"Patience is not just about waiting for something… it's about how you wait, or your attitude while waiting." - Joyce Meyer
For the second week in a row, the equity markets opened with a noticeable risk off mindset as momentum names were again the main target of the sellers. High on the list were tech and consumer discretionary which were coming off all-time highs. Anything "China" was also in the cross hairs of investors that feared the worst. All of this over the China devaluation headlines, and what is now nine straight weeks of protests in Hong Kong. That situation was described by Chief Executive of Hong Kong, Carrie Lam, as a being on the verge of a "very dangerous situation".
As is the pattern when market sell-offs materialize, headlines are usually the culprits. In a matter of a week, what was described as a normal 3-4% pullback after a big rally morphs into a situation that has most investors very worried. Monday was the worst day for the markets this year, and the Nasdaq losing streak matched the worst losing streak of 2016. It was a global rout. When we look at the S&P 500, Nikkei 225 (Japan), STOXX 600 (Europe), and CSI 300 (China) only a combined 4% of stocks on these indices were higher on Monday.
The selling abated when another headline surfaced. The People's Bank of China announced that it would provide some stability to the yuan in the coming weeks. It'll take about 30 billion yuan ($4.2 billion) out of the market in Hong Kong on Aug. 14. The move is designed to make the yuan "scarce", giving it a chance to strengthen against the dollar. For the younger investors out there, this isn't the first time there have been issues with China and the yuan; it has been going on for decades.
The week continued with traders deciding what word from the Fed's press conference they deemed important, and then had to deal with the sudden collapse of Treasury yields. Volatility ensued as the algorithms kicked in and traders decided to do what they do best, "sell then look at the data" later. The S&P lost 56 points, then reversed to close the day up 2 points. The Dow 30 reversed a 600 point loss to close down 22 points. Savvy investors avoided the whipsaw, sitting back, watching the action, and making decisions as necessary to achieve their long-term goals. They do that without emotion and let the spin masters control the microphone and look ridiculous.
"Let's see what develops first" trumps "sell then look at the data" EVERY TIME.
For the year the index is up 17%, and investors need be reminded again that the S&P and Nasdaq are coming off all-time highs just 11 trading sessions ago.
The human mind loves to highlight negativism. The financial narrative today always starts with "The indices have lost "x" % for the week/month". No one dare add:
"Prior to these declines the indices rose "x"% for the week/month, year trouncing the declines we just witnessed".
Deciding to act without putting the issue into perspective is a recipe for failure.
Back and forth action continued on Friday, when another headline indicating the ban on doing business with Huawei will remain in effect. The mid week turnaround left the S&P flat, losing 13 points.
Despite all of the headlines, the noise, and the volatility, the stock market action after the rally this year is following a logical and healthy path. There is no surprise then; watching the price action is THE CORE of any successful investment strategy.
Ahh, but not so for the gurus out there; they see danger, they also saw real danger in 2015, 2016, 2018, and as recently as June 2019. Each time they told investors to sell, each time they were wrong. Will they be right this time? Who knows, but I rarely follow those that have been wrong over and over. When I hear someone that tells me the S&P is going to plumb to new lows, when it was on its way to 3,020, I run as far away as I can. These forecasts have been absolutely toxic. The same culprits are at it again.
In June the irresponsible forecasts occurred with the S&P 4% from an all-time high. This week with the S&P now about 4% off the 3,025 level, the warnings for a severe drop in the stock market are back on the table. Each can now decide their own strategy. I take it one day, one week at a time, and never guess at market tops. That strategy continues to post the best track record around.
Atlanta Fed's GDPNow index projects a 1.95% growth rate for Q3, slightly better than its 1.88% projection from Friday, but little changed from the 1.94% from August 2nd.
The seasonally adjusted final IHS Markit U.S. Services Business Activity Index registered 53.0 in July, up from 51.5 in June and accelerating further from May's recent low. The upturn in business activity was solid overall and the fastest for three months. Service providers attributed the rise to greater new business and improved client demand. That said, the pace of expansion was slower than that seen at the start of the year and below the series average (55.1).
Chris Williamson, Chief Business Economist at IHS Markit:
"An improvement in the overall rate of business growth signaled by the services PMI for July is welcome news, but the overall weak pace of expansion remains a concern. The PMIs for manufacturing and services collectively point to GDP expanding at an annualized rate of under 2% in July, below that seen in the second quarter and among the weakest seen over the past three years."
"A sharp drop in future expectations meanwhile suggests downside risks have increased in the near-term at least, hinting that the upturn in growth seen in July could prove short-lived and that GDP growth could remain disappointingly modest in the third quarter."
"Optimism is at its lowest ebb since comparable data were first available in 2012 as companies have grown increasingly concerned about the year ahead, fueled by trade war worries and wider geopolitical jitters, as well as growing worries that the economic cycle has peaked."
July PPI report revealed a firm 0.2% headline rise but with a surprising -0.1% core price drop, leaving the headline y/y gain at the same 1.7%.
JOLTS reported job openings fell 36k to 7,34k in June after edging up 12k to 7,384k in May (revised from 7,372k April). November's 7,626k remains the record high, and this is the 15th consecutive month above the 7 million mark.
The unemployment rate held steady at 3.7% in July, but the percentage of workers involuntarily working part time fell further. Details in the report also showed a sharper rise in summer jobs for teenagers and young adults this year. That is consistent with strong labor demand, and a bigger hiring challenge may come in the fall, when they go back to school.
The J.P. Morgan Global Services Business Activity Index, a composite index produced by J.P. Morgan and IHS Markit in association with ISM and IFPSM, posted 52.5 in July, up from 51.9 in June. The headline index remained below its long-run average of 54.2.
In central bank news, the New Zealand, Indian, and Thai central banks surprised markets with larger-than-expected rate cuts. In India, we saw a similar story play out as the central bank lowered rates by a rather unconventional 35 bps to 5.4%, the lowest in nearly a decade. While the world has become accustomed to rate moves in increments of 25 bps, Central Bank Governor Shaktikanta Das threw that convention out the window saying:
"There's nothing sacred about a multiple of 25."
He then went on to explain that a quarter point cut would have been inadequate while a half point cut would have been seen as excessive.
Finally, the Thai central bank also surprised markets by lowering rates from 1.75% down to 1.50% and said that more rate cuts could be coming in an effort to thwart appreciation in the Thai Baht relative to trading partners like China. That's three surprisingly dovish moves by Asian central banks over a 12 hour span. All this follows the escalation of the trade war and a devaluation of the yuan earlier this week. And this is what a global race to the bottom looks like.
The IHS Markit Eurozone PMI Composite Output Index slipped closer to the 50.0 no-change mark during July. Unchanged on the earlier flash reading, the index posted 51.5, a level indicative of only modest growth and down from June's seven month high of 52.2.
Chris Williamson, Chief Business Economist at IHS Markit:
"The service sector continued to sustain the expansion of the overall eurozone economy at the start of the third quarter, but there are signs that the scale of the manufacturing downturn is starting to overwhelm. Trade war worries, slower economic growth, falling demand for business equipment, slumping auto sales and geopolitical concerns such as Brexit led the list of business woes, dragging manufacturing production lower at its fastest rate for over six years. While the service sector has helped offset the manufacturing downturn, growth also edged lower among service providers in July, meaning the overall pace of expansion of GDP signaled by the PMI has slipped closer to 0.1%."
"The main source of expansion currently appears to be the consumer, in turn buoyed by the relative strength of the labour market. However, with the July survey indicating the weakest jobs gains in over three years, there are signs that this growth engine is also losing impetus, and adding another headwind to the economy for the coming months."
Little-changed from 50.8 in June at 50.6 in July, the IHS Markit Eurozone Construction PMI pointed to a marginal rise in total construction activity. There were contrasting results across the currency area's three largest economies, with a modest expansion in France and declines in Germany and Italy. That said, those reductions were only marginal.
The U.K. economy contracted by 0.2% in the last quarter. The forecasts had GDP coming in flat for the quarter.
Boris Johnson has instructed the UK's civil service to make preparations for leaving the EU without a deal its "top priority" for the immediate future, urging all officials to work "urgently and rapidly" to ensure their departments are ready.
The Caixin China Composite PMI data (which covers both manufacturing and services) indicated that business activity across China continued to expand at a marginal pace at the start of the third quarter. This was highlighted by the Composite Output Index posting 50.9 in July, up slightly from 50.6 in June.
Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group:
"The Caixin China General Services Business Activity Index dipped to 51.6 in July, falling from 52.0 in the previous month. Demand for services remained solid. The gauge for new business edged down, although it remained in expansionary territory. The gauge for new export business rebounded back into positive territory, signaling a recovery in overseas demand."
"In general, China's economy showed signs of recovery in July, thanks to large-scale tax and fee cuts, as well as ongoing support from monetary policy and government-driven infrastructure investment. It remains to be seen if the economic recovery can continue amid trade fictions with the U.S. and rigid regulations on the financial sector and debt levels. The recovery in July suggests that China's economic slowdown is under control."
Rising from 49.6 in June to 53.8 in July, the IHS Markit India Services Business Activity Index pointed to the quickest increase in output in one year. Four of the five monitored sub sectors posted expansion, the sole exception being Real Estate & Business Services.
Pollyanna de Lima, Principal Economist at IHS Markit:
"India's service economy showed renewed vigour in July as businesses and households welcome the recent government budget announcement. PMI data indicated that the strongest upturn in new work for nearly three years led to a rebound in business activity."
"Encouragingly, service providers reported a widespread improvement in demand, from the public and private sectors as well as domestic and international markets. Growth of export orders hit a series peak. These favorable results from the service sector were accompanied by improved momentum among goods producers, which combined showed the sharpest rise in output for eight months. The ground gained in services during July meant that the gap in the performance of the two monitored sectors was the narrowest in one year."
FactSet Research weekly update:
For Q2 2019:
To date, 90% of the companies in the S&P 500 have reported actual results. In terms of earnings, the percentage of companies reporting actual EPS above estimates (75%) is above the five-year average. In aggregate, companies are reporting earnings that are 5.7% above the estimates, which is also above the five-year average.
In terms of sales, the percentage of companies (57%) reporting actual sales above estimates is below the five-year average. In aggregate, companies are reporting sales that are 0.8% above estimates, which is equal to the five-year average.
The blended earnings view, which combines actual results for companies that have reported and estimated results for companies that have yet to report earnings decline for the second quarter, is -0.7% today. If -0.7% 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.
Five sectors are reporting year-over-year growth in earnings, led by the Healthcare and Financials sectors. Six sectors are reporting a year-over-year decline in earnings, led by the Materials and Industrials sectors.
The blended revenue growth rate for the second quarter is 4.1% today. If 4.1% is the final growth rate for the quarter, it will mark the lowest revenue growth rate for the index since Q3 2016 (2.7%). Eight sectors are reporting year-over-year growth in revenues, led by the Communication Services and Healthcare sectors. Three sectors are reporting a year-over-year decline in revenues, led by the Materials sector.
Looking at the second half of 2019, analysts see a decline in earnings for the third quarter followed by low-single-digit earnings growth in the fourth quarter.
The forward 12-month P/E ratio is 16.7, which is above the five-year average and above the 10-year average.
The Political Scene
Good news! There is one less thing to worry about. Both the House and now the Senate are on their August recess. Since one could argue that policy announcements have been the largest contributors to negative sentiment on the issue of Corporate America this year, it is good to have one fewer branch of government to worry about. That last sentence typifies the irony of the present situation. Political leaders offering negative views with their proposed attacks on corporate America from every conceivable perspective. Welcome to what is considered "normal" now.
The headlines continue, the tariff situation is worse, there is no resolution in sight. Perhaps we need to start looking at different sources to attain an open-minded view with less opinion.
While Trump wants to be seen to be tough on China, he does not want to be so tough that he risks precipitating a crash in the US stock market, or a slump in the U.S. economy, with the U.S. presidential election less than 15 months away. That much can be deduced from Trump's August 1 pledge to impose a tariff of just 10% on the $300 billion of as-yet-untariffed imports from China.
Before the G20, the U.S. administration had been threatening to impose a 25% tariff on these product lines, a shock which would have had far more disruptive effects on the U.S. market and economy. Compared with the U.S. position before the G20, Trump's latest tariff pledge is therefore a moderation of his administration's stance.
The direct costs of the new tariff to the U.S. corporate sector will be relatively small. In May, the U.S. government increased its tariffs on some 5,700 product lines imported from China to 25%, from close to zero before September 2018. In response, the total customs duties collected by the U.S. rose only by around $2 billion per month. The promised new tariffs will further increase the cost burden.
However, the aggregate effect will still be small compared with the $6.3 billion in monthly savings handed to U.S. corporations by the administration's 2018 tax cuts. As a result, the U.S. corporate sector as a whole looks well placed to ride out the latest planned tariff increase. Of course, you won't hear that from many pundits as they continue to post their agendas and leave out the other side of the tariff equation, the benefit of lower taxes.
Mid cycle adjustment, three words that sent some investors running to sell stocks. It was all about guessing and rampant speculation taking over as investors extrapolated those words to mean, "don't expect any more rate cuts, it is one and done".
Of course the latter comments were never uttered. With all of the crosscurrents we have seen in economic data recently, NO ONE knows how the economy is going to fare in the next quarter or two.
I'm not sure why investors resist the data dependent model, despite that being the Fed's mantra for quite some time now. In fact that phrase was once again seen in the last FOMC minutes.
The 3-month/10-year Treasury curve inverted on May 23rd, and other than a brief one day change, that curve remains inverted. The 2-year/10-year has yet to invert.
The 2-10 spread started the year at 16 basis points; it stands at 11 basis points today.
The AAII survey, after falling to its lowest levels since the Q4 2018 sell-off in May, bullish sentiment had been steadily making its way higher over the past couple months. Last week actually saw bullish sentiment finally move back above the historical average for the first time since the first week of May. Now, all of that progress has been erased as the percentage of bulls in the survey fell from 38.44% last week down to 21.66%. Bullish sentiment is now below the lows seen during the May correction and is only 0.76% above the lows reached during the last year's market downturn.
Other sentiment surveys like Investors Intelligence also echoed that bearish tone. In fact, this week's results of the AAII survey of newsletter writers showed the largest increase in the percentage of respondents expecting a correction since February 2018 while bullish respondents fell by the most week-over-week since the final days of 2018.
The price of WTI had lost around $12 since the trade tariff rhetoric was ramped up. With the price of crude oil continuing to drop earlier in the week, a headline crossed indicating the Saudis ARE Considering All Options To Halt Oil Drop.
WTI rebounded to end the week at $54.55, down $1.15 for the week.
The weekly inventory report showed a 2.4 million barrel increase in supply. That concluded the 36 million barrel draw in the prior month. At 438.9 million barrels, U.S. crude oil inventories are now about 2% above the five-year average for this time of year. Total motor gasoline inventories increased by 4.4 million barrels last week and are about 4% above average for this time of year.
The Technical Picture
This graph below was presented to subscribers on July 25th, and it was meant to alert everyone that the S&P index was extended. Note in the chart below that "price" was at the top of a longer-term channel which is penciled in.
What we are witnessing is a normal occurrence when overbought periods are neutralized. The question that always follows, how much of a decline should we expect?
Volatility ruled this week and investors find themselves getting whipsawed on an hourly/daily basis. When we see these over-sized moves, always remember we are living in a different trading world today. As beautiful as ETF and index investing is, these wild moves are the unwanted result. It is a vicious negative cycle: the ETF's Net Asset Value - NAV - goes lower, therefore the ETF sells stocks, then stocks fall, then the NAV of the ETF falls, then the ETF sells stocks, and so on.
Not to mention that Algorithmic trading rules the land, and they all follow some kind of "model", so if the model says to sell, that is what happens.
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.
Investors need to recognize and deal with an occurrence that is quite normal when investing in the equity market. An occurrence that will happen to them time after time during their investing lifetime, they will get caught off guard. How many saw the multiple weeks of violence in Hong Kong occurring? I don't see any of that posted anywhere. How many saw the yuan devaluation coming? Pundits didn't seem to have that on their radar screens as well. A quick note on the latter point; we have already seen China devalue the yuan in 2015/2016, and the S&P rallied from 2,000 to 3,040.
Trying to prepare for the quick, "no one knows", "out of the blue" headline can be very costly. If someone wants to claim they were worried about the entire tariff situation, and then acted on that, they watched the S&P rally from 2,550 to 3,040 with negative headlines and tariffs in place. It turned out to be a costly decision. Yet investors still want to play that game. Identify any issues and go into a cocoon. Not advisable in a bull market backdrop.
The S&P is 4% off the all-time highs, and the drumbeat to "get prepared" goes on. We hear the predictions now, these forecasts for much lower prices, and not ONCE do we hear about corporate earnings in ANY of these predictions. Believe what you wish, follow the pundits that have been wrong, and listen to the noise.
Despite the current drama and the consensus views, the stock market will not likely be driven by the Federal Reserve, ongoing trade negotiations, or by presidential politics. Although these spectacles will continue to bounce the market around, ultimately, its direction will most likely be tied to corporate earnings. S&P 500 earnings per share have been essentially flat since last fall after the huge bounce in 2018. Either companies will "show us the money" or they won't.
Listen to the message of the market. I am prepared to 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!
The question now, a deep correction, or new highs ahead ? My year end view was just released to subscribers. Many follow these public articles, but they only scratch the surface of my detailed market strategy.
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Disclosure: I am/we are long EVERY STOCK/ETF IN ALL OF THE SAVVY PLAYBOOKS. 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.