S&P 500 Weekly Update: No Need To Sell In May; Remain Resolute And Stay The Course
- Paranoia is in control. Perception of slow global growth, trade wars, higher interest rates, and inflation have investors paralyzed.
- Buyers are on strike as they adopt a “wait and see” approach.
- Peak earnings? Investors are talking themselves into believing a problem that is not present.
- Stock selection is key. We haven't seen a major market top just yet.
"It is better to be roughly right than precisely wrong."
- John Maynard Keynes
April is in the books, and while it doesn't feel that way, the S&P finished the month higher. That comes after the losses experienced in both February and March. The index is down less than 1% for the first four months.
The U.S. economy is doing OK, earnings have been exceeding already lofty expectations, and geopolitical tensions seem to be easing. The stock market, as measured by the S&P, is flat on the year. Reading that, one would think it has been quiet during the first 4 months of the year. Investors know that it has been anything but quiet. The major indices can be down 1% one minute on little or no news and turn on a dime the next. 50 point swings in the S&P have been common this year.
So, the obvious reaction is that something has to be wrong, there must be underlying issues that no one can see. Sorry, I’m staying with my conclusion that was mentioned here last week: a simple consolidation phase after a huge 13-month run-up in stocks. That surge left the indices as overbought in the short term as they had ever been at any time during this entire bull market.
The problem is, that may well be the truth, but as we have seen before, many can’t handle the truth. Well, here is an alternative for that crowd. Last year, a common cry was the stock market doesn't care about anything, it just goes up. Record streak after record streak was being broken. The common phrase was something has to be wrong. It started right after the election, where we heard the words being used calling the situation a Teflon market. Nothing (bad) was able to stick. What actually turned out to be wrong was the barrage of comments that told investors not to buy into that 28% uptrend.
All of that price action has faded away. Every bit of minutia now sends the trading crowd into a mind-blowing trip. History shows that this transition is actually quite normal. So I conclude, nothing is wrong. It is the way markets work over the long haul. Problem is, everyone is concentrating on the short term. That is short-termism, an affliction that can be fatal to financial health if left unchecked. In this case, please don't confuse the word long term to mean decades. I always just look out in 6-9 month increments, while many want to have immediate gratification and resolution every day or week.
Here’s another concern that is commonplace now. This past week marked a very important milestone for the U.S. economy, as the current economic expansion will enter its 107th month. Not many have confidence in the duration of this cycle. We hear the words "we can’t invest in this market" because both the market and economic cycles are ending.
Funny how that works. At S&P 1800, many told the bulls their crystal ball was way out of whack, no one could be predicting higher stock prices. After all, no one knows the future. Now, all of a sudden everyone that is skeptical has a crystal ball, and the one they own is the only one that works.
No one is talking about how stable the U.S. economy is. OK, it has been growing more slowly than we have in the past, and everyone keeps harping on that fact. However, the economy is doing so with increasing stability. Some might say it’s like generating lower but more stable returns in their portfolios. This isn’t the manufacturing and industrial economies of an era gone by, this economy is much more diverse. That fact means it has reduced its dependency on any specific industry.
In addition, statistics show that state and local governments are significantly larger now. This has likely contributed to slower growth, but has also added stability to jobs and income over time. Government jobs tend to be more recession-proof than private industry jobs. This has acted as a greater safety net for the total economy. In the past, a couple of World Wars disrupted the global economy. The current period of relative peace has lowered the fluctuation rate of both the U.S. and global economies.
I am not here to suggest that we will never see an end to an expansion cycle and a recession. Quite the contrary, they are both inevitable. What I am suggesting is to take a look at the entire picture. Do that before you decide to buy into the story being told by the guys and gals that have their crystal ball all polished up and ready to entertain us.
Here are just two examples of recent strength that is appearing in what many are calling late in the cycle. New home sales rose 4% in March, double the expectations, boosting the 3-month average to its highest level since November 2007. Wide divergence between median and mean home prices indicated demand was strongest for lower-priced homes, in line with the Conference Board findings that plans to buy a home surged to a record high. Existing home sales also rose above consensus to a 5-month high.
The flash manufacturing PMI hit a 4½-year high, led by marked increase in output and new orders. Durable goods orders also were stronger than expected, and on a year over year trend basis, rose at nearly their fastest pace since October 2014.
I’ll stay with the idea that there is no time clock on an economic recovery, and instead of concluding the cycle is over, just continue to monitor the data.
Atlanta Fed's initial Q2 GDPNow estimate is 4.1%, compared to the 2.3% advanced Q1 GDP just released last week. The advance estimate of first-quarter real GDP growth released by the U.S. Bureau of Economic Analysis on April 27 was 2.3 percent. Take your pick.
U.S. personal income rose 0.3% in March, with spending rising 0.4%. The PCE deflator was unchanged versus February's 0.2%. The core rate is at a 1.9% year-over-year clip.
April Dallas Fed Manufacturing Survey General Activity Index comes in at 21.8 versus consensus view of 18.0
Chicago PMI rises to 57.6, up slightly from the March reading of 57.45.
Markit U.S. Manufacturing PMI accelerated with an April reading of 56.5, up from the March report of 55.6. Chris Williamson, Chief Business Economist at IHS Markit, said:
“April saw U.S. manufacturers reporting the strongest monthly improvement in business conditions since September 2014. The survey suggests the economy has started the second quarter on a solid footing and sends an encouraging signal for GDP growth to accelerate after the modest 2.3% rate of expansion seen in the first quarter. With inflows of new orders rising at an accelerated pace, greater input buying and business expectations regarding future production levels running at one of the highest levels seen over the past three years, there’s plenty of evidence to suggest strong growth will persist through May.
“The upturn is being led by large firms, with smaller companies trailing behind but nonetheless also seeing some of the best business conditions for three years. Warning lights are being flashed in relation to inflation, however, with factories reporting the strongest rise in prices for nearly seven years. Suppliers are hiking prices in response to surging demand, while tariffs and higher oil prices are also exerting upward pressure on costs. With the average price of goods leaving factories rising at the fastest rate since 2011, consumer price inflation looks set to accelerate.”
Here is a report where pundits read the headline and then report that weak economic data is adding to the weakness in stocks. Construction expenditures disappointed, coming in 1.7% lower than expected. Keeping this report in perspective, January and February were revised higher, so total construction spending for the year to date is 5.5% higher than that in the same period in 2017.
U.S. Services PMI registered 54.6 in April, up from 54.0 in March. Chris Williamson added:
“The improved service sector performance comes on the heels of news of faster manufacturing growth, pointing to a welcome broad-based strengthening of the economy at the start of the second quarter. As such, the data support the view that second quarter GDP growth will come in stronger than the 2.3% rate seen at the start of the year. The two surveys also collectively point to another month of solid job gains, commensurate with the official measure of non-farm payrolls rising by approximately 200,000 in April.”
“Perhaps the most important development, however, is the upturn in price pressures. Survey evidence indicates that rising demand has allowed increasing numbers of companies to raise prices for both goods and services in recent months.”
ISM Non Manufacturing index fell 2.0 points to 56.8 in April, after dipping 0.7 points to 58.8 in March. It's below the 57.3 print from last April and is the lowest since December.
Pending Home Sales reported up 0.4% versus consensus of 1.0% for the month. Lawrence Yun, NAR chief economist, noted:
“Contract activity is moving sideways and not breaking higher despite the strong job-creating economy. Healthy economic conditions are creating considerable demand for purchasing a home, but not all buyers are able to sign contracts because of the lack of choices in inventory. Steady price growth and the swift pace listings are coming off the market are proof that more supply is needed to fully satisfy demand. What continues to hold back sales is the fact that prospective buyers are increasingly having difficulty finding an affordable home to buy."
Markit Eurozone Manufacturing PMI fell to a 13-month low of 56.2 in April, down from 56.6 in March. Chris Williamson had this to say:
“The manufacturing sector saw growth weaken further at the start of the second quarter, but let’s not lose sight of the fact that the overall pace of expansion remains encouragingly solid. “Although growth has slowed markedly compared to the start of the year, December had seen the best performance in over 20 years of survey data collection, with factory activity clearly surging at an unsustainable rate. Since then, supply constraints – including raw material scarcities, supplier delivery delays and skill shortages – have constrained production. Strikes, bad weather and unusually high levels of illness have also plagued businesses. “Some of these adverse factors are therefore likely to be reversed in coming months, as capacity is increased, supply improves and factors such as strikes and weather cause fewer problems.
Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group, said:
“The Caixin China General Manufacturing PMI edged up to 51.1 in April. Output increased at a faster rate last month from March, while the contraction in employment narrowed. However, growth of new business moderated for the second straight month, reflecting weakening demand across the manufacturing sector. Manufacturers are facing a sharply deteriorating foreign demand environment as new export orders declined for the first time in 17 months in April.
“The rate of output charge inflation eased slightly while growth in input costs posted its first acceleration since September, likely due to increases in crude oil prices. This may squeeze the profit margins of manufacturers and has thus contributed to a decline in the sub-index of future output, a gauge of companies’ confidence in their business outlook over the next 12 months. Stocks of finished goods expanded at a faster rate in April compared to March, suggesting that inventory levels for manufacturers have remained rather high. Overall, operating conditions across China’s manufacturing sector continued to improve in April. But uncertainty in exports has increased significantly, and the dependence of the Chinese economy on domestic demand is rising.”
Japan Manufacturing PMI remained steady and rebounded to a reading of 53.8, up from the March report of 53.1. Joe Hayes, Economist at IHS Markit, said:
“April data pointed to a renewed acceleration in Japanese manufacturing sector growth. New order inflows rose at a solid and faster clip, prompting firms to recruit new staff and expand production. “However, the new export orders index subcomponent fell noticeably, albeit still remaining in expansionary territory, to signal only a marginal pace of growth. Consequently, the uptick in total new orders is indicative of more robust demand conditions domestically. Although this will be unreservedly welcomed by policymakers, weak export sales will be a concern and may be a sign of things to come amid the recent strength of the yen.”
Japan Services PMI increased to 52.5 in April from 50.9 in March. Hayes added:
“Following successive months of softening output growth through February and March, Japan’s service sector started the second quarter by gathering some momentum. The fastest rise in business activity for six months was supported by another monthly expansion in employment and a solid improvement in demand. However, business confidence regarding future activity weakened to a seven-month low despite the stronger inflow of new work and rise in backlogs. Panellists noted that increased competition and rising labor shortages may impact output potential over the coming 12 months. Nevertheless, businesses raised their selling charges to a greater extent in April, even with a weakened rate of input price inflation. Indeed, stronger output price hikes, in the wake of weaker cost pressures, signals confidence in the purchasing power of service sector clients.”
The Nikkei India Manufacturing Purchasing Managers Index rose from 51.0 to 51.6 in April. Aashna Dodhia, Economist at IHS Markit, noted:
“The Indian manufacturing economy started the quarter on a slightly stronger footing as growth picked-up from March’s five-month low, buoyed by stronger demand conditions. Putting the PMI data under a magnifying glass, consumer goods was again the bright spot, with output growth being the fastest among all the three market groups. Meanwhile, investment goods was the weakest performing category as both production and new orders declined during April. Encouragingly, PMI data highlighted inflationary pressures moderated for the second month in a row, with input cost and output charge inflation at the weakest since September 2017 and July 2017 respectively.”
The UK Construction Purchasing Managers Index picked up sharply from the 20-month low seen in March (47.0). The latest reading of 52.5 was the highest since November 2017 and signalled a moderate expansion of overall construction output.
Tim Moore, Associate Director at survey compilers IHS Markit, had this to say:
“A healthy flow of new orders and an upturn in business optimism to its highest for 12 months meant that Canadian manufacturers remained fully in expansion mode during April. “April data revealed that unfinished work increased at one of the fastest rates since the survey began in 2010, reflecting constraints on production capacity and ongoing supply chain issues. “In particular, longer-lead times for materials were linked to shortages of truck drivers in the U.S. and delays at ports in China following the implementation of stricter environmental policies. “Manufacturers responded to constraints on production schedules by boosting employment and building up their stocks of inputs in April. “Strong demand for raw materials resulted in the fastest rise in input costs for over four years, while the robust demand backdrop enabled manufacturers to pass on prices at the factory gate at the fastest pace since 2011.”
A mixed bag as far as the global economic reports this week. In my view, there is little to nothing that supports the claim that global growth is slowing to the point of being the issue many are making it out to be.
Renaissance Macro said most of the evidence it reviews suggests fears of a cyclical peak are overdone, exacerbated by nervous longs who are using good news as a source of liquidity to sell into. Cyclical peak talk exploded Monday when it was reported that Caterpillar (CAT) claimed Q1 represented the peak of the cycle, rattling investors who felt such a big global name must have unique insight into global growth and the health of the overall economy. The only problem, according to many who actually listened to management’s call, is its “high-water mark’’ comment wasn’t meant to suggest the company thinks the economic cycle has peaked.
At this point in time, earnings do not seem to matter at all. If the prevailing mindset is leaning to the thought that we are seeing peak earnings, then that may make sense. I'm not ready to concede that fact just yet. Over 77% of companies are beating revenue estimates. That implies stronger business and nothing to do with gains from tax rates, etc.
Ironic that all during this bull market, the cry was earnings are being "engineered" because revenue growth was weaker than it is today. I didn't follow that line of thinking, and I'm not following what some of the pundits are selling about "peak" earnings now.
FactSet Research Weekly Update
For Q1 2018, with 81% of the companies in the S&P 500 reporting actual results for the quarter, 78% of S&P 500 companies have reported a positive EPS surprise and 77% have reported a positive sales surprise. If 78% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008.
Earnings Growth: For Q1 2018, the blended earnings growth rate for the S&P 500 is 24.2%. If 24.2% is the actual growth rate for the quarter, it will mark the highest earnings growth since Q3 2010 (34%).
Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.0. This P/E ratio is below the 5-year average (16.1) but above the 10-year average (14.3).
The Federal Open Market Committee held the funds rate at a target of 1.5 percent to 1.75 percent, as expected. The committee noted:
"Overall inflation and inflation for items other than food and energy have moved close to 2 percent. Business fixed investment continued to grow strongly."
Reading the entire statement, some are interpreting that the Fed is perfectly comfortable letting inflation run a bit over 2%, just as it was comfortable starting and continuing hikes with core PCE running below target. It appears that the FOMC wants 3 more hikes this year and is signaling it’ll look past a bit of above-target inflation in sticking to that course.
With the S&P 500 continuing to act like a roller coaster, investors are once again on the defensive, causing bullish sentiment to retreat. According to this week’s sentiment survey from AAII, bullish sentiment declined from 36.9% down to 28.4%. While anything sub-30% is considered low, we actually saw a lower weekly print back in the first half of April when bullish sentiment dropped down to 26%.
WTI is trading at its highest levels since late 2014, and is up 39% in the last year and 26% in just the last six months. The weekly inventory report showed a huge inventory increase of 6.2 million barrels in the past week. Gasoline inventories increased by 1.2 million barrels. The price of crude oil stayed in a narrow trading range this week, closing out the week at $69.72, up $1.65.
The fact that crude oil has been resilient while trading just shy of $70 is a sign that the global economy is NOT slowing down.
The Technical Picture
The shorter-term view using the daily chart of the S&P highlights the recent price action portraying a picture of the ongoing consolidation phase. Rallies don’t hold, and late-day sell-offs seem to be the norm. This period is now entering its fourth month. Like all else in the markets, there are no time limits to when this market phase will be complete. Sometimes a few weeks or months, or like we saw in 2015/2016, a period of about 2 years before stocks broke out to the upside.
(Chart courtesy of FreeStockCharts.com)
It also has to be stated that the completion of this consolidation can end with a breakdown or a breakout in prices. Look at the wedge pattern that has now emerged over this consolidation phase. Higher lows, but also lower highs. What usually develops when the fundamental story is good, the price action gets squeezed and is forced up and out of the triangle. Of course, no guarantees come with that pattern. In this present set-up, the index might still remain in the consolidation box with no immediate resolution.
What may be back on the table of scenarios to consider is another retest of the February lows (2532). A possibility also exists for that retest to establish a quick, shallow undercut low that could then end the corrective phase. The volatility continued, and the short-term look changed again with the reversal on Thursday, followed by a continuation rally on Friday. That action placed the index right back in the middle of the consolidation phase.
Going back to probabilities, one can only assemble the evidence available and then conclude what scenario has the better chance of occurring. I know all of this is redundant, but that's what makes a successful investor. Going over the same solid principles that successful investors employ, best not to jump ahead and get reactionary. One day, one week at a time.
Short-term support slips to the 2594 and 2575 pivots, with resistance at 2681 the site of the 50-day moving average (blue line).
Any and all of the people who promoted absurd stories that were bandied around about Apple (AAPL) prior to earnings need to simply enter the hall of shame and then speak to investors no more. Well, we know that will never happen, so here is the next best thing - don’t listen to them!
Individual Stocks and Sectors
Utilities and REITs, two groups that were tossed aside because rates were going higher, rebounded towards the end of April. Utilities wiped out a loss for the month and finished with a gain of 2+%. The rumor was that many hedge funds have decided to go with the pure domestic plays. The talk of trade wars has them piling into this seemingly safe group, disdaining the fact that rates are rising. I can always make a case for being diversified and having some of these stocks in a portfolio at all times. However, the recent action, from "shunned" to "have to own," shows how herd mentality can turn around the narrative in a heartbeat. I won’t be following that move.
A lot of the money used for that rotation came from the Industrials, as no one seemed to want to have anything to do with a company that was about to be destroyed in a trade war. I’ll take the other side of those trades now. Remain with an underweight rating on the pure, slow-growing domestic sectors and pick up some of the beleaguered Industrial stocks. If one looks around, there are some that have little exposure to the international scene, yet their stocks are getting hammered. I believe this talk of an all-out trade war is way overblown.
Since the lows of the Financial Crisis in March 2009, the best-performing sectors in the May through October period have been Technology and Health Care, while Telecom Services has lagged. Technology and Health Care just happen to be at the top of the list when it comes to earnings growth.
If you were one of the unlucky folks that lightened up on Apple, or were dissuaded from purchasing the stock when it was sold off because of all of the negativity, you are not alone. The boat is now full of analysts, media and other market geniuses that sold a story that Apple debunked with its latest earnings report. I could go on for three more paragraphs and explain how the entire story was misinterpreted from the beginning and then reported incorrectly, but I‘ll leave investors who doubt Apple and say that overall retail demand is waning in China with this statement by Tim Cook:
“The iPhone X was the most popular smartphone in China in the last quarter.”
Apple isn’t dead, and neither is growth in China. I’ll stay with what I mentioned two weeks ago and reiterated last week:
“Those who continue to tell me the FAANG trade is in trouble or over, might be disappointed once again. All one has to do is watch the earnings results and then the price action that is ahead for this high growth group. I suspect we will see the other names in the group continue a positive flow of earnings results.”
Time to step out on a limb and tell anyone that wants to listen, this group of stocks is not finished going higher. AAPL was up 13+% this past week.
A final note to reinforce the point that was made earlier. Consumer Discretionary has continued to outperform despite a drawdown in equities over the last 3 1/2 months. Historically, outperformance of Consumer Staples versus Discretionary has taken place during bear markets. That is NOT happening today. The recent price action for the two sectors on a relative basis suggests that the current drawdown is not the start of a bear market. The bull market trend is still in force.
The market’s recent performance continues to dictate uncertainty. Despite some of the headwinds facing investors, there are still a number of positives to keep in mind too. The U.S. economy is currently showing no sign of impending weakness, earnings are positive and sentiment has retreated considerably from exuberant levels earlier this year. These are all positives for the market from a long-term perspective. However, in the short run, we are entering into a period that at times has been weak.
Now we can add in the fact that we could see a buyers' strike. The average investor seems to be a seller, or is adopting a "wait and see" approach. If that occurs, we could very well wait and see the stock market drift right back to the lows. Market participants have highlighted and are now preoccupied with other matters. Late-day selling and weakness in the face of good news are signs of the malaise that is present.
Until that downtrend is broken or the market reacts better to positive news, it would be foolish to say any significant rebound in prices is imminent. While that may be upsetting to traders or those that can’t deal with a corrective phase, it is hardly the end of the bull market if this sideways pattern continues. Remember, this price action comes after 13 months of unabated gains. Thursday’s reversal in the S&P, and the follow-through on Friday, may have been the first step indicating investors' attitude may be changing.
At 106 months, the current expansion now ranks tied with the 8+ year stretch in the 1960s for the second longest in U.S. history and behind the ten-year record run from March 1991 through March 2001. While many people continue to think that the U.S. economy will never see solid 5+% growth again, that may be the new norm.
Let’s face it, the U.S. economy is very mature - it's not some non-diverse emerging market. Our economy has captured huge market share as that maturity was taking place. Like any huge corporation, it’s likely that the U.S. economy is seeing some reduced growth on a relative basis, due in large part to unsustainable market share capture. Slower but more stable growth should not necessarily be viewed as worse than high and unstable growth.
Market participants still have the memory of two stock market busts and a financial crisis in the last 20 years, and believe it or not, that still weighs on investors' decisions. Along comes the drop in 2016 that scared many investors into believing a bear market had begun.
The human mind went to work and it renewed the memory of the financial crisis, despite no evidence of such. 2017 was the opposite - a year of perfect calm - yet the year saw net outflows in equity funds. 2018 has been the opposite of that, with wild swings and now new fears of an economic downturn and a bear market.
There is nothing new here, nor is there something wrong. Quite the opposite, this is how markets operate. Just when investors get comfortable and think they have it figured out, the stock market has a mind of its own and proceeds accordingly. That means bringing calamity to a large group of participants. Investors are still skeptical of equities, and the data bears that out.
Despite how frustrating the present-day price action is, there is little to no evidence that a major market top is in. If I add in the present general market sentiment, it suggests higher, not lower, prices down the road. Investors do not have to know how to time the market. What they need to do is listen to what the market is telling them. The key is to interpret the language properly. Part of that interpretation is starting with a conversation that includes the long-term trend. Anything else will usually produce a lot of misunderstanding about what is really going on.
Remember this when you go about reviewing your usual financial websites and find that every article, every economic data point is coming up rosy with no controversy, that will mark the top. I don’t see any evidence of that now. Stay the course.
to all of the readers that contribute to this forum to make these articles a better experience for all.
Best of luck to all!
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