"Experience tells you what to do; confidence allows you to do it." - Stan Smith
Earnings were a bit mixed this season, but hardly very weak, while U.S. data has been improving sharply; sentiment based on collapsing then stabilizing rates was more important for equity prices this week. The yield spread widens, stocks go up, and the yield spread flattens, stocks go down. Algorithmic trading programs and many traders are mesmerized by the yield curve now.
Nonetheless, the 10-year note remains below 1.6% this week. The 30-year bond trades around 2%, and the 2/10 yield curve inverted intraday midweek as well. The rabid buying of fixed income looks like a combination of factors ranging from risk aversion, extreme investor enthusiasm for duration, expectations that the Fed will cut rates multiple times this year and next, and longer-term supply factors. Not to mention, the rest of the globe is basically at zero or less.
Given improving data, we have to wonder how long this sort of move can last, especially given housing data that indicates consumers are piling into mortgages via refinances and new purchases; that activity is a natural support for bond yields.
The trend of opening the trading week on a risk off note was broken. Instead of investors watching the geopolitical theater over the weekend, they instead realized interest rates have temporarily stopped falling, and bond spreads widened. For the algos and a contingent of investors, that move suggests widening spreads equal no recession. BUY replaced SELL as the order of the day as the week began. Amazing how the algorithmic trading and human mind can work at times.
Choppy market action continued as traders stayed fixated on the 2/10 Treasury spread. A couple of brief intraday inversions weakened stocks for a while, but when it became obvious there would be NO inversion at the close, stocks rallied in the final minutes of trading on Wednesday and Thursday.
The fireworks began on Friday as China retaliated with tariffs on $75 billion more of U.S. goods and resumed auto tariffs. President Trump then fired off a tweet storm in which he demanded U.S. companies to "Get out of China".
A positive week turned negative as the S&P closed down 1.4%. The month of August has seen the index drop 4.4%, it is now 6% off the all-time high, and holding on to a 13.5% gain for the year.
Despite how this market may feel to investors, the sideways pattern that emerged three weeks ago continues. Depending on your outlook, the glass is either half empty or half full. Take your pick, the market is either in a topping pattern or it is forming a base for an assault on a new high.
For many market participants, the picture is blurred. Global data remains poor and could be signaling a recession, or it's in a bottoming process, and will start to turn positive. U.S. data looks much stronger than prior months, but for some, the bond market is signaling recession. Debates will rage on, start hedging, and take a lot of money off the table now as the situation seems unstable, or make minor adjustments as warranted to follow the ongoing long-term uptrend.
The same skeptical stock market story is being replayed for investors again. Market pundits, politicians, the media, and many investors are using the same buzzwords:
"There is significant uncertainty in the markets today".
Ladies and gentleman, whenever change is in the air, there is ALWAYS uncertainty. How that uncertainty is viewed and interpreted is the key to being successful in the markets or just muddling along.
The same approach that has allowed an investor to garner the lion's share of this secular bull market's gains should remain in place. As the opening quote states:
"Experience tells you what to do; confidence allows you to do it."
Speculating on what comes next isn't part of that game plan. At times that approach has and will be questioned vehemently by those that seem to have all of the answers. Trying to outguess the stock market usually winds up in failure. However, many continue to make that their primary strategy.
GDPNow from has jumped to 2.2% for Q3 courtesy of stronger retail sales; while Blue Chip consensus range has narrowed.
The following data does not confirm the sentiment that exists in the fixed income market. None of the following have the look of "recession".
Trucking tonnage +7% year over year in July to a new all-time high.
Chart courtesy of Urban Carmel, Data from American Trucking Assoc.
Trucks carry 70% of US freight.
July real retail sales at a new all-time high, +1.6% year over year.
Chart courtesy of Urban Carmel, Data from Federal Reserve
Retail ex-gas is +1.9%. Gas has been a drag, down -1.8% year over year.
As shown below, Citi's Economic Surprise index which measures how economic data comes in versus forecasts has begun to pick up over the past few months and is now at its highest level since the start of the year.
U.S. leading index bounced 0.5% to 112.2 in July, a fresh record high (first time with a 112 handle) after slipping 0.1% to 111.6 in June (revised from 111.5). Half of the 10 components that make up the index made positive contributions, led by building permits (0.23%) and jobless claims (0.16%), with solid gains in stock prices (0.14%), the leading credit index (0.14%) and average consumer expectations (0.12%).
Four of the indicators made negative contributions, paced by ISM new orders (-0.1%). Consumer goods orders were unchanged.
The ratio tends to plunge consistently for long periods of time in the lead up to recessions, unlike three instances of sideways movement as we've seen this expansion. So far the leading indicator data does not look recessionary.
IHS Markit Flash U.S. Composite PMI Output Index dipped from 52.6 in July to 50.9 in August to signal only a slight increase in business activity and the slowest pace of expansion for three months.
Tim Moore, Economics Associate Director at IHS Markit:
"August's survey data provides a clear signal that economic growth has continued to soften in the third quarter. The PMIs for manufacturing and services remain much weaker than at the beginning of 2019 and collectively point to annualized GDP growth of around 1.5%. The most concerning aspect of the latest data is a slowdown in new business growth to its weakest in a decade, driven by a sharp loss of momentum across the service sector. Survey respondents commented on a headwind from subdued corporate spending as softer growth expectations at home and internationally encouraged tighter budget setting. Manufacturing companies continued to feel the impact of slowing global economic conditions, with new export sales falling at the fastest pace since August 2009."
"Business expectations for the year ahead became more gloomy in August and remain the lowest since comparable data were first available in 2012. The continued slide in corporate growth projections suggests that firms may exert greater caution in relation to spending, investment and staff hiring during the coming months."
July existing home sales report beat estimates with a 2.5% July rise to a 5.42 million pace, following a boost in the June clip to 5.29 million from 5.27 million. That is the second-strongest print for existing home sales since April of 2018. Analysts saw a -1.6% July median price drop-back from an all-time high in June, though analysts still have a 4.3% y/y climb. Analysts saw a -1.6% July inventory drop, both m/m and y/y, that still leaves a seven-month climb of 23.5%.
Lawrence Yun, NAR's chief economist:
"Falling mortgage rates are improving housing affordability and nudging buyers into the market. However, the supply of affordable housing is severely low. The shortage of lower-priced homes has markedly pushed up home prices."
"Clearly, the inventory of moderately-priced homes is inadequate and more home building is needed. Some new apartments could be converted into condominiums thereby helping with the supply, especially in light of new federal rules permitting a wider use of Federal Housing Administration (FHA) mortgages to buy condo properties."
New home sales fell 12.8% to 635k in July, a little weaker than expected, but that followed a big upward revision to June with a 20.9% rebound to a revised 728k pace in June (was 646k) and versus -8.2% to 602k in May (revised from 604k). Sales were at a 609k clip last July.
In an effort to stem the tide against recent poor economic data, the ECB is prepared to deliver "very strong" stimulus package in September.
German Finance Minister Olaf Scholz said that Germany has the fiscal strength to mitigate any future economic crisis with "full force" and suggested that Berlin could free up around 50 billion euros ($55 billion) of extra spending.
Flash Eurozone PMI Composite Output Index at 51.8 (51.5 in July). This is a two-month high. Andrew Harker, Associate Director at IHS Markit:
"The dynamics of the eurozone economy were little changed in August, with solid growth in services continuing to hold the wider economy's head above water despite ongoing manufacturing decline. While the rate of overall expansion ticked up, we're still looking at GDP only rising by between 0.1% and 0.2%, based on the PMI data for the third quarter so far. The lack of a quick rebound from the recent economic slowdown has impacted firms' confidence, with sentiment the lowest in over six years. It appears that companies are braced for a sustained period of weakness, and as a result are showing greater reluctance to take on additional staff."
Eurozone construction activity has continued growing even as industrial production has collapsed. The construction numbers are very volatile, but if the Eurozone was in a recession, we would expect them to look very similar to IP's collapse, as they did in 2007-2009 and 2011-2012. Instead their strength has been broad, with both building and infrastructure construction volumes running at a healthy pace.
China's central bank unveiled a key interest rate reform intended to lower borrowing costs for companies and reinvigorate an economy being negatively impacted by its trade war with the U.S.
Japan's economy grows at fastest pace in eight months. The flash composite index rolls in at 51.7 compared to 50.6 in the prior month.
British Prime Minister Boris Johnson traveled to Germany and France to insist to Emmanuel Macron, the French president, and Angela Merkel, the German chancellor, that Parliament cannot stop Brexit.
Johnson is expected to tell them that they have two months to agree a deal acceptable to the cabinet and parliament, without which the U.K. will exit without an agreement on Halloween.
Earnings Observations and Valuations
"With a 10-year Treasuries yield at 1.6%, the bond P/E is currently at 64X. That compares to the median bond P/E of 18.9 from 1953 to present. The current bond P/E is more than three standard deviations above the mean."
"The P/E multiple for the S&P 500 is currently at 17.7X, based on the consensus bottom-up estimate of $162.18 EPS for FY2019 and the current S&P 500 price of $2870. The forward PE using 2020 earnings estimates of $177 and the S&P at 2870 yields a PE of 16.2. The median S&P 500 P/E is 16.6X from 1953 to date."
It is quite evident what is overpriced and where the bubble exists in today's markets.
The Political Scene
As the trading week started, it appeared a more amicable tone on U.S/Chinese trade was in place.
Reuters reports: The U.S. Commerce Department is expected to extend a reprieve given to Huawei Technologies that permits the Chinese firm to buy supplies from U.S. companies so that it can service existing customers.
The "temporary general license" will be extended for Huawei for 90 days by renewing an agreement set to lapse on August 19.
All of that swiftly changed on Friday. The moment trade tariffs were initially put in place in 2018, "Get out of China" was the subliminal message to U.S. corporations. On Friday that message was emphatically announced by the President, after China retaliated with new tariffs of its own.
President Donald Trump in a series of tweets:
"Our Country has lost, stupidly, Trillions of Dollars with China over many years. They have stolen our Intellectual Property at a rate of Hundreds of Billions of Dollars a year, & they want to continue. I won't let that happen! We don't need China and, frankly, would be far better off without them. The vast amounts of money made and stolen by China from the United States, year after year, for decades, will and must STOP. Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing your companies HOME and making your products in the USA."
"I will be responding to China's Tariffs this afternoon. This is a GREAT opportunity for the United States. Also, I am ordering all carriers, including Fed Ex, Amazon, UPS and the Post Office, to SEARCH FOR & REFUSE, deliveries of Fentanyl from China (or anywhere else!). Fentanyl kills 100,000 Americans a year. President Xi said this would stop, it didn't. Our Economy, because of our gains in the last 2 1/2 years, is MUCH larger than that of China. We will keep it that way!."
After the market closed on Friday, the administration announced an increase on Chinese tariffs to 15%. The beat goes on, and in some respects uncertainty has been alleviated. While some may not like what is developing on this front, the situation is less murky now, instead it is very clear, "Get out of China".
The Fed and Interest Rates
FOMC minutes didn't provide strong clues on the direction of rates, and there was little market reaction. Most officials saw the July cut as a "mid-cycle adjustment". A number of participants note the various risks weighing on the outlook, and the "absence of clarity regarding when those risks might be resolved, highlighted the need for policymakers to remain flexible and focused on the implications of incoming data for the outlook."
The other key element of the minutes was that: "Members generally agreed that it was important to maintain options in setting the future target range for the federal funds rate and, more generally, that near-term adjustments of the stance of monetary policy would appropriately remain dependent on the implications of incoming information for the economic outlook."
Meanwhile, two participants wanted a 50 bp easing, though obviously they did not dissent. They favored a stronger action to better address the stubbornly low inflation rates of the past several years. Probably Bullard and perhaps Evans were the two.
Anyone expecting earth-shattering news from the Jackson Hole Symposium was disappointed. Fed Chair Powell was pretty coy in his policy related comments in the text of his speech from Jackson Hole. He provided no clear clues on the rate course ahead and hence maintained the FOMC's optionality with respect to the September meeting.
"The Fed will 'act as appropriate to sustain the expansion.' The economy is in a 'favorable place,' but faces 'significant risks,' including Brexit and Hong Kong, along with weakness in China and Germany.
Since the July 31 FOMC decision, events have been 'eventful' with further evidence of a global slowing. Closely watching developments for their impact on the U.S. economy. However, we see some signs that inflation is moving closer to the 2% goal."
Since Powell didn't firmly take another cut off the table, analysts suspect there will be one more 25 bp rate easing, with the onus on the data and global events to keep the Fed sidelined next month.
There is absolutely nothing new in any of the commentary from the Fed. Obsessing over the wording from any of the Fed officials that come out and get their five minutes of air time is a waste of time.
As shown below, the decline in rates that has taken the five year to 1.4%, 10 year to 1.5%, and 30 year at 2% as well as (briefly, intraday) inverting the 2/10 yield curve that has sent bonds parabolic.
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 on a closing basis.
Source: U.S. Dept. Of The Treasury
The 2-10 spread started the year at 16 basis points; it stands at 1 basis point today.
Risk Off is the positioning in place today. Investors are heavily overweight cash, bonds, bond proxies and defensive equities, and massively underweight equities.
This type of sentiment is seen when markets bottom, not at market tops.
This week's AAII survey showed a second straight weekly increase in positive sentiment with 26.6% of investors reporting as bullish. Although it is off the lows of 21.6% from the first week in August, bullish sentiment remains more than one standard deviation below its historical average.
The good news in the chart presented below, the price of WTI has held support in the $50-51 range.
The bad news, a series of lower highs has been in place since June.
The weekly inventory report showed a decrease of 2.7 million barrels from the previous week. At 437.8 million barrels, U.S. crude oil inventories are about 2% above the five-year average for this time of year. Total motor gasoline inventories increased by 0.3 million barrels last week and are about 4% above the five-year average for this time of the year.
With production unchanged over the past three weeks, net exports were the main factor playing into this draw down, and the deficit in crude exports is now at its narrowest in five years.
Plenty of headlines citing global recession amidst the trade rhetoric, but the price of WTI held steady and closed the week at $54.11, down $0.82.
The Technical Picture
The DAILY chart shows how the S&P index once again advanced, then stopped right at overhead resistance.
The S&P 500 remains trapped between support and resistance levels shown as the 200-day MA at 2,802 (brown line), and the 50-day MA 2,946 (blue line).
Until we see a resolution either up or down, I suspect the volatility will continue as the emphasis on the 2/10 yield curve and tariff issues dominate the scene. The yield curve widens and stocks rally, the yield curve flattens and rallies are snuffed out.
That makes for a very difficult short-term picture, and it may be best for most of us to just sit and watch. A difficult time to navigate.
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.
We have heard how CEOs are cautious and seen the reports where the majority say they see a recession soon. So this piece of news is interesting. As stock markets skidded early this month, company insiders boosted their buying.
For the contingent that jumped to conclusion when they heard how negative the CEO community was, they might want to adjust their mindset now.
Morgan Stanley has been bearish since the last quarter of 2018. Its latest report shows that opinion hasn't changed:
Bullet points are courtesy of an Urban Carmel Twitter post on Aug 21st.
Market myths and the spin to tell a story get old after a while, and the perpetrators of this nonsense look more ridiculous as the days go by.
"Equities made new all time highs during the buyback blackout period. They have fallen as the blackout period has been winding down. It's almost like this meme is meaningless."
"Stocks are flat since January 2018 meme. Add or subtract a month and include dividends, and the gain is a healthy 17%."
Individual Stocks and Sectors
The S&P 1500 Home Builder group has had a great 2019 as mortgage rates have fallen over 100 bps from their highs in late 2018. As shown below, the group just recently broke out to new 2019 highs after a three-month sideways period, and as of this morning, it was up 40% year-to-date.
That price action does not appear to be signaling a recession that is around the corner.
Some pundits (myself included) are out with their charts and commentary about how stocks can continue higher once the yield curve inverts and the recession clock is started. Maybe what we all need to do is pack that story up and wait until the yield curve inverts and stays inverted for at least 30 days. The recent fears about the yield curve are overdone. Neither the depth nor the length of the inversion (2 hours) qualifies as any form of a recession signal. Simply put, there is no recession signal yet and the clock has not started.
There have been times where I have witnessed the tendency to search for, interpret, favor, and recall information in a way that confirms one's preexisting beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities. What you just read is the definition of confirmation bias. When an investor begins with preconceived notions, then follows that up with what I just described, they have conjured up a brew that will be poison to their investment portfolios. Time after time we have seen that play out in this old, tired, ready to crumble bull market. Each time it has surfaced, those that have followed that path have been left wondering what is going on. The latest example, December 2018. Last year showed how tightly most of us cling to our preconceived notions, how fiercely we resist evidence that we might be wrong and how adept we are at deluding ourselves into thinking we were right all along.
A book titled, The Rationality Quotient, brings to our attention that rational beliefs "must correspond to the way the world is," not to the way you think the world ought to be. If an investor can't be honest with themselves about the difference between the truth and what they think ought to be true, they may well be intelligent, but they aren't rational.
Translating this to the investing world starts with what I continue to state, look at ALL of the data. Listen for signals that say you might be off base. The keyword is listen, then of course evaluate. This is most important when your strategies are going astray. Strategies go astray when speculation is part of that strategy. An example; claiming this bull market was ending for the last three years is the definition of going astray, and that group is enormous.
When the long-term trend remains in place, it is best not to try and outguess the stock market. Do so at your own risk. 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!
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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.