periods for market gains, the November to April time frame.
Back in September, the commentary suggested concentrating on things that could go right instead of what could go wrong. The S&P is higher on the back of something that is going right; earnings. Active investors can use any weakness to add to the companies where growth is expanding. Anyone wanting to be a hero and predict this is a market top can be my guest. History shows that heroes take a lot of arrows. Other than minor tweaks here and there it is best to just stay the course.
Thanks to all of the readers that contribute to this forum to make these articles a better experience for all.
Best of Luck to All!
Disclosure: I am/we are long AAPL, FB, BABA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article contain my views of the equity market and what positioning is comfortable for me. Of course, it can’t be for everyone, there are far too many variables. Hopefully it sparks ideas, adds some common sense to the intricate investing process, and makes investors feel more calm, putting them in control.
The opinions rendered here, are just that – opinions – and along with positions can change at any time.
As always I encourage readers to use common sense when it comes to managing any ideas that I decide to share with the community. Nowhere is it implied that any stock should be bought and put away until you die. Periodic reviews are mandatory to adjust to changes in the macro backdrop that will take place over time.