What Will Happen When The Market Has A Down Year?

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Includes: ACWF, ACWI, AIIQ, BIBL, CHGX, COINB, CRF, DDM, DGT, DIA, DMRL, DOG, DTEC, DUSA, DXD, EDOW, EEH, EPS, EQL, EQWS, ESGF, ESGL, ESGW, FEX, FIHD, FLQG, FWDD, GLQ, GSEW, HACW, HDMV, HUSV, IVV, IWL, IWM, JHML, JKD, OMFS, OTPIX, PMOM, PPLC, PSQ, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RVRS, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, USA, USMC, UWM, VFINX, VGFO, VOO, VT, VTWO, VV, WBIL, XMX, ZF
by: Nell Sloane

Global equity markets continued to advance. Last week's newsletter noted the importance of closing the week above the all-important 2750 level in the EMINI SP500 Sept contract. We knew this level was huge, considering the close below on June 29th sent the contract below our 7-week moving average and was on the cusp of losing further ground. But all tariff worries aside, all geopolitical NATO posturing aside, the equity markets continued their advance on the tailwinds of massive continued corporate buybacks.

Before we get into the markets, let's dig into a few notable names from last week. Wells Fargo (NYSE:WFC) saw Q2 profits sink 11% on weakness in its main business units as well as ongoing costs related to its terrible mismanagement of corporate integrity. Shares fell 1.2% to $55.36 on Friday. On the flip side, PNC Financial Services Group (NYSE:PNC) saw profits jump 24% to $1.35 billion. Shares rose 33 cents to $138.42. JPMorgan (NYSE:JPM) and Citigroup (NYSE:C) also posted double-digit profits as borrowing rose. So, it seems the flat yield curve hasn't shown up in the earnings (yet).

Papa Johns American Airlines (NASDAQ:AAL) group lowered its Q2 revenue outlook, noting rising fuel charges. AAL lost 8% on the news from Wednesday and closed Friday at $37.12 up 79 cents. CA Inc. (NASDAQ:CA) spiked 19% last week as it agreed to a buyout from Broadcom Inc. (NASDAQ:AVGO). Broadcom is offering $44.50 per share. The deal is valued at $18.9 billion. Papa John's (NASDAQ:PZZA) popped 11% last week as founder John Schnatter resigned as chairman. Can you say insert pizza foot into mouth please? We can't imagine the PR nightmare - for some reason, one Paula Deen comes to mind...

We also read a good note from John Mauldin last week. One thing he pointed out was this:

"A new report by the American Legislative Exchange Council (NASDAQ:ALEC) shows the unfunded liabilities of state and local pension plans jumped $433 billion in the last year to more than $6 trillion."

We point this out because if the S&P 500's return was 22% last year and the NASDAQ's was 27%, yet the unfunded liabilities grew some 38%, what will happen when the market has a down year? These are truly scary figures. We have said time and time again, update after update, that the mathematics will eventually destroy all of these illusions. Using debt to supplant savings for organic growth is governed by the exponential laws of diminishing returns. Or in simpler terms, as time moves to the right, it will take more and more debt to produce an equalized amount of growth. The longer that persists, the larger the problem gets - and it never truly goes away, but it dies in spectacular fashion, unfortunately!

As long as the pension funds and central banks are willing buyers, either directly or indirectly through stealth operations, the day of reckoning keeps getting pushed out. Speaking of central bank and pension fund buying, and the correlation as to why markets never fall, we present this chart from Zero Hedge:

Total Japan ETF Holdings

Staying in Asia, the next chart is troubling. We touched upon Chinese shadow banking last week, and we have seen noticeable contractions in the data there. Considering this tightened environment, it is no surprise that junk bond indexes in China and Asia are climbing:
Asia Junk Bond Indexes

We also saw an interesting chart from our Zero Hedge friends, this time displaying the Europe and EM equity fund flows, which have plummeted to multi-year lows:

EM & European equity fund flows

The contrarian in us can't help but think a hefty global pension and SWF roll-tack maneuver may be upon us - for those that aren't into sailing, it's a reference to sailors moving in unison to one side of the boat while turning through the wind, using the weight of the crew to assist. In the market's case, it's getting everyone on the same side and then taking the trade square in their face. Anyway, and considering the huge underperformance of the DAX this year compared to its U.S. counterparts, our intuition senses a change may be upon us, as everyone's on one side of this boat. As far as looking at an overall European picture of funds in regard to the high yield market, this chart clearly shows the breakdown since late 2017:

European domiciled High Yield Credit fund flows

Ok, just to be fair, there is a flip side to all of this selling, right? Zero sum games, after all. Ok, so in order to save the day, the buying can simply be summed by taking all the buybacks, all the dividends, and even further, all the share-smashing M&A activity. So, I guess it's a function of simple supply-demand - remove shares, and the share price increases nominally:
Corporate Flow, dividends, share buybakcs, M&A

Ok, let's take a look at last Friday's settlement prices:
US Futures Markets-2

We will continue to monitor this asset allocation of EM versus DM and, more precisely, the Nikkei and DAX versus their US counterparts. I find it very curious that US fixed income has held up so well with equities rising. In particular, both the US government 30-year and 10-year auctions went well. The yield curve continues to flatten, and option gamma seems to be picking up in the short rates, so something might give here. We will see. Let's take a look at some S&P 500 charts (Source: Keystone Charts, Inc.). The Sep Future looks heavy under 2814, and that provides formidable resistance for now:

The SPY is also providing similar resistance near the 279.70 area:

As far as the SPX goes, this 2800 level seems obvious for the bulls to maintain or lose their mojo:
SPX Chart

As far as the change in the Term Structure of the SP VIX goes, we have this chart. Obviously, 6 months ago, VIX was 40% cheaper:

Moving on to crypto land, we have some key developments. "The U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority approved Coinbase's (COINB) purchase of Keystone Capital Corp., Venovate Marketplace Inc. and Digital Wealth LLC, a company spokesman said Monday. The acquisitions enable the firm to offer so-called security tokens, and also place the businesses under federal oversight. Coinbase has primarily been regulated by a patchwork of state authorities."

The move provides Coinbase licenses to operate as a broker dealer, an alternative trading system, and a registered investment adviser, the San Francisco-based company said in June. Alternative trading systems operate outside traditional public stock exchanges. (Zero Hedge)

CryptoCorner Recap

We can only figure that Coinbase, originally backed by a few US institutions and seemingly in favor with the IRS, is now prepared to be the house or exchange for US crypto currency participants. For all those that think buying and selling crypto is anonymous, think again. Each and every transaction, purchase, and transfer will now be logged and traced, i.e., pay your taxes! As far as last Friday's crypto settles, this week has the latest PPI and CPI reports, fodder for some inflation/deflation debates, as well as a slew of earnings which can be found HERE.

Congrats to this weekend's big winner, France, at the World Cup. However, we think the real winner was actually Juventus, as they welcomed their newest team member, Cristiano Ronaldo, from Real Madrid. Juve has a long-celebrated history, much like Real Madrid. We studied Real Madrid in biz school, and we were quite impressed with their president, Florentino Perez. He truly turned soccer into a global enterprise by merging modern-day business tactics and marketing with a globally embraced sport for all ages. Perhaps Mr. Agnelli of Juve hopes Ronaldo will increase not just victories but revenues. We would bet that is a solid lock on both fronts! Congrats to Novak Djokovic and Angelique Kerber on their Wimbledon victories. Ok, that does it, we hope you have a great week of trading and investing, thank you for reading our report.