"Here is part of the trade off with diversification. You must be diversified enough to survive bad times, or bad luck, so that skill and good process can have the chance to pay off over the long term." - Howard Marks
The roller-coaster market swings continue to baffle many investors. Coming into the week of June 3rd, the S&P was about as oversold as it has been in a while. Just five trading days later, as we entered this past week, there was already a hint of an overbought situation in the short term. The indices settled down and entered into pause mode as they got closer to the old highs.
Extremes, whether it be in valuations or investor emotions, are always corrected. It is just a matter of time. Reversion to the mean or the correction of any extreme usually is an unpleasant event when it comes to the markets. That comes about because not only is the swing back to the norm very volatile, but also, as we have seen in the past, the market then typically overshoots in the other direction.
Since the fourth quarter of 2018, the stock market has been a great example of that. Fast forward to the present day, and we now see that after the streak of weekly declines in the Dow and the S&P was broken, one has to wonder if a dash in the opposite direction has just started. The U.S. stock market has come roaring back in recent weeks with a gain of about 5% since the first trading day of June. Over the last few days, the indices settled into a narrow 40 point trading range this week. Sitting just above support, but below a resistance zone below the old highs.
The S&P was basically flat for the week, which follows the 4.4% gain in the prior week. Despite the backdrop of negativity, the index is up 15% for the year.
Global markets stabilized and moved higher as well, buoyed by plunging interest rates as bad economic data led traders to press bets for multiple Fed cuts this year. The weakening of the USD this week was also a substantial driver of returns by asset class.
Investors face a slew of psychological challenges. Perhaps the most difficult is updating beliefs when new information arrives. Enter this entire tariff issue that has been with investors since early 2018. In my view, the explanation for the wild swings in emotion and stock prices. We can see how overwhelming all of this can be when we consider that the average person has more information available to them in a week than a person in the seventeenth century had available in a lifetime.
The real issue for investors comes down to absorbing this abundance of information, which contains a great deal of not-so good news. What makes this even more difficult is that the human brain is evolutionarily wired to seek out and process potentially dangerous stimuli that could do us harm.
This "fight or flight" response served people well back in prehistoric times when it was necessary to simply survive the day. Now it interferes with our processes to obtain and understand knowledge in a much more advanced technological surrounding that abounds with headlines and sound bites.
As the authors of "Abundance" also point out, unlike the threats to human life back in the prehistoric setting, the dangers today can be described as probabilities, and that is a HUGE difference.
"The economy might nosedive, China can send the world into global recession, there could be a terrorist attack, crude oil can drop to $30 a barrel, the Fed is on the wrong track, etc."
However, our brain's early warning system can't tell the difference between these probabilities and real danger. What makes the situation worse, the system is also designed not to shut off until the potential danger has vanished completely, but threats that may take place never vanish completely. This is why there are so many pundits and strategists who love to constantly sell fear about bad things happening.
The desire for it is based on a psychological fascination of bad news that could potentially do us harm, however, unlikely the threat. And this is also exactly why I repeatedly tell nervous investors that if they are waiting for the uncertainty in the markets to disappear before putting capital to work, they're never going to buy stocks again. If one thinks the "wall of worry" is just a tired old axiom, please think again.
So, while there are great sources of solid informative data out there and of course there are times when caution is warranted, you have to be on high alert whenever you come across these overly negative news items. Simply because evolution has made it very easy to become a victim to the makeup of our brains that involve decision making and survival.
I think it is necessary to always pound the table regarding the topic of human behavior and investing. If nothing else, it is to constantly remind myself of the dangers that emotion brings to the table when managing money. In my view, it is THE reason why some investors are successful and so many fail.
Last week I posed the question can we talk ourselves into recession?
Who knows what the final outcome of the ongoing trade tensions will be. We have already heard Fed governors say they haven't seen any major impact on the economy. That doesn't seem to resonate with anyone, because we are being told a different story every day of the week. The concern that we should be paying attention to is the mindset that is prevalent now. The impact the trade situation is having on business confidence. At the end of the day how much of that will increasingly filter down to consumer confidence, finally impacting hard economic data.
We keep hearing the same negative overtones of how terrible the situation is. Keep telling yourself things and soon they become reality, in your mind. A self-fulfilling prophecy.
If the worst-case scenario does not come to pass that could easily elongate the runway between now and the next recession. In the meantime, any investor that stays focused on what really matters will be able to seek out the opportunities that the market is presenting. The inevitable gyrations are a great time to rebalance portfolios.
In summary, the economy here in the U.S. remains stable, but just about every forecast for Q2 GDP is in the 1% range. Remember Q1 was also forecast to be at that level, but rolled in at 3.1%. New York Fed GDP forecasting models for 2Q19 are moving lower.
Chart courtesy of Charles Schwab, Inc.
The consensus view says trade tariffs will have a big impact on the economy, and that has been the commentary since early 2018. Perhaps a more realistic common sense approach need be considered. The fact that tax cuts and deregulation aren't going away is seemingly left out of the equation. While the trade tariffs are given an extreme negative weighting, so far those extremes have yet to materialize.
Given all of the angst over tariffs and effects on the economy, the worst-case scenario might be a return to the 2% growth days. The benefits of tax cuts and deregulation offset by the impact of the tariffs roughly equal the negative effects of the past administration's tax hikes and over regulation.
Urban Carmel shares a few graphics that show the economy remains stable and there is no recession in sight.
New high in full-time jobs
New home sales in March reached a new cycle high and grew 7% year over year in April: in the past 50 years, a median of 28 months has lapsed between new home sales' expansion high (arrows) and the start of the next recession, so the recent cyclical high two months ago is a significant positive.
Real retail sales declined on a year-over-year basis in December, but rebounded to just 1.1% growth in April. The trend flattened in the period prior to the past two recessions, and there is some risk that the same is beginning to happen now.
Here is an issue that needs to be monitored. The May retail sales result detailed later in the article shows a nice rebound.
In addition he notes that the 3.1% compensation growth is near a 10-yr high, and core inflation is still near 2.0%.
It appears the CEOs are taking the lead on the idea of talking ourselves into a recession.
May PPI rose 0.1%, while the core rate rose 0.2%, following respective gains of 0.2% and 0.1% in April. On a 12-month basis, the headline rate slowed to 1.8% y/y versus 2.2% y/y, and the core rate was 2.3% y/y from 2.4% y/y.
May CPI report undershot assumptions with 0.1% gains for both the headline and the core that rounded from respective increases of 0.077% and 0.113%. Analysts now have six-month average CPI price gains of just 0.157% for the headline and 0.155% for the core. Another datapoint that puts a dent in the idea that tariffs will increase costs causing inflation to spike.
NFIB small business optimism index rose 1.4% to 105.0 in May after climbing 1.7% to 103.5 in April. It's a fourth consecutive monthly gain (the best in two years) and puts the index at the highest since October, and it compares to the historic high of 108.8 from August. A third of all small business owners cite Labor Quality or Costs as their most important problem.
May retail sales rose 0.5% for both headline and ex-autos. Headline April sales were revised to a 0.3% increase (was -0.2%, and March was bumped to 1.8% from 1.7%).
Industrial production increased 0.4% in May, with capacity utilization rising to 78.1%, both better than expected. The 0.5% decline in April production was bumped up to -0.4% (but March was nudged down to a 0.1% gain from 0.2%).
JOLTS report : Job openings dropped 25k to 7,449k in April, after bouncing 332k to 7,474k in March (revised from 7,488k). Though openings have been eroding in recent months, they are not far off from the 7,626 historic high from November. The JOLTS rate was unchanged at 4.7%, and is up from 4.5% in February.
Mortgage rates dropped to their lowest level in nearly two years, so total mortgage applications surged 26.8% in just one week, according to the Mortgage Bankers Association's seasonally adjusted index. Volume was 41% higher than a year ago.
Manufacturing activity in the Eurozone continues to run at a much more robust pace than other indicators (PMIs). On a 3-month/3-month annualized basis through April, industrial output rose 2.6% annualized while manufacturing production rose 3.3% annualized.
With German exports values down almost 4% in April, it's worth wondering where the shock is coming from. Everyone is assuming it is all about China, but the data doesn't support that theory. Through March, export growth had held up very well despite collapsing manufacturing surveys and new order numbers.
The source of the shock is not China, at least not directly. Looking for outliers, there are three countries that saw their share of German exports fall from 2017's average by at least 0.2% through March. Those three countries are Turkey, Korea, and Sweden.
Turkey is in the midst of a full blown Foreign Exchange crisis and has been for the past year, while the other two are small, open economies with exposure to the global cycle. All three have seen share of exports plunge while China's has trended stronger. If there's been a shock, it's better to assign it to those countries than China.
Chinese retail sales had a good month with a beat versus estimates, rising by 8+% in May, reversing the April sales miss.
Industrial Production remains very weak with output growing at 5.0 percent in May from a year earlier, missing analysts' expectations of 5.5% and well below April's 5.4%. That is a 17-year low.
FactSet Research weekly update:
For Q2 2019:
The estimated earnings decline for the S&P 500 is -2.5%. If -2.5% is the actual decline for the quarter, it will mark the first time the index has reported two straight quarters of year-over-year declines in earnings since Q1 2016 and Q2 2016.
The estimated (year-over-year) revenue growth rate for Q2 2019 is 3.9%. If 3.9% is the actual growth rate for the quarter, it will mark the lowest revenue growth rate for the index since Q3 2016 (2.7%).
Nine of the eleven sectors are expected to report year-over-year growth in revenues, led by the Communication Services and Health Care sectors. Two sectors are expected to report a year-over-year decline in revenues: Materials and Information Technology.
Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.5. This P/E ratio is equal to the 5-year average (16.5) but above the 10-year average (14.8).
Earnings Scorecard: For Q2 2019 (with 2 of the companies in the S&P 500 reporting actual results for the quarter), 2 companies have reported a positive EPS surprise and 2 companies have reported a positive revenue surprise.
The Political Scene
U.S. and Mexico struck a deal after the close on Friday June 7th avoiding the tariffs that many believed would send the economy into turmoil, and cost America hundreds of thousands of jobs. It turns out to be more of the fanatical clamoring by the media presenting their agendas, and to think market participants actually sold stocks over tariffs that were never in place. Another example how an investor has to navigate a very difficult market backdrop. In reality it is simple, never jump to conclusions.
Anyone believing corporations on both sides of the trade dispute are going to sit idly by and not look for alternative plans need to reconsider. I continue to believe the entire trade issue with China has been blown way out of proportion. No one has to subscribe to my theory; all they need to do is take note that the S&P is 2% off an all-time high and the trade dispute has been going on since January 2018. The stock market may have sniffed out that much of the tariff situation being presented to investors is pure noise.
Barron's presented another article that presents the "other side" of the tariff argument, a position that investors need to also consider in forming a market strategy.
Critics are now rallying around the idea that "Tariff man Trump" will go on a spree putting tariffs on anything that moves. That conclusion is void of common sense. There was a reason why Mexico came into the tariff picture. The threat of tariffs was an attempt to find a solution to the immigration issue at the border, because any other solution is being shelved by congress over their differences with the administration.
All of the jump to conclusion investor angst was misplaced. Unless I missed something, there are no Mexican tariffs in place, yet the commentary continues as if the tariffs were enacted. The complaint from pundits and some investors remains: "We can't invest with this market backdrop". Perhaps market participants, analysts, and pundits are annoyed and taking out their frustration surrounding the tariff backdrop because they made premature decisions due to the PROPOSALS that were on the table. Perhaps they view this entire subject with a preconceived agenda.
I simply ask what are people watching? The S&P is 2% off an all-time high in the SAME environment they are moaning about. Analysts and market participants who are crying have no one to blame but themselves. They need to look in the mirror and stop blaming the situation for their mistakes, and perhaps lose the agenda they bring to the table.
Finally, forget about any whirlwind, earth-shattering deal where both parties walk away happy and content. The U.S./China rift over intellectual property and trade imbalances have been around for years. It is simply not going to get resolved on the first attempt at negotiations.
The media and most of the pundits reporting this issue have the entire Trade Tariff story WRONG.
The Fed and Global Interest Rates
Markets are now pricing in a 25% probability of a quarter point rate cut at the June meeting, a 75% chance of a cut at the July 31 meeting and a 99% chance of a rate cut by year-end. I believe the market is overestimating the odds of a June rate cut. This is the first time the Fed Funds market has priced in multiple Fed cuts without getting one yet.
Presidents Trump and Xi will meet at the G20 summit in Osaka, Japan (June 28-29), and that could easily at the very least get the trade and tariff discussions back on track.
All eyes were on the latest jobs report that was weaker than expected. However, the Fed would much prefer to base a policy change on a trend rather than one data point. The next labor report will be released on July 5 and that may refute the prior report or bolster the notion that rates should be lowered. I believe they stay prudent, no rate change in June, then regroup in late July after seeing June's employment data and the status of the U.S.-China trade negotiations.
I am not in the camp that says rates need to be lower to boost growth. Does anyone seriously think there are firms that are not investing because the Fed has lifted short term rates to 2.375%?
A key point to see here is that rate cuts by themselves don't necessarily provide a boost to the market. If the Fed starts to cut rates and there is no recession in the 12 months that follow, equities do well (first three easing cycles).
However, if the fed cuts rates and the economy still contracts, rate cuts haven't provided much help. Rate cuts are bullish outside recessions, so if you are in the camp that isn't forecasting a recession, there's no reason to be afraid of the market.
The 3-month/10-year Treasury curve inverted two weeks ago and that curve remains inverted. Take the following for what it is worth. Historically an inversion in the curve has an 18- to 24-month lead time before recession. Furthermore in that period of time, stocks have done quite well.
The 2-year/10-year has yet to invert.
The 2-10 spread started the year at 16 basis points; it stands at 25 basis points today.
Bespoke Investment group:
"In May, investors flocked to the safety of US Treasuries sending yields plummeting. But this was not just a U.S. phenomenon. The median 10-year yield for 23 countries that are tracked fell from 1.79% a month ago to 1.52% this week. Across these 23 countries, from the first week of May to this week, ten-year yields fell for every country except South Africa and Taiwan."
"Yields have been consistently falling for most of these countries over the past year, and May's further declines have brought many of them to new multi-year lows. Notably, Brazil's 10-year yield fell 80 bps in May, the largest decline of these countries. None of the other countries saw their 10-year yield decline by nearly as much, as the next largest decline was seen by India whose 10-year yield fell by less than half of that (39 bps)."
Since the inception of the S&P 500 futures market, there have been two time periods with this much premarket anxiety.
- The bottom of the 2002 bear market.
- The bottom of the 2008 bear market.
Even while stocks rose last week, the smallest of options traders were hedging. They bought to open more than 3 million put options for the first time ever.
These types of sentiment "events" do not occur at market tops.
Investor sentiment has been bearish over the past few weeks. A slight change this week as the percentage of investors reporting as bulls in this week's AAII survey grew to 26.8% from 22.5% last week. This week's reading is still over one standard deviation below the historical average of 38.1%.
Crude Oil and the U.S. Dollar
Despite threats towards Iran from the U.S. and claims of attacks on foreign tankers, WTI finished the week down 2.8%.
The Weekly inventory report showed an increase of 2.2 million barrels. At 485.5 million barrels, U.S. crude oil inventories are now about 8% above the five-year average for this time of year. Total motor gasoline inventories also increased by 0.8 million barrels last week and are 2% above the five-year average for this time of year.
WTI closed the week at $52.52, down $1.52 for the week.
The short-term uptrend that has been in place for the USD appears to have been broken. There may be more dollar weakness ahead, or at the very least a consolidation of that move followed by sideways action. The combination of an accommodative Fed, the bullish story for the dollar may be challenged.
A weaker USD will benefit U.S. multinationals, EM assets, and potentially serve as a catalyst to boost commodities, particularly crude oil.
The Technical Picture
The rebound rally was impressive in that it wasn't just buying of the biggest losers during May. There was broad participation.
The DAILY chart of the S&P 500 shows the index in pause mode after a challenge to poke above the 2,900 level. Buyer exhaustion and the end of the rally, or a simple pause that refreshes and moves stock prices higher?
Chart courtesy of FreeStockCharts.com
When we get very close to all-time highs after a rally off the lows, all of the short-term possibilities remain very difficult to interpret. The index is consolidating above the 50-day moving average (blue line), as it is stuck in the resistance zone leading up to the old highs. This support area might be used as a springboard to achieve a move to attack and take out the old high. Conversely, a move back below the immediate short-term opens the door for a possible retest of the early June lows.
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
58% of S&P 500 stocks are currently above their 50-day moving averages.
A little more than half of stocks in the Tech sector are above their 50 DMAs, while Utilities and Real Estate still have the strongest breadth reading by this measure. It is quite obvious that many are piled into the defensive areas of the market.
The stock market is fickle, what preoccupies it one day may be shrugged off the next. Short-term trends ultimately amount to background noise during the long-term pursuit of your financial goals. Yet far too many get pre-occupied with the next 3% move in the S&P. It seems the caution lights are always on and the next bear market is right around the corner. I find this commentary comical when I also see the S&P 2% from an all-time high, because none of that is warranted now.
The Bears are lined up just waiting to tell us when the index fails to make a new high on this rally, look out below. The Bulls tell us when the index breaks to a new high, the sky's the limit. One group will be going against the long-term trend and making a guess. The other will default to the long-term trend in place and maintain that the probabilities lean to their conclusion. No one should be listening to either of those arguments in the short term, as both sides will be merely speculating as to what comes next. The warnings have been incessant during this entire bull market, and they have been wrong.
Who exactly are these warnings meant for? It's amusing how the folks that have garnered the most gains by being correct in their strategy aren't given the benefit of doubt that they have a brain to know when it may be time to make significant portfolio changes.
Of course, there will be another bear market. No one that has experienced the equity market over time will deny that. However, those that have remained resolute in their approach to this Bull market also know that abandoning an upward trend can turn out to be big mistake.
The wall of worry is in place and the majority concentrates, and at times, obsesses over that. The balance of the data is forgotten and suddenly not a part of any strategy. Forget all this trade angst and Fed "insurance" talk and look at stock valuations, margins, revenue and profit growth. S&P 500 revenue estimates for 2019 and 2020 continue to be stable keeping forward revenues in record high territory. Industry analysts expect revenues to grow 4.9% this year and 5.3% next year. If 2019 and 2020 earnings per share estimates prove correct, the S&P is trading at its lowest multiple in eight years.
The message has been to stay invested in the equity market. I am now looking within the market for opportunities that have the potential to garner additional gains. Despite the headlines, it isn't wise for investors to talk themselves into the next bear market and start making major portfolio adjustments now.
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!
Confused? A correction, or new market highs ahead? Investors like to jump to conclusions. The Savvy Investor uses a strategy that keeps them grounded. LEARN, then employ those principles to manage what YOU have in place today.
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Disclosure: I am/we are long EVERY STOCK/ETF IN EVERY SAVVY INVESTMENT 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.