Trade Wars Extend Worries

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Includes: AAPL, AMZN, FB, GOOG, MSFT, NFLX, SPY
by: Richard Marzouka
Summary

Given near term concerns the market will likely under perform in August and September.

Portfolio maintenance ahead of the pullback to raise some cash is advised.

Mid Term Elections will serve as a positive catalyst for the market after a period of weakness.

The market has cautiously edged back toward all-time highs. There continues to be a problem in broad leadership in the market in order to take new highs and hold them. Expectations of a near term pullback are almost certain. Take time to re-evaluate your portfolio positions and make changes now while the opportunity is still there.

Market pullbacks can precipitate from anything once they are due, and we are getting due for one. First, let me say that small pullbacks can be healthy for the market. August/September are typically a tough months, and chances are that they will disappoint with the uncertainties of midterm elections, and trade concerns.

Source: CFRA

On average August returns -0.8% in midterm election years, and September -0.9%. Initially I underestimated the magnitude and length we would face over trade negotiations. This uncertainty seems to have lingered and the stakes constantly are being raised to achieve a deal we all are patiently waiting on. I digress...

Unmistakably the market has been led by FAANG this year. This has been the trade to be in so far.

Earnings for the group were mixed. Apple (AAPL) just reported a strong quarter and forging ahead with a market cap soon to breach 1 Trillion dollars. Amazon (AMZN) racing for the same market cap is performing on par with expectations. Microsoft (MSFT) and Google (GOOG) both brought home a win with their reports beating street expectation. Netflix (NFLX) and Facebook (FB) both took a short term hit on their share price over user growth issues and rising costs.

Source: TipRanks

Apple share price in February represented an upside of 30%+ based on analyst price targets. Current price targets only average a 5.04% upside.

Source: TipRanks

During the same period the analyst price targets for Amazon represented an upside of 40%+ and currently the upside average consensus is 17%.

Source: Think or Swim NYSE FANG index

The NYSE FANG index shows us we are now in correction territory for the group. This has been the driving force in market leadership and we have a weakening RSI with lower highs and pushing against the lower lows. This is not to mean this trade is over, but it does mean the momentum that has propelled us to this point is going to need time to recharge and the upside expectation is lower. If FAANG need a break from leadership, then who will be the new sector leader?

Financials is the go to answer for everyone looking for a leadership group to pick up the slack. Just how many experts pounded since 2017 and early 2018 that financials was the go to trade? The problem with financials is they are trading as a proxy to the 10 year yield. Financials are the very heart of the market and lending is still weak. In order to get financials to move higher, there needs to be a substantial uptick in lending or a wash out of the sector (sell off event) to bring in buyers.

Source: Think or Swim

Taking a picture of the S&P 500 (SPY) we can see the slow climb back to near January high of 2872. This will act as a huge wall and stocks will sell off if we reach it. The market is driving up in a channel seen in red and will likely take two weeks to retest the highs. That is not guaranteed as a breakdown can occur quickly and breaking the channel will send us lower to the green uptrend support. This is a good area to buy back positions. It is my opinion that the market will increase in volatility over the next few weeks and the midterm elections will serve as a positive catalyst to reverse the expected pullback. Adjusting around this will help increase portfolio returns.

Exhibit: Month-on-Month changes to Global FMS positioning

Description: http://www.fxwatcher.com/wp-content/uploads/2018/03/Exhibit-2.png

Source: BofA Merrill Lynch Global Fund Manager Survey, Bloomberg

Fund managers are raising cash positions in their portfolios which give them more firepower to buy opportunities but mainly it signals this market has more room to the upside. Lower cash positions signals a weak market ahead.

We are facing a seasonal slow period with August/September and ahead of midterm elections. Add this to the uncertainty of trade wars and managers will look for higher cash positions in the near term. Some managers have a more flexibility on the cash position they keep in a portfolio while others are mandated to keep so much invested.

I am not advocating you liquidate and sit on cash. I do think that a 10%-20% cash position right now is a healthy move. This will give you an opportunity to reload after an expected period of weakness in the market. The trade debacle may take longer to sort out and I think it will get darker yet before we see the light. Making some changes now might be a smart move before the midterm elections.

I will leave you with this final chart showing the biggest perceived risk to the market. The fear of a trade war now is taking the lead. Federal Reserve policy and ECB and the fear of quantitative tightening has taken a back seat. The ECB continues to delay rate hikes while the Fed moves to raise again in September in a time where trade could push us in any direction. This uncertainty will create volatility and that will create opportunity. This is a great time to look at positions that may have matured in your portfolio and make proper adjustments or trim back some gains.

I am bullish on Technology, Biotechnology and Financials. I will publish my top picks in these sectors but I do expect broad market weakness in the next few weeks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.