"It's not always easy to do what's not popular, but that's where you make your money." - John Neff
While it doesn't feel that way, the stock market has managed the pullback from its recent all-time high relatively well, and while "trade" has been given the lion's share of the blame for the sell-off, I think it can equally be attributed to normal mean reversion that occurs following steep rallies like we saw in Q1.
Two straight weeks of declines for the S&P turned into three, and four straight weekly declines for the Dow turned into five. The last time the Dow 30 was down for five straight weeks was in 2011.
For the third week in a row, the trading started off on a negative note as the major indices suffered a tariff tantrum. Turnaround Tuesday brought relief from the scary tariff headlines. That move came with positive breadth. The S&P 500's Advance /Decline line was +405. A very strong reading for the magnitude of the move (+0.72%). From there, it was all downhill for the Bulls as investors that were skittish were now downright fearful.
This selloff felt more like a buyers strike than outright institutional selling. On a closing basis, this pullback remains contained to the 4.5% range. After the gains achieved off the lows and the backdrop that exists today, one would think the S&P would be MUCH lower.
Whether I am speaking to investors or gathering information on the market, there appears to be a common theme. It seems that many are looking for a sign, a clear signal, to help them make decisions with their investments.
There really aren't any clear signals, just facts that need to be assembled to form a strategy. Searching and waiting for that clear sign that it is OK to be invested in stocks is usually met with utter failure.
In reality, what we face is a myriad of issues.
"A U.S. economy that some say is good, others say it's just muddling along. Both sides may have a case, one week the data seems ok, the next week, not so good. On the global scene there are challenges daily with the constant chatter about China's impending hard landing. The Eurozone is mired in a slower recovery than what we have experienced here in the U.S. It seems if it isn't this or that country with issues, then it's "Brexit" that is on the table that could upset the entire apple cart over there."
There is some irony in what you just read, and it may surprise you. The same word for word commentary was written (by me) and offered here on Seeking Alpha three years ago.
In the three years that have transpired, it's apparent many of the same "issues" are still with us. It can be said there were many new challenges tossed at investors during that time frame as well. The S&P was 2,050 three years ago. Today, it is 2,850. A gain of some 39%. There is a message there. Over time, markets trade on sentiment, emotion, trends, and less on what is going on at any precise moment in time.
A successful investor will listen and observe the concerns that are ever present. However, at the time they are highlighted, it should be obvious why they don't panic or make rash decisions over them.
So, as the week ended, the drawdown from the last peak on a closing basis remains at 4.5%. While we should keep an open mind that there could be more weakness, investors should also realize that the equity market was set up for a pause in the upside and we got it. The recent price action is hardly a surprise. The average year sees the S&P 500 pullback 5% more than 3 times on average. We have yet to experience ONE in 2019.
All eyes shifted to the increased trade tension with China as the root cause. Ultimately, if it wasn't the trade tensions, there would have been some other excuse like global economic data, D.C. shenanigans, or something else. There are never any shortages of excuses for market action. Sometimes, it is as simple as there are more sellers than buyers and vice versa.
Opinions on what happens next will range from the 4% drop I anticipated as the extent of this pullback, to a more dramatic 15-20% pullback like 2011, 2015-16, and 2018. Meanwhile, the market is now meandering around trying to make up its mind whether it will make new highs or fall back to the lower end of the trading range. Perhaps, even totally break down and test the December 2018 lows.
The ebb and flow between "deal" and "no deal" are likely to keep markets on edge. Expect continued volatility in the U.S.-China trade relationship leading up to the late-June G20 Summit. Believing a trade deal was going to get done was pure speculation. Assuming that there is little or no chance of a deal getting done is the same. Some will let the noise affect their decisions, others will put it in perspective.
The number of consumers facing foreclosure or bankruptcy is falling.
The share of consumers facing collection is also falling and is right near series lows.
Investment grade spreads made new multi-month highs this past week, with investment grade trading 20 basis points above where it sat in the middle of last year.
High-yield spreads are also at the top of their year-to-date range. While credit markets have responded in typical risk-off fashion, the overall moves been relatively modest so far. This remains a fluid situation, but for those that want to extrapolate this issue becoming a major problem might want to rethink their ideas. They may be on the edge of a bear trap and ready to fall into an abyss.
Plenty of consternation over the last drop in the retail sales report. However, the April-May holiday season (Easter and Passover) were solid. Commerce Department reported average total retail and food service sales of $513.8 billion for the 2-month holiday period in 2019. That's a solid 3.4% year-over-year rise compared with a powerful 4.9% rise in 2018, the best in six years (since 2012's robust 5.6% gain).
Flash Markit manufacturing index fell to 50.6 in May versus 52.6 in April. It was at 56.4 a year ago. This is the worst since September 2009.
Chris Williamson, Chief Business Economist at IHS Markit said;
"Growth of business activity slowed sharply in May as trade war worries and increased uncertainty dealt a further blow to order book growth and business confidence. A decline in the headline 'flash' PMI to its lowest for three years pushes the survey data down to a level historically consistent with GDP growing at an annualised rate of just 1.2% in May. Worse may be to come, as inflows of new business showed the smallest rise seen this side of the global financial crisis. Business confidence has meanwhile slumped to its lowest since at least 2012, causing firms to tighten their belts, notably in respect to hiring. Jobs growth in May was the weakest seen for over two years."
"The slowdown has been led by manufacturing, but shows increasing signs of spreading to services. The survey data have been consistent with falling manufacturing output since February, but suggest that the sector's woes intensified in May to mean factories will therefore likely act as an increasing drag on the economy in the second quarter. Trade wars remained top of the list of concerns among manufacturers, alongside signs of slower sales and weaker economic growth both at home and in key export markets."
Kansas City Fed manufacturing report indicated the month over month composite index was 4 in May, similar to a reading of 5 in April, but down from 10 in March.
Existing home sales slipped 0.4% to 5.190 M in April, disappointing expectations for a strong rebound following the 4.9% drop to a 5.210 M rate in March. It's the slowest pace since September's 5.180 M, which was the worst since April 2015.
Lawrence Yun, NAR's chief economist;
" I am not overly concerned about the 0.4% dip in sales and expects moderate growth very soon. First, we are seeing historically low mortgage rates combined with a pent-up demand to buy, so buyers will look to take advantage of these conditions. Also, job creation is improving, causing wage growth to align with home price growth, which helps affordability and will help spur more home sales."
"The median existing home price for all housing types in April was $267,300, up 3.6% from April 2018 ($257,900). April's price increase marks the 86th straight month of year over year gains."
"Total housing inventory at the end of April increased to 1.83 million, up from 1.67 million existing homes available for sale in March and a 1.7% increase from 1.80 million a year ago. Unsold inventory is at a 4.2-month supply at the current sales pace, up from 3.8 months in March and up from 4.0 months in April 2018."
"We see that the inventory totals have steadily improved, and will provide more choices for those looking to buy a home. When placing their home on the market, home sellers need to be very realistic and aware of the current conditions."
"Properties remained on the market for an average of 24 days in April, down from 36 days in March and down from 26 days a year ago. Fifty-three percent of homes sold in April were on the market for less than a month."
"College student debt continues to hinder millennial homebuyers. "Given the record high job openings in the construction sector, some may want to take a gap year to work there and save, and thereby lessen the student debt burden."
New home sales report beat estimates with only a modest April pullback after a steep upwardly revised climb through Q1. New home sales posted a -6.9% April pullback to a still solid 673k pace, after what is now an 11-year high of 723k in March. This was the third strongest result of the expansion, and sales are up 7% year over year.
Consumer confidence in the Eurozone has now risen for four of the past five months and is at the highest levels since October. Consumer confidence is broadly correlated with real consumer spending, leaving this data point as an item to watch closely.
IHS Markit Eurozone Composite PMI recorded 51.6 in May, according to the preliminary 'flash' estimate, up only fractionally from 51.5 in April.
Chris Williamson, Chief Business Economist at IHS Markit said;
"The eurozone economy remained becalmed in the doldrums in May, adding to signs that only modest growth will be achieved in the second quarter. At current levels the PMI is so far indicating GDP growth of only 0.2% in the second quarter."
"A renewed deterioration in optimism about the year ahead suggests that the business situation could deteriorate further in coming months." Worries reflected concerns over lower economic growth forecasts, signs of weaker sales and rising geopolitical uncertainty, with escalating trade wars and auto sector woes commonly cited as specific causes for concern."
"Sector divergences remain marked, with manufacturing still in decline and the region therefore reliant on the service sector to support growth."
The expectations component of monthly German IFO manufacturing surveys beat expectations and rose, suggesting that the recent slowdown in growth it has forecast may end mid-year.
Conflicting signals from the economic data continues. Manufacturing data is weak, while German consumer spending hit an eight year high in the first quarter.
Japanese GDP was much stronger in Q1 than expected, +2.1% quarter over quarter. The economy was expected to contract by 0.2%.
Flash Japan Manufacturing PMI falls to 49.6 in May, from 50.2 in April. Output and new orders decrease for fifth successive month.
Joe Hayes, Economist at IHS Markit, which compiles the survey, said;
"Following some tentative signs that the downturn in Japan's manufacturing sector had softened in April, flash data for May revealed these were short-lived, as output and export orders fell at stronger rates. The re-escalation of US-China trade frictions has heightened concern among Japanese goods producers. Underlying growth weakness across much of Asia led to struggling exports, which fell at the sharpest rate in four months. Difficulties on the international front merely add to uncertainties domestically, with upcoming upper house elections in July, and the impending sales tax hike later this year. Subsequently, sentiment turned negative in May for the first time in six and a half years."
Remember all of the panic over Brexit when it was first announced? Another one of those "you better sell equities" moments.
Fast forward to this week. Theresa May started off the week by pledging to set out a "new and improved" Brexit deal next month as she attempts to put together a cross-party coalition of MPs to finally pass her Withdrawal Agreement Bill.
On Friday, she announced her resignation. Her basic failure to get the Withdrawal Agreement through Parliament is the cause of her resignation. The EU is already busy signaling that her successor will not get another chance at negotiating. That infers the three choices for the UK (unilaterally revoke Article 50 notification and cancel Brexit, crash out with no deal, or pass the Withdrawal Agreement through Parliament) won't change with the new PM.
The drama continues to unfold.
Just when analyst estimates were stabilizing along comes the fear of what tariffs will do to corporate earnings. 10%, 15%, 20% and as high as 30% declines in certain sector earnings are being bandied about now.
Investors have a choice whether they wish to model their holdings to match what could be or sit back and observe the market's price action to give them a clue as to what may lie ahead. At the moment, no one is contemplating how companies are not only dealing with the tariff issue today, but how they will attack the situation in the coming months. It may not be this horrible negative that is being factored in today.
FactSet Research weekly update:
For Q1 2019:
With 97% of the companies in the S&P 500 reporting actual results for the quarter, 76% of S&P 500 companies have reported a positive EPS surprise and 59% have reported a positive revenue surprise.
The blended earnings decline for the S&P 500 is -0.4%. If -0.4% is the actual decline for the quarter, it will mark the first year-over-year decline in earnings for the index since Q2 2016 (-3.2%). Initial Q1 earnings estimates ranged from -3% to -5%.
Revenue growth was 5.3%.
Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.1. This P/E ratio is below the 5-year average (16.5) but above the 10-year average (14.8).
For Q2 2019:
Analysts are projecting a decline in earnings of -2.1% and revenue growth of 4.1%.
The Political Scene
U.S. and China are leaving room for negotiation despite re-escalation, and investor focus is on the late June G-20 meeting in Japan where Presidents Trump and Xi are set to meet.
Back to back knee-jerk reactions this week. The U.S. effectively banned Huawei from importing U.S. technology, a decision that forced several American companies, including Google (NASDAQ:GOOG) (NASDAQ:GOOGL), to partly sever their relationships with the Chinese handset and telecom provider. That announcement rattled the markets, especially the tech sector.
The administration walked back the talk on the aforementioned Huawei ban by offering a temporary reprieve. Huawei has a little breathing space to figure out what it should do next without U.S. technology. That spurred a rebound in the all-important semiconductor sector on Tuesday. That didn't last very long.
More sabre-rattling now with the idea of blacklisting other Chinese technology companies. That talk kept investors guessing if there would ever be resolution to the trade issues with China.
There seems to be a universal belief that the G20 meeting in Osaka on June 28-29 will serve as the next opportunity to de-escalate the trade tensions between the United States and China. While anything remains possible, at the moment, no meeting has actually been scheduled. No negotiations are currently scheduled between the U.S. and China to set the stage for a meeting.
It is important to come to the realization that this remains a fluid situation. It also wouldn't be a bad idea to come to the conclusion that there will probably not be any overwhelming sweeping reforms from this entire trade process. The latter has been my conclusion since the beginning back in 2018.
An investor can listen to the day-to-day headlines or listen to the CEOs of corporations and watch the bottom line results.
The earlier views that the Fed is out of the picture for 2019 seemed to be confirmed with the verbiage in the latest Fed minutes. The policy setting committee expects to keep a patient stance on rates "for some time".
Federal Reserve policymakers continue to speak in very neutral terms about the economy. While some, notably Minneapolis Fed President Kashkari and St. Louis Fed President Bullard, argue for easing, and others like Governor Brainard want the FOMC to run the economy hotter than it has recently, the consensus for the committee is clearly biased against rate cuts that are being priced by short-term interest rate markets.
Atlanta Fed President Bostic pushed back against the idea of cuts in an interview with CNBC, while Vice Chair Clarida repeated a previously used line that "the economy is operating at or close to the Fed's twin goals."
N.Y. Fed's Williams reiterated he sees no strong argument to move rates one way or another currently, in comments at a press briefing. Monetary policy is really well positioned and near the neutral interest rate. The economy is still in a very good place, and he still sees a strong labor market and a low unemployment rate. Some of the risks from abroad have receded somewhat. On inflation, pressures are essentially nonexistent. He added some factors may be holding prices down.
For those obsessed with the yield curve:
Source: U.S. Dept. Of The Treasury
The 2-10 spread started the year at 16 basis points; it stands at 16 basis points today.
Urban Carmel shares the Global Fund Manager survey with this illustration on twitter.
The AAII investor sentiment survey saw bullish sentiment decline sharply once again this week falling to 24.7% compared to 29.8% last week. Just two weeks ago, bullish sentiment was at 43.1%, which was the highest reading of the year. Falling 18.41% from this recent high, the current decline is the largest two-week drop in bullish sentiment since 6/6/13 when it fell 19.5% over the two previous weeks. That was a period where many doubted the new highs because the fundamental backdrop was so poor. The S&P continued on an unabated run to more new highs into year end.
Money managers are overweight cash and underweight equities. Bullish sentiment is under 30%. Everyone is on one side of the boat. Ask yourself, does that have the look of euphoria? Anyone continuing to tell themselves all of that is meaningless and dismiss that message may want to reconsider.
This is a time where the opening quote has true meaning.
"It's not always easy to do what's not popular, but that's where you make your money."
The Weekly inventory report surprised everyone as it showed another increase of 4.7 million barrels. At 476.8 million barrels, U.S. crude oil inventories are now about 4% above the five-year average for this time of year. Total motor gasoline inventories increased by 3.7 million barrels last week and are at the five-year average for this time of year.
That report and the angst over global demand were the suspected causes of the selling that took the price of WTI below the $60 level for the first time since March 28th. WTI closed the week at $59.02 down $3.69.
The Technical Picture
So far, the pullback from the highs has played out the way I thought it might. It has remained in the range of around 4.5%, but that commentary was tested this past week. Based on what I see today, there is always the possibility that the next level of support will come into play.
Chart courtesy of FreeStockCharts.com
I find it better to take things step by step rather than speculate and come up with large ranges to consider, up or down. That accomplishes nothing and causes more investor stress. Once an investor places any speculative forecast in their heads, they usually run with it. Unfortunately, the short-term views are so fluid, running with those ideas will have many running themselves into the ground. At the close today, the drawdown remains contained at the 4.5% level. Is there really any need to hear, then react to the idea that the S&P may drift to 2600 or lower until this drawdown is exceeded?
No need to guess what may occur; instead, it will be important to concentrate on the short-term pivots that are meaningful. However, the long-term view, the view 30,000 feet, is the only way to make successful decisions. These details are available in my daily updates to subscribers.
Short-term views are presented to give market participants a feel for the current situation. It should be noted that strategic investment decisions should NOT be based on any short-term view. These views contain a lot of noise and will lead an investor into whipsaw action that tends to detract from overall performance.
Individual Stocks and Sectors
The stock market's brutal month of May continued with a steep decline, especially for growth areas of the market like technology. Tech has been weak, but is still up 17% YTD. Perhaps, this is the pause that refreshes, instead of a dire warning that the sector is ready to fall apart.
I have voiced concern over the utility sector at various times during the bull market. The gap between the PE of the utility sector versus the Financial group is the highest ever recorded in history. The spread is primarily due to the huge overvaluation in Utilities. Investors have piled into the sector as defensive plays. While I don't believe anyone should undertake a wholesale sell program for these stocks, it might be wise to tread lightly with any new additions. If nothing else be aware that on a historical basis the sector is very expensive. This fact also screams how fearful investors are, sending a message that wild speculation in the stock market is not on the scene.
Best Buy (BBY) - the positive fundamental story continues as the company delivered a strong Q1 report by beating estimates on both the top and bottom line. BBY backed Q2 and full year guidance at the upper end of the range.
Perhaps, Best Buy is an example of how companies are coping with the tariff issues, and the impact in the minds of many investors may be overstated. Best Buy CEO says FY20 guidance accounts for impact from tariffs.
Best Buy CEO Hubert Joly;
"First, let me say that the administration has so far done a very good job of minimizing the impact of tariffs on U.S. consumers by limiting the number of consumer products on the tariff list. They have done this in part by taking input from companies like us. The company mitigated impact of tariffs by limiting the number of consumer products from China, buying ahead of tariff implemented, and working with vendors."
"Second, no decision has been made by the administration at this point on the actual implementation of tariffs on additional product categories. There is a comprehensive process the administration will be going through to take inputs and we intend to be actively engaged in this process to help the administration continue to minimize the impact of tariffs on U.S. consumers."
"In addition, there is time for the trade negotiations to progress before any decision gets made. Our fiscal 2020 guidance incorporates the estimated impact of the recent move from 10% to 25% tariffs."
Somehow that gets extrapolated to a 10-15+% hit on future earnings, despite the comments being made and the forward guidance presented.
With the S&P near highs amidst a backdrop of so many negative issues, many investors are scratching their head to try and figure out how can this be happening. There is talk of how investors are complacent. The prevailing logic is that this group of complacent folks simply don't see all of the pitfalls that are about to befall them. That makes sense to the person that doesn't have an answer. They immediately proceed to their fallback position. The situation doesn't look good. Stocks have to be headed lower.
Maybe so, but with the market near highs, I have a difficult time agreeing with anyone who wishes to extrapolate that to a precipitous fall in prices. Tariff tantrums will do that to the average investor. With this ugly backdrop, this has been a good time to exchange thoughts on which way the market will go. I see and hear many cite the same theories that were already shown to be an incorrect way to manage money. Yet these theories persist. They should know by now what happens to investors that make the same mistake over and over. Yet that continues to happen.
When I look over the landscape, there are plenty of pundits that have their caution lights on now. However, until we start to see things unravel, watch indices break support level after support level, I need to remind everyone that the light is still flashing green. When that was stated in January, not many believed. Some claimed the bull market was over. Perhaps, not many will believe it today either.
One thing is certain now, some investors will misjudge the situation as they take on the belief they MUST get ahead of the situation. They have already decided they won't be left holding the bag. There is no amount of examples that can be rendered to convince an investor that is set in their predetermined views to change. It simply is the wrong way to approach the situation as it exists today.
As noted in the opening remarks, the stock market thrives on trends. For those that decide to keep the fundamental backdrop in the forefront of their minds without acknowledging the trend are lost. Just ask the person next to you who decided to sell out because of the fundamental scene they saw 3 years ago. Please go back and read the opening of this article. It is virtually the same picture today!
Admittedly, there are some key levels of support that need to be monitored now, but there are ALWAYS key levels to be watched. Highlighting them more today than any other time in this bull market is absurd. Taking them and extrapolating out to a scenario that suggests large moves in either direction is disingenuous. That will always be a fool's errand. We saw that happen during the last market decline. The situation is fluid, and the only way to be successful is to go with that flow without making exaggerated assumptions.
Memorial Day brings up the notion of reflection. We all have much to be thankful for. Reflecting back on the entire bull market brings up many good stories and memories. It is time to reflect on the one axiom that plays out time and time again for successful investors.
"Always take advantage of the fear of others, don't let fear take advantage of you".
Enjoy the holiday!
Please take some time to remember all of those that gave the supreme sacrifice so we can enjoy what we have today.
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.
to all of the readers that contribute to this forum to make these articles a better experience for everyone.
Best of Luck to All!
A deeper correction seems to be the consensus thinking now. Plenty of opinions about how low the market might fall. We've seen how quickly these speculative notions fall apart. Learn to manage what YOU have in place today without getting whipsawed. Successful investors start at the macro level."
"Want to know what we are doing with stocks like Best Buy and others now? The Savvy Investor is here to assist. The difficult news backdrop has many confused. Learn to use the FEAR of others to your advantage. Please consider joining in on our success."
Disclosure: I am/we are long EVERY STOCK/ETF IN EVERY SAVVY PORTFOLIO. 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: My portfolios are ALL positioned to take advantage of the bull market with NO hedges in place.
This article contains my views of the equity market, it reflects 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.