Psychology is probably the most important factor in the market, and one that is least understood." - David Dreman
The S&P 500 came into the new trading week up 20.2% year to date, which is the biggest gain at this point in the year since 1998. A calendar year that was part of the last secular bull market. Q3 market performance is picking up right where Q2 left off, which left off right where Q1 left off, and that's with strong gains. Month to date, large cap indices are all up around 2%, while mid and small caps remain laggards. The Russell 2000 is slightly negative in July. Small caps have been totally absent from the latest leg higher in equities and continue to underperform.
Small caps outperformed early on during the bull market but haven't made much headway since then. While the Russell 2000 made a marginal new high on a relative basis in early 2014, ever since then it has given up nearly ALL of its outperformance since the start of the bull market. Anyone that changed strategy because they believed in the small-cap warning commentary has seen the S&P make new high after new high. As mentioned in previous missives, altering your view of the overall market based on that stat may not be the best idea.
The same goes for the comments that the "Dow Transports are telling us something" views. While I won't abandon Dow Theory which suggests the Transports are important in any bull market scene, in our present technology based environment, semiconductors are the sector I watch more closely now. I'll note that the lagging DJ Transport index has posted gains in six of the last seven weeks. Patience is a virtue.
International markets have seen much more muted returns. Germany (EWG), China (ASHR), and India (PIN) are all down over 1% this month, while Brazil (EWZ) and Italy (NYSEARCA:EWI) have been the biggest gainers.
Reversion to the mean also occurs in the fixed income markets as well. As the yield curve steepened, Treasuries have seen some profit taking in July with long-term Treasuries (TLT) down around 2% as the worst-performing ETF this month.
The week started with the Dow 30, Nasdaq, and the S&P posting new all-time highs. 13% of the S&P 500 posted new highs in a quiet tape on Monday, which was higher than the prior two trading sessions. The five-day market winning streak ended on Tuesday, and a much anticipated pause had the S&P close the week with a 1% loss. The index is up 19+% for the year and shows a 4.5% gain from the January 2018 high. Considering this is all after the 19+% return in 2017, the argument that the "market hasn't gone anywhere" starts to lose credibility.
For the next several weeks, investor focus shifts from the "forest" (macro headlines) to focusing on the "trees" (corporate earnings). As earnings are the fundamental driver of the equity market, Q2 earnings season will give us a picture of how healthy the "trees" are as many of the big banks kicked-off the reporting season this week.
From an economic perspective, the pace of economic indicators in terms of both their momentum and relative to expectations is the weakest in some time. Also, data outside of the U.S. has been sluggish at best. One silver lining though, consumer comfort and confidence remains elevated. If you are a contrarian, you are elated to see overall investor sentiment at levels seen at market lows not market highs.
There have been many questions and reservations about the magnitude of the rally off of the December 2018 lows. If readers have been following along, the market is basically following a pattern that is typical of how it has performed coming out of prior "near-bear" markets.
This scenario was laid out and discussed in early January. The historical pattern of how the equity market reacts after a "near bear" was an important data point that many discarded, but one that made the call to say invested a lot easier for me.
More evidence that it always comes down to looking at all of the data with an open mind.
In the charts below we see the three-month average for Federal receipts (at seasonally-adjusted annual rates) across three categories. Customs duties were at a record level in June, though weaker April and May readings held down the three-month average. More volatile (and much larger) tax receipt categories have also started to bounce over the last couple of quarters too.
The post 2015 declines in corporate receipts (thanks to lower oil prices and tax cuts) appears to be over, while record personal income receipts are a sign of a solid labor market.
Someone forgot to tell the consumer about the economic slowdown. Retail sales rose 0.4% in June. That follows gains of 0.4% for both in May, with each revised down from 0.5% previously. Sales excluding autos, gas, and building materials (which feed into GDP forecasts) increased 0.7% following a 0.7% prior increase (revised from 0.5%)
As this article suggests, the rise in the "free and clear" trend is adding to the positive look of consumer balance sheets.
Industrial production rose slightly in June, with capacity utilization dipping to 77.9% from 78.1%, weaker than expected. Capacity is one of the lowest readings since February 2018.
Empire State manufacturing reported a bounce to 4.3 in July, and that reversed the June plunge that saw a three-year low of -8.6 from a six-month high of 17.8 in May. The ISM adjusted Empire State similarly bounced to 49.6 from a three-year low of 48.5 in June but a higher 52.7 in May.
Philly Fed index rose 21.5 points to 21.8 in July, much better than expected. It more than erases the 16.3 point drop to 0.3 in June. This is the best in a year, while the June figure was the worst since the -4.1 from February. The up and down reports confirm that using one report to make a case is a mistake.
Consumer sentiment inched up 0.2 points to 98.4 in the preliminary July reading, after falling 1.8 ticks to 98.2 in June. That's not as strong as expected, but it's improving. The index was at 97.9 last July. Sentiment has picked up and the index is again closer to the 101.4 14-year high from March 2018 than January's 91.2 low spot over the last couple of years.
"One factor keeping wages from accelerating despite the tight labor market: aging boomers. The participation rate for the 65+ group is at a record 20%. There are well over 1.5 million more workers in the over 65 pool than just two years ago."
My $0.02. Sadly this group could easily represent the population that decided the stock market was just too risky.
July NAHB housing market index rebounded 1 point to 65 after falling 2 points to 64 in June. The index was as high as 74 in December 2017 (which was the best since 1999). It hit a recent low of 56 in December 2018.
Housing starts fell 0.9% to a 1.25 M clip in June, disappointing expectations, after falling 0.4% to a 1.26 M rate in May. Building permits dropped 6.1% to 1.22 M following the revised 0.7% gain to 1.29 M.
Some say a global recession is imminent. The chart below shows the Baltic Dry Index at the highest point in five years.
Chart courtesy of Ryan Detrick
The graphic also brings into question the worries over slowing global trade.
China's GDP for Q2 was as expected at 6.2% year over year.
There may be many issues at work here. Let's not lose sight of the fact that the sheer size of their economy now cannot be expected to rise at the incredible rate of growth we have been accustomed to.
Chinese Industrial production beat estimates handily, up 6.3% YoY versus 5.3% expected and 5.0% last month.
U.K. wages rise at the fastest pace since the financial crisis in 2008. Average wages excluding bonuses rose 3.6%.
A look at the expected trajectory of Corporate Earnings for the S&P.
Chart courtesy of Yardeni Research
When the analyst expectation bar is set low for earnings season (negative spread), the S&P 500 typically sees a positive performance during earnings season. Conversely, when the bar is set high heading into earnings season (positive spread), the market has tended to struggle during the reporting period.
With regards to this earnings season, expectations are very low. There is no evidence to suggest that strong run-ups into earnings season lead to a "sell the news" reaction during earnings season. Consensus earnings forecasts currently reflect an earnings decline of 1.4% on a year-over-year (YoY) basis. Based on history, I am in the camp that says companies will beat their lowered earnings forecasts, which they have done for five consecutive quarters, by approximately 3% to 5%. That will then lift earnings growth back into positive territory.
Another earnings season where everyone is focused on forward guidance. I can't see guidance being robust. The negative tariff mindset remains in place. In my view, it will be about the actual results coming out now to use as a gauge. The guidance was lousy entering this season, and perhaps we will come to see it was all too negative due to tariff sentiment.
The financials started off with positive results. The large sector money banks did not disappoint, while the regional banks showed decent loan growth. All of this is another indication that the overall economy is doing fine.
Right on cue, some analysts are coming out and saying the earnings reports are "low quality beats". They cite that as the reason the market is not rising while earnings are being reported. Perhaps they forgot the index has rallied strong into this time period.
The Political Scene
Here is a comment from a reader that simply had to be put in this article for everyone to see.
"Yes, trade concerns are overblown. The President can play this game for a long time without capsizing the economy. His approach is brilliant in a bizarre way. Impose a few tariffs. Bluster about the lousiness of trade terms with China, Mexico, etc. Either get a reasonably quick deal (like the new NAFTA), or let the stew of tariffs and uncertainty simmer while CEOs divert their supply chains to markets that align better with US interests."
"China may believe its 'long game' is wise. They are fools. American politicians are now united against China in the trade war. Working class voters see President Trump as the first president in their lifetimes to stand up for them against the hollowing forces of free trade and globalization."
"America is now playing the long game too. Somehow, the most divisive president in modern history united the country on that. China had better come back to the table with reasonable terms fast. A future without the U.S. as a major trading partner will not help the Chinese either in the short term or long term."
"Once the trade wars are settled, probably a few years from now, the stage will be set for an extended period of prosperity. A new golden age of global trade. That is one of my chief reasons for believing this secular bull market still has a long way to run."
The statement leaves any political bias at the door and places the tariff situation in proper perspective.
Many investors say it's simple, the stock market is all about the Fed. We hear that every week. The Fed has raised rates nine times since 2015, the S&P is up 60+%. Isn't the stock market supposed to be down?
Following the day-to-day, week-to-week, short-term commentary about what the Fed Chair is going to eat for breakfast and when he will make the next move on rates is a fool's errand.
This week the Fed released its bi-quarterly qualitative assessment of economic activity, the Beige Book. After plunging from its strongest reading in years last July, more recent readings have bounced a bit, but the last two have represented declines. The last couple of quarters of readings have suggested GDP growth of roughly 2% year over year, which is hardly disastrous. It does, however, represent a slowdown in growth similar to the 2014-2016 downshift in activity that saw GDP go from nearly 3% to around 1%. Again, nothing disastrous, but they definitely see slower growth than what we witnessed in recent quarters.
The 3-month/10-year Treasury curve inverted five weeks ago and that curve remains inverted, but barely. One basis point separates the two now.
The 2-10 spread started the year at 16 basis points; it stands at 25 basis points today.
Last week we saw example after example of how the "crowd" loathes stocks these days. Yet some still say it doesn't mean much. It's dismissed as more of the same bullish commentary.
If one is a contrarian, it sure is bullish commentary, but it's also a wakeup call that many still haven't received. Bespoke Investment Group:
"There have only been eight other periods where the magnitude of outflows from equity mutual funds has been more than $40 billion (as it is now). If you look at the dates of each of those occurrences, more often than not they were during periods of elevated volatility during a market decline rather than in unison with an all time high in the equity market."
In addition to that fact, if you look closely, you will notice that the majority of these occurrences coincide with a period where a huge rally ensued. I'll repeat, this isn't just negative sentiment, people are afraid of this stock market.
Investors remain cautious because the majority sees danger looming.
The recent result of the survey posted above just eclipsed the fear present during the global economic recession scare in 2016. The stock market is up 67% since then.
The facts are there. Listen to the message or toss it aside.
In the weekly AAII investor survey, bullish sentiment now rests at 35.9%. The highest since May 9th when it was 43.12%. Bullish sentiment has slowly recovered following May's retracement even as the major indices reached new all-time highs. Bullish sentiment is still within a normal range and by no means is overly extended. At 35.9%, it remains below the historical average of 38.1% as it has for 10 straight weeks now. That is the longest such streak of below average readings since a 12-week streak ending in May of last year.
After the first weekly close above the $60 level, WTI fell and closed the week at $56.02, down $4.26 for the week.
The weekly inventory report showed a draw of 3.1 million barrels. That brings the four-week draw to 25+ million barrels. At 456 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 4.6 million barrels last week and are 2% above the five-year average for this time of year.
The Technical Picture
Breadth as measured by the S&P 500's cumulative A/D line has been strong for the last couple of years now. Every time the market has seen a pullback, the rebound in stocks was led by breadth, where the cumulative A/D line would hit a new high and the index itself would follow. Last week as the S&P 500 was poised for its first close above 3,000, breadth confirmed that high by hitting record highs as well.
Looking at the DAILY chart shows why I continue to believe that anyone calling for any meaningful dip with what is presented in that picture is simply guessing. Look at how long the index stayed above the 20-day moving average (green line) this year, all while plenty of analysts were calling for a correction.
Chart courtesy of FreeStockCharts.com
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
Healthcare (XLV) and Materials (XLB) are the only sectors down so far in July, while most others are up well over 1%, led higher by Consumer Discretionary (XLY), Technology (XLK), and Communication Services (XLC).
While Info Tech has been the best performing sector year-to-date (up 31% through mid July), Info Tech is supposedly one of the most impacted sectors as a result of trade given its exposure to China and the sanctions imposed on Huawei. While we could see a pause in this run, it is important to note that Info Tech historically beats earnings estimates, on average, by a healthy 5%. Investors might want to stay focused on this group.
One contributor to the sector's strength recently is semiconductors. While many want to use the Dow Transports as a gauge of the economy, I prefer to watch the performance of the "Transports" of the 21st century, the Semiconductor sector. As the Semis go, so goes the general market.
The Philadelphia Semiconductor Index (SOX) nearly reached bear market territory on an intraday basis falling 19.8% (identical loss as the S&P). Since then, the SOX has rallied 18.9%, and while it is still shy of new highs for the year, it did close on Thursday at its highest level since 5/6.
If the index can continue forward and post new highs, it bodes well for the overall market trend.
"Why is the market so high? How can this market go up? This has to be another bubble."
"It just doesn't feel right, I can't invest at all time highs. The risk/reward scenario is awful in this current environment."
This is typical commentary now and we've heard it at just about every market top. That is in keeping with the typical investor reaction when equity markets act like this.
The evidence on where the market is headed is always there. It then becomes a matter of how that information is interpreted. Investors that enter the process with bias or preconceived notions will have a hard time succeeding. That also holds true for anyone that wishes to play a guessing game because of how the situation "feels" to them.
When stocks start to pull back after a rally, some partake in wild assumptions because they let the headlines rule their minds. People want an answer to the question, "Why should we remain bullish"? They look for and ask, "Where is the biggest risk"? When new highs are forged an army of people rise up and immediately look for reasons why they can't invest. What they should be looking for are motives why they can invest. Most won't come to grips with that because it doesn't feel comfortable. It's why the stock market always wins when a market participant doesn't come to the table with an open mind.
The majority of investors have fought this rally since January. Market participants found reasons to doubt the equity market at the lows, cautious because they didn't believe the rally, and afraid because the market indices are at new highs. Evidence is there that they continue to feel skeptical. They view the 3,000 level on the S&P as danger. More analysts are claiming they see trouble brewing in the overall market. They are worried about select sectors, and therefore remain cautious. Problem is these pundits said the same thing at S&P 2,400.
No one knows when the next pullback will occur, but what we do know is that when it does, the "I told you so" clowns will appear on the scene. Worse than that group, will be the same folks who were wrong with their market predictions back in May. They will now be tempted to try their luck again, and once again come to the table with preconceived ideas, bias and an agenda.
If an investor is searching for reasons to leave the stock market, they will satisfy their goal, as those issues can be found everywhere. However, as they accomplish that mission, they avoid looking at ALL of the data and fail to understand how the stock market works. At some point in time, investors will start to realize that the best rallies in this bull market have come when a predicted "bad" event never materialized.
The stock market has handed out many lessons along the way to S&P 3,000. One that is quite evident. Neither the ever present "Top Callers" nor the "I told you so" gang has been shown to be correct. Neither has a chance of catching up to the investor who has remained steadfast in the approach that kept them invested. The latter is the only group that remains in the pilot's seat.
Year after year, new high after new high, and yet many have not heeded that lesson.
Stay the course.
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, or new market highs ahead? Plenty of opinions around now. Learn to manage what YOU have in place today without getting whipsawed. Successful investors start at the macro level."
Savvy investors didn't sell in December 2018, now they have reaped the rewards. It's very simple, we follow the strategy that called the last two bear markets and avoided making major missteps in 2016 and again in 2018."
"If you are sitting on a mountain of cash because you listened to the "gurus", it is best to not make the same mistake over and over. The Savvy Investor is here to assist.
Disclosure: I am/we are long EVERY STOCK/ETF IN ALL OF THE SAVVY 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: 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.