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S&P 500 Weekly Update: A Selloff, A Rebound Rally, And Now A More Neutral Stance

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by: Fear & Greed Trader
Summary

Nothing has been resolved regarding the present market correction; the story is still unfolding.

Investors can stop wringing their hands over the midterm elections; they have come and gone. Time to get back to investing.

The same holds true for the Fed. The December rate hike is already priced in, and that means the Fed is a non event until early next year.

Investors need not get caught up in the "mind games" by trying to outthink the stock market.

"I have not failed. I have just found 10,000 things that do not work." - Thomas Edison

When it comes to financial markets, the last few weeks provide a great example of how quickly the situation can change. It was only a month ago that the performance of equities was leaving Treasuries in the dust, but in the span of less than one month, equities gave up more than half of their outperformance relative to Treasuries. Before that it was 8 months ago in February of this year. When I look at the year, the one word that comes to mind is whipsaw.

If you think you can time these events successfully over time, you may need to reconsider that approach. People often come up with statistics to prove anything (or sell you anything), and while politicians may be the most guilty of this approach, financial pundits also risk falling into this same trap if they are not careful. Well, please allow me to rephrase that. Financial gurus are very much guilty of that. This army of market prognosticators like to tout their remedies for what ails the average investor. From what I have seen during this bull market, they have killed off many patients.

With all sorts of financial information bombarding investors on a daily basis, it can be difficult to weigh all of the data to eventually form an opinion and a strategy. It then becomes important to develop a good filter for identifying those metrics that really jump out as being significant compared to the other fluff being presented. Once we do that, it becomes important for all to then question the opposing thoughts to put our theories to the test.

The next step, take those thoughts and come up with a "model' for the short- and long-term approach to the markets. At the end of the day, it is much better to have that "model" rather than follow the crowd that relies on an opinion based on emotions. Those opinions are usually fed by the news headlines of the moment. Over the long term, a "model" and strategy tend to work much better than knee-jerk opinions that are often offered to investors.

A successful investor also has to learn to admit they're wrong or learn from their mistakes to prosper. They also need to learn from history. One thing a market participant has to remember though is that studying market history is more about studying human emotions and behavior than figuring out what's likely to happen next.

The truth is every market scenario is different. We often see some similarities in different time periods, but the 2000 technology bubble was far different from the 2008 financial crisis; there is no playbook that fits all.

That doesn't imply that an investor should wander around and let their emotions rule the day. Therein lies the pitfall many seem to fall into. If one stays focused on what matters, then practices a heavy dose of self-awareness, they will do just fine. An investor has to know themselves first before they attempt to know the market situation at hand. They need to know exactly how they will react based on their personal profile and risk tolerance to any situation BEFORE that situation arises.

Any reader that has been following these articles for a while knows that I like to take it one step at a time. View the equity market in 3- to 6-month intervals. Letting the longer term view play out by allowing the longer term trends guide my strategy.

It is why a short-term strategy has to be ever evolving. It must be flexible and it must contain the words, "what if I'm wrong." There is a fine line between staying with your plan and admitting you were wrong and re-assessing. That "fine line" gets even more complex when you factor in all of the conflicting signals that are being thrown at investors now.

Impulsive, emotional reactions can then turn a plan into a disaster. No one ever said it was easy, and when faced with stress an investor MUST stop and look at the long-term trend first. That practice eliminates the daily/weekly noise both on the fundamental and technical side of the equation.

Those short-term views are loaded with land mines. Anyone can make anything out of a short-term notion. As stated in the opening comments, they often do. That does not mean we toss out the message that the stock market is putting forth. Instead we go back to the start of this conversation. Determine what is important and what is not. That isn't as easy as it sounds.

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Economy

Plenty of positives to consider regarding the situation here in the U.S. economy. Strength continues to be seen in the manufacturing and non-manufacturing surveys released by the Institute for Supply Management.

The consumer accounts for nearly 70% of economic growth. U.S consumer consumption continues to trend higher, running at a 4% annualized pace based on quarterly consumption reported in last Friday's advanced estimate of GDP. This is up from 3.05% in the second quarter. Recent reports show that same store sales were up 5.5% on a year-over-year basis.

The consumer is supported by a strong job market with job openings continuing to outpace job hires. Job openings are up 18% on a year-over-year basis and exceed the number of individuals actually looking for jobs by nearly 1.2 million. All of this explains why consumer confidence is strong as well.

Looking out to year end, these historically high confidence levels should continue to support healthy consumer spending, and should be welcome news for retailers as they begin gearing up for the holiday season.

U.S ISM Non-Manufacturing Index slipped to a still-robust 60.3 from a 21-year high of 61.6 in September versus lower readings of 58.5 in August and 55.7 in July. The ISM-NMI is still above the prior 12-year high of 59.9 in January. Since Composite data for the index begins in the late 1990s, there have only been four readings of 60 or above, and two of them came in the last two months.

The final IHS Markit U.S. Services Business Activity Index registered 54.8 in October, up from September's recent low of 53.5. Chris Williamson, Chief Business Economist at IHS Markit:

"A rebound from a weather-torn September and strong demand propelled service sector growth in October. Combined with the steady output growth being recorded in the manufacturing sector, the survey data suggest the economy grew at its fastest rate since July. Comparisons with GDP indicate that the latest survey data translate into an annualized rate of economic growth of around 2.5%, representing a solid start to the fourth quarter. Expectations of future business growth spiked higher, suggesting companies are expecting a strong end to the year for the economy."

Producer prices jumped in October, its biggest monthly gain since 2012 October PPI surged 0.6%, with the core rate expanding 0.5%. September PPI was not revised at a 0.2% gain, while the core rate was also not revised at 0.2%. The 12-month PPI pace accelerated to 2.9% y/y from 2.6%, while the core grew at a 2.6% y/y pace versus 2.5%

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September JOLTS report showed job openings fell 284k to 7,009k. That followed the 216k August jump to 7,293k. While job openings slipped from their record high, they remain over 7M for a third straight month.

Wages have started to accelerate.

Source: Bespoke

Month-over-month wage growth for non-managerial workers is up an average of 3.9% annualized in the last three months.

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Global Economy

The J.P. Morgan Global Services Business Activity Index rolled in at 53.4 up from September's two-year low of 52.9 and has now signaled growth for 111 straight months. David Hensley, Director of Global Economic Coordination at J.P. Morgan:

"The October PMI surveys signaled the first improvement in global service sector growth for four months. With the trend in new business also holding up well, backlogs of work rising and business optimism strengthening, the outlook for the sector remains positive for the coming months."

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Final IHS Markit Eurozone PMI Composite Output Index in October was reported at 53.1. That is down from the previous month's 54.1 to the lowest since September 2016. Chris Williamson, Chief Business Economist at IHS Markit:

"Eurozone companies reported a disappointing start to the fourth quarter. Business activity is growing at its slowest rate for over two years and expectations have slumped to the bleakest since the end of 2014. An export-led slowdown, linked to growing trade tensions and tariffs, has been exacerbated by rising political uncertainty, growing risk aversion and tightening financial conditions. The slowdown has consequently become more broad-based to increasingly envelop the services economy."

German factory orders beat expectations for the second straight month.

Eurozone retail sales volumes increased 0.8 percent from a year earlier in September 2018, easing from an upwardly revised 2.2 percent growth in August and beating market expectations of a 0.7 percent gain.

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While China's Markit manufacturing PMI was up sequentially from 50.0 to 50.1, an average of seven other Emerging Market Asia economies (South Korea, Taiwan, Malaysia, Myanmar, Thailand, Indonesia, and Vietnam) made new cycle lows.

Source: Bespoke

The average for the seven economies is now right at 50, which is the joint-lowest since December 2016 and the exact dividing line between growth and contraction.

Caixin China General Services PMI fell from 52.1 in September to a 28-month low of 50.5. Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group:

"The Caixin China General Services Business Activity Index slipped significantly to 50.8 in October from the previous month, marking its lowest level since September 2017. The sub-index for new business dropped to its lowest point since November 2008, despite staying in expansionary territory, indicating an obviously weakening demand for services. The employment sub-index returned to positive territory following a drop in the previous month. The sub-index for prices charged by service providers also returned to positive territory, while the one for input costs dropped despite staying in positive territory, suggesting easing pressure on company profit margins. The sub-index for business expectations, which gauges services provider's confidence toward operation prospects over the next 12 months, edged down mildly."

Nikkei India Services Business Activity Index posted in expansion territory for the fifth straight month. Moreover, rising from 50.9 in September, the latest report at 52.2 pointed to the quickest rate of growth since July. Pollyanna De Lima, Principal Economist at IHS Markit:

"The PMI surveys brought positive news of stronger economic growth at the start of the third quarter of Nikkei India Services PMI. Stronger upturn in new business boosts services jobs, indicating a welcome rebounded in private sector expansion from September's four-month low. A stronger upturn in services activity complemented the faster rise in manufacturing production reported last week."

"Cost pressures faded in October, but service providers continued to report rising costs, especially for food and fuel. At the same time, a robust expansion in work forces, one of the best seen for over seven-and-a-half years, added to firms' expenses. The waning of cost inflation, coupled with competitive pressures, resulted in only a marginal uptick in charges."

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The headline index from the Nikkei Japan Services PMI survey increased to 52.4 in October from 50.2 in September. The sharpest rate of output expansion since April. Joe Hayes, Economist at IHS Markit:

"As was the case with manufacturing PMI data in October, growth in Japan's crucial services economy rebounded at the beginning of Q4. Business activity expanded at the fastest pace in six months as firms observed the best monthly improvement in demand conditions since May 2013."

"However, many respondents noted that the rise in both output and new sales was a normalization effect following the business impact of natural disasters in September. November PMI data will be important to assess whether the stronger monthly improvements in output and new business are knee-jerk reactions."

UK manufacturing output increased 0.5% to beat estimates.

Earnings Observations

Corporate margins are at all-time highs, and the talk is that they have peaked.

However, I seem to remember hearing that tune being played in 2015. It seems we have a remake of the hit single, "Corporate profits have peaked".

In keeping with the strategy of being flexible and having an open mind, it suggests that we do need to listen to what is being said now. However, making the decision that this commentary on earnings is FACT was a mistake earlier in this bull market. It is quite possible the same mistake will be made again. In essence, anyone that refuses to acknowledge that possibility could be setting themselves up for failure.

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The Political Scene

Thankfully the midterm elections have come and gone. No blue wave, no red wave, no wave at all. The results were in line with what happens to every incumbent administration during this election cycle. A loss of congressional seats.

The rhetoric is sure to be ramped up now. Avoid letting the divisive atmosphere that is sure to follow alter your strategy.

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The Fed

Topdown Charts tell us:

"Since commencing Quantitative Tightening, total assets have been reduced by over $220B, and of that holdings of Treasuries have been reduced by $140B in total. Many have attributed the entire gain in the S&P to quantitative easing. If so, it stands to reason that quantitative tightening will be the death of equities."

I didn't buy into the quantitative easing commentary and I'm not buying into the quantitative tightening theories. Let's just play the cards we are dealt and let the situation play out.

The November FOMC meeting was a non-event. With a December rate hike already priced into the market, it tells us the Fed is now out of the picture until early next year.

The yield curve was THE topic of conversation a few months ago.

Since it has actually steepened, we don't hear much about the Armageddon it will bring to stocks IF it inverts.

Sentiment

The sentiment of individual investors in the weekly AAII survey saw a huge jump in bullish sentiment last week. This week there was another increase after a solid week of gains. The bullish camp saw a 3.4 percentage point increase to 41.2% from 37.9%. Bearish sentiment fell to 31.1% from 34.4%. It is now well below the high of 41% from only a couple weeks ago.

However, We also should consider this:

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Crude Oil And the U.S. Dollar

We only need to take a peek at the chart of the USD to understand why the price of crude oil remains weak. The U.S. Dollar Index looks to have broken out above what has been a significant resistance level.

Source: Bespoke

While the dollar has moved to the upside, WTI has now broken a support level put in earlier in the year.

Source: Bespoke

The EIA weekly inventory report posted another inventory build of 5.8 million barrels for the week. That is now six weekly increases in a row totaling 35+ million barrels. At 431 million barrels, U.S. crude oil inventories are about 3% above the five-year average for this time of year. Total motor gasoline inventories increased by 1.9 million barrels. They are now about 8% above the five-year average for this time of year.

Five straight weeks of declines have dropped the price of WTI to the March lows. WTI closed the week at $59.87, down $2.84. That is a $7.71 or 11+% loss in two weeks. Bearish inventory reports and the fear of a global slowdown seem to be the reasons for the selling.

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The Technical Picture

For those that want to look at a larger universe of stocks to draw their conclusions, the MONTHLY chart of the NYSE is presented.

Chart courtesy of FeeeStockCharts.com

October saw a close below the Long-Term trend line, and the rebound rally in early November has placed the index right at the trend line. A situation that will need to be monitored as we close out the year.

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The shorter-term DAILY chart of the S&P depicts the rebound rally that took the index right to a resistance zone. We should expect the volatility to continue. Markets rally from oversold conditions, then we see more counter rallies. At the end of the day, watch for a series of higher lows and higher highs as the S&P tries to reverse this corrective phase.

Chart courtesy of FeeeStockCharts.com

Nothing has been resolved yet. Now we should be on alert and look for a drop back into the middle of the consolidation box. There is a "gap" in the S&P chart that probably gets filled at S&P 2,756. Just like we saw in the February to October period, all of this should take time.

Short-term support is at the 2,750-2,760 range, with resistance at 2,815-2,830 zone. A more bearish scenario takes the index back to the 2,680 range, a distinct possibility.

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Individual Stocks and Sectors

The theme now from many research institutions; Strategas Research says the recent environment is one in which active strategies tend to perform at their best relative to passive strategies. Their reasoning, an earlier cycle environment in which a rising tide lifts all boats (along with the indexes) is no longer here.

For much of this year, the FAANGs (Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX) and Google aka Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL)) and small caps have led the market, During this pullback defensive and dividend-oriented stocks caught a bid. Given the late-cycle signals in some of the data, Renaissance Macro believes this shift will last for the next six months, with defensive names outperforming cyclical stocks by more than 200 basis points.

No matter how one views the present market situation, remember to stay diversified.

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After a large pullback from a market high, followed by a deep oversold reading in the Relative Strength Index, the S&P 500 has returned to neutral. It is now anyone's guess as to whether the next move will be higher or lower. Given all of the crosscurrents, I believe a trading range and more of a sideways market has the highest probability of occurring now.

Ben Carlson tell us:

"The S&P 500 has had 20 bear markets (down 20% or worse) and 27 corrections (down 10% but less than 20%) since 1928. The average losses saw stocks fall 24% and lasted 228 days from peak-to-trough."

"Of those 47 double-digit sell-offs, 31 of them occurred outside of a recession and didn't happen in the lead up to a recession. That means around 66% of the time, the market has experienced a double-digit draw down with no recession as the main cause. Of those 31 which occurred outside of a recession, the losses were -18% over 154 days, on average."

The obvious conclusion; sometimes the stock market goes down, and it has zero to do with the situation or issues that so many are concentrating on. My view on many of these drawdowns is very simple. They are NOTHING more than a normal market reaction. A period of consolidation that resolves the excess of the prior period in time.

The fundamentals then get time to catch up to price. The 14% correction in the 2015-2016 time frame had many negative headlines associated with it. Among other points I was attempting to make at the time was to look at what transpired leading up to that corrective phase. The S&P rose 30% in 2013, then followed that up with a 12% gain in 2014. In two calendar years a 42% gain. I would argue that the subsequent sideways action, then the decline was simply necessary to work off the excesses.

Fast forward to today. Plenty of negatives are swirling around now, and everyone has their opinion on what will take down the stock market. Their conclusions are drawn, and they are all focusing on the negatives. Indulge me for a moment and allow me to review the period leading up to the present day. Since November 2016 to the peak in October here in 2018, the S&P is up 41%. The extent of this corrective phase to date has been approximately 12%.

It may be pure coincidence, but I do NOT believe it is a point that should be dismissed. Perhaps this is just another period in time where equities revert to the mean. So while many have drawn their negative conclusions, they just might get caught being wrong once again like they were in 2016.

Investors that practice that style of money management get whipsawed because they believe they have the godlike ability to make calls before all of the evidence is in. On October 3rd, the S&P hit a new high. Eighteen trading days later, the talk was that a complete market break down was imminent. The words bear market and losses of hundreds of S&P points were being tossed around.

Can these phases morph into a bear market? Of course, but I for one don't make those types of calls with the S&P 5% from an all-time high.

Despite the recent rally, NOTHING has been resolved regarding the pullback. It remains a market event that is still unfolding. When I say NOTHING, I mean NOTHING, and that is exactly what investors need to start doing when there is any outbreak of trouble in the equity market.

The story that was sold a few weeks ago called for stocks to be sold because the pundits saw dangerous signals at S&P 2,800. While they may have looked like geniuses when the S&P dropped to 2,600, the question for the average Joe and Mary that followed that strategy is, now what? Some of the issues seem to be easing, no midterm worries, and we know what the Fed is doing and stocks rallied. Time to get back in?

But wait a minute, 18 days ago the S&P was going to 2,000, now suddenly it is time it is time to get back in? Let the mind games begin. Sorry the human mind doesn't work that way. When fear is installed it does NOT leave the next day. Let me clue the doubters in, the market NEVER loses these mind games, NEVER.

As these calls are being made, anyone proclaiming they aren't being whipsawed by the market activity is selling us a fantasy. Here is what typically happens. The average investor starts to overthink the situation. They fall to emotion again, act prematurely and compound the mistake. That leaves them in a complete state of confusion. They begin to second guess every move they made in the last six weeks. More mind games.

The message is simple, and it has been stated here over and over again. I will repeat it one more time. The ONLY investors that are in the driver's seat are the folks that have done little or NOTHING. They have NO decisions, no angst. And they can decide without anguish how they may want to proceed now.

Each can decide how they want to approach these types of events, but I caution investors to think long and hard before they decide they can outguess the stock market. An investor should not leave a long-term trend until there is a DECISIVE signal. A signal that is void of speculation, conjecture and a whole lot of what ifs.

Stay the course. This bull market story is still unfolding, and there is no clear cut answer to the next market move, no matter what anyone wants to tell us.

A moment of silence for the victims and their families involved in the California Bar shooting. Our thoughts also go out to the many veterans that have served, as we observe Veterans Day on November 12th.

I would also like to take a moment and remind all of the readers of an important issue. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore, it is impossible to pinpoint what may be right for each situation. Please keep that in mind when forming your investment strategy.

Thank you #2.jpg 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 ALL POSITIONS MENTIONED IN MY PORTFOLIOS. 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 contains my views of the equity market, the strategy and positioning that is comfortable for me. Of course, it is not suited for everyone, as 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.