“The surprise is that you continue to be surprised.” … Jill A. Davis
Surprise! Treasury rates are actually rising. Surprise! The S&P 500 is less than 1% below an all-time high, yet market participants are drowning in the negative news backdrop and geopolitical drama. The ongoing trade talks, the Brexit fiasco, another political crisis in Italy, Hong Kong protests, and resulting weak global data are keeping everyone cautious.
With all of the uncertainty floating around, if you are confused, you are not alone.
As the graphic above illustrates, the “experts” are sitting right next to you, and they too have no idea of what to make of the investment scene.
The characteristics and nature of the stock market presents a unique set of circumstances every chance it gets. Situations with so many variables and unknowns rarely seen anywhere else. Surprises tend to be the norm not the exception. Yet, market participants are asked to make important decisions while managing their finances, based on these circumstances. The usual result is confusion.
No one really knows if a stock or the entire market has peaked or is ready to roll over. Nor do we know for sure when the next correction will be, how long it may last and how deep it will be. Same with rallies, how high and when is that high too much. Then, there are the questions about the economy. Where are we in the cycle? What will it look like 6-9 months, or 2 years down the road? Add on the uncertainty of inflation, interest rates, etc., and it makes a sane person wonder how in the world can they cope and make any sense out of all of the unknowns.
All of those external unknowns are out of our control, therefore they render all of those concerns meaningless. This is where the majority of investors become lost. That ‘meaningless’ comment is hard for an investor to comprehend. In order to help one understand that concept, and how stock market “works”, simply look at where the S&P sits today, and remember ALL of the angst over the trade tariff situation that began in January 2018.
We may not be able to predict where stocks will go, but we have to be able to predict how we are going to react. That is well within our scope of control. Many investors fail because they overreact. They lose sight of what matters, price action and sentiment.
This entire Bull market has tested the will of investors month after month, year after year. There is but a handful of financial analysts that have maintained their conviction and stayed on board this train. That small percentage translates to the investment community as well. Why wasn't this Bull market embraced like so many others? Fear over the last financial crisis, overreaction to the meaningless, and losing sight of what matters.
Multiple years of market gains have been questioned every step on this journey. Years later I see the exact scenario regarding “sentiment” I saw when the S&P was trying to reach 2000, then 2500. We hear the same story today, the economy is about to go into recession, and the Bull market is about to end.
More evidence that an investor has to follow what really matters and how markets work. This week began with the S&P 1.5% from an all time high. No one was talking about that last week, instead its concern over what is the Fed going to do, and will there be a trade deal. Congress returned to Washington on Monday, and the usual baggage they bring to the situation can’t be far behind. Some will watch how the major indices trade, others will listen to the headlines. One thing I know for sure, the former will be successful, the latter won’t.
The major indices started the week on a positive note in an effort to keep up the momentum from the last two weeks of gains. However, there was a notable change to the trading scheme. Investors witnessed a massive shift out of growth momentum rate-sensitive names, and into value beaten down rate-insensitive names The 50 stocks in the S&P that were UP the most YTD coming into Monday were down an average of 1.45%. The 50 WORST performing S&P 500 stocks of 2019 were up an average of 3.37%.
Basically the bottom half of the S&P in terms of YTD performance exploded higher, while the top half lagged badly. All of that while the general market indices finished flat on the day.
Turnaround Tuesday was unusually quiet. Investor sentiment was buoyed as treasury rates slowly crept higher. Stocks took that cue and also drifted higher as well, then continued to bounce around reacting to every headline on tariffs and interest rates.
The S&P rallied 1% during the trading week, making it three straight weeks of gains. Dow Industrials rose for eight straight days and closed higher for three straight weeks as well. The Russell 2000 was the big winner, gaining 5+% in the last 5 trading days. Selling in the momentum names kept the Nasdaq Composite in check, as it stands 1.8% from its all time high. The calls for a bear market that some announced in the latter part of August, including the “Elliott Wave” analysis that I shared here, may have to wait as the jury is still contemplating new market highs.
The S&P 500 is holding on to a 20% gain for the year, and along with the DJIA is now less than 1% off the all time highs. Given that backdrop there remains an army of skeptics.
Why all this confusion? Perhaps market participants need to pay attention to the two issues that matter. Price action and sentiment. The major indices are all within shouting distance from all time highs and not many trust the rally or likes the stock market. The majority have bought into the recession rhetoric. An economic downturn that will be the most advertised recession in economic history.
Think about it.
The Atlanta Fed's Q3 forecast slipped slightly to a 1.80% pace for Q3, versus yesterday's 1.82%, and Monday's 1.87%, after averaging 1.66% last week.
Chart courtesy of Urban Carmel
Surprise! High yield spreads are normal and default rates remain below average.
Despite the narratives calling for the U.S. consumer to be overwhelmed by prices that were forecast to increase sharply, surprise, retail sales made a new all time high in July.
Chart courtesy of Urban Carmel, Data from Federal Reserve database.
More importantly, the overall trend remains higher, in comparison to the period prior to the past two recessions. The risk to the consumer and the economy isn’t the threat of higher prices, it's the threat of what appears to be a false narrative convincing everyone they need to be concerned about a recession. Pessimism can be contagious.
August retail sales rose 0.4% and was unchanged excluding autos. The 0.7% jump in the July headline was revised higher to 0.8% (with the 0.3% June rise bumped to 0.4%), while the 1.0% ex-auto surge was not revised (nor the 0.3% June gain). This is the 6th straight monthly increase in the headline, and are up 4.2% y/y.
Consumer sentiment bounced 2.2 points to 92.0 in September, taking back a little of the 8.6 point drop to 89.8 in August, which was the lowest since October 2016. The index was at 100.1 last September, which was the third highest print since January 2004. The current conditions index increased to 106.9 from 105.3. The expectations component increased to 82.4 from 79.9.
The headline from the NFIB report reads;
"Small Business Economy Remains Steady, Despite Doom and Gloom Narrative That’s Hampering Expectations."
That reinforces my view that the constant bombardment by the mainstream media may at some point take its toll on the average consumer. This is what can do more damage to the economy than any actual tariff.
NFIB President and CEO Juanita D. Duggan.
“In spite of the success we continue to see on Main Street, the manic predictions of recession are having a psychological effect and creating uncertainty for small business owners throughout the country. Small business owners continue to invest, grow, and hire at historically high levels, and we see no indication of a coming recession.”
NFIB small business optimism index fell 1.5% to 103.1 in August after rebounding 1.4% to 104.7 in July. It's the lowest level since March. The 108.8 reading from last August was a record high.
August PPI report beat estimates with a 0.1% headline rise with a firm 0.3% core price gain, leaving average gains for both the headline and core of 0.2% over the past six months. Resumed trade war fears in August depressed goods prices, which fell -0.5%, but service prices rose by a sturdy 0.3% with gains that were widespread.
U.S.CPI rose 0.1% in August, with the core rate increasing 0.3%, a little above expectations. There were no revisions to July's 0.3% gains for both. On a 12-month basis, the headline index slowed to a 1.7% y/y pace versus 1.8% y/y and the core rate accelerated to 2.4% y/y versus 2.2% y/y.
JOLTS report showed job openings declined 31k to 7,21k in July after slumping 136k to 7,24k in June (revised from 7,34k). The 7,62k from November remains an historic high. Job openings have been above 7 M since April 2018. The job openings rate fell to 4.5% from 4.6%.
As expected, the ECB cut its deposit rate by 10 basis points to -0.50%. QE will be restarted on Nov. 1 to the tune of 20 B euros per month. This restart of their QE program is open-ended.
Perhaps this is a piece of evidence that global trade may not be as bad as some believe. While deflated export volumes have been shrinking of late, container volumes have held up very well. As shown in the chart below, container volumes for APAC have been positive on a 3m/3m basis for almost all of 2018 and 2019. Re-routing of supply chains, causing more ton-miles per unit of export could be one explanation for this.
Eurozone Industrial Production Index is at a current level of 103.5, down from 103.9 last month and down from 105.4 one year ago. This is a change of -0.38% from last month and -1.8% from one year ago.
UK GDP: Q2 was the weakest 3m/3m growth rate for GDP since January of 2013. Q3 is showing a bounce back though: industry, services, construction, and trade all contributed to a significant beat for activity. It’s doubtful that the 4.7% annual pace of growth from July can be sustained longer term but at least the UK economy isn’t yet collapsing as it moves towards the October 31st Brexit deadline.
The latest headlines on the Brexit situation.
- David Cameron attacks Boris Johnson and Michael Gove over Brexit as he breaks silence
- Daniel Capurro: What is Boris Johnson's "all-Ireland" Brexit solution and how does it differ from Theresa May's backstop?
- John Bercow likens the Prime Minister to a bank robber
- General election: Who would win, and will it happen in 2019?
- PM faces new legal challenge which could see judges sign letter asking for Brexit extension
I’m not in the camp that says trade tariffs take a big chunk out of earnings. Second quarter reports showed that earnings are still growing and an earnings recession appears to be off the table for now. Boeing’s multi-billion charge during the quarter detracted 1.5% from S&P 500 EPS by itself, which appears to be a unique event that shouldn’t recur.
Corporate America has done a good job delivering modest earnings gains amid significant headwinds, including tariffs and trade uncertainty, slowing growth in Europe and Japan, and a strong U.S. dollar. Companies are showing flexibility in minimizing the entire tariff issue. I believe that only gets better as companies now conduct business knowing the tariff backdrop in place.
There are other factors that could continue to keep corporate profitability resilient. By any measure, the regulatory costs on the private sector are rising much more slowly than anytime in the last 10 years.
This sharp reduction in new rules and more business friendly enforcement environment has been an important support for economic growth and has probably been generally under appreciated and overlooked by investors. Until that changes it remains a tailwind for earnings improvement.
- Fwd 4-qtr est: $171.55 vs last week’s $171.68
- TTM est: $164.44 vs $164.39 last week
- FWD PE: 17.4x
- TTM PE: 18.1x
- PEG (fwd): 12x
- PEG TTM: 4x
- SP 500 earnings yld: 5.76% vs last week’s 5.87%
- Year-over-year growth fwd est: +1.45% vs +1.51%
- Year-over-year growth TTM est: +4.32% vs last week’s +4.43%
The Political Scene
The South China Morning Post reported Tuesday that China has offered to increase U.S. agricultural purchases in exchange for a delay in tariffs and easing of a supply ban against Huawei Technologies.
"China makes largest U.S. soybean purchases since at least June. Chinese importers purchased no fewer than 10 boatloads of U.S. soybeans on Thursday, their most significant acquisitions since at least June. The purchases come ahead of high-level negotiations next month aimed at ending a bilateral trade dispute between China and the U.S. The soybean buys, totaling at least 600,000 tonnes, are scheduled for shipment from U.S. Pacific Northwest export terminals from October to December."
In yet another trade related development this week, President Trump announced a delay in hiking tariffs on Chines goods scheduled to go into effect on Oct 1st.
China's Ministry of Commerce says it will exempt soybeans, pork and other agricultural products from the U.S. from additional tariffs, in the latest move to ease trade tensions before the two countries restart trade talks next month. China says it is responding to Pres. Trump's decision to delay tariffs by two weeks.
The beat goes on.
The consternation over proposed Mexican tariffs was all for naught. Reuters reports;
“Mexico sees lessened U.S. tariff threat after migration efforts, Mexican President Andres Manuel Lopez Obrador said that the U.S. threat of tariffs on Mexican goods has diminished, after his top envoy met with U.S. President Donald Trump and other White House officials to go over progress on cutting down on migration."
"After meeting with Vice President Mike Pence and a brief exchange with Trump in Washington yesterday, Mexican Foreign Minister Marcelo Ebrard anticipates additional decreases in U.S.-bound migration through Mexico. Lopez Obrador said the talks had a softer tone than in June, when Mexico agreed to tougher measures to curtail migration in exchange for averting U.S. tariffs on Mexican exports, and to examine progress in 90 days. They had a more rigid stance, this time it was different. There was recognition that promises have been met on our side."
Here is another “issue” highlighted as a negative, containing a lot of "spin", that never materialized.
The Fed and Interest Rates
After a relentless downward move for much of August, long-term interest rates have started to stabilize in the last week or so and have even started to show small upward moves. Take the 30-year US Treasury yield, for example. After hitting a low of 1.90% on August 28th, the 30-year yield has moved up to 2.37%.
The 3-month/10-year Treasury curve inverted on May 23rd, and other than a brief one-day change, that curve remains inverted. While it lasted for 3 days, the inverted 2/10 yield curve is inverted no more. Stock market participants are watching this closely and continued flattening or steepening of the yield curve will help boost sentiment towards owning equities.
The 2-10 spread started the year at 16 basis points; it stands at 11 basis points today.
As we craw closer to the next FOMC meeting analysts are ramping up the discussion of how much the Fed will cut rates later this month. One interesting observation came from an analyst that noted he believes Mr. Powell has learned his lessons on how to characterize and communicate the interest rate scenario and the Fed’s policy.
In my view if Mr. Powell simply takes the approach that he is speaking to a group with the attention span of a room full of kindergarten kids playing with their crayons, he will do just fine.
It appears hedge funds are ready for a recession.
If we assume they have “hedges” in place as well, this under exposure position in equities may have huge implications for the market going forward.
Hedge funds have had difficulty keeping up with the averages all during this bull market for one simple reason. Hedging (betting against the primary trend) during a Bull market is a losing proposition. One need only look at the results in the last few years to see what I am referring to.
Investor sentiment has shifted more positive. The percentage of investors reporting as bullish in AAII's weekly survey rose from 28.6% last week up to 33.1%. That is the highest since August 1st when 38.4% reported bullish sentiment. This week marks the sixth straight week with below average bullish sentiment, so the party hats remain in the closet for now.
“Booming shale production has allowed the U.S. to close in on, and briefly overtake, Saudi Arabia as the world's top oil exporter."
The weekly inventory report showed that crude oil inventories decreased by 6.9 million barrels from the previous week. That brings the three week decline to 21.7 million. At 416.1 million barrels, U.S. crude oil inventories are about 2% below the five year average for this time of year. Total motor gasoline inventories decreased by 0.7 million barrels last week and are about 3% above the five year average for this time of year.
Crude oil hit a six-week high before trading back down to close the week at $54.93 down $1.80.
The Technical Picture
Last week it was all about a very important technical event that took place.
“The S&P not only closed above 2930, but also above another important demarcation line, S&P 2950. The index is now back above what many thought would be insurmountable resistance as bearish calls were ramped up. For now the make or break moment for stocks has been resolved in a positive fashion.”
The DAILY chart of the S&P shows a slow melt up in the index that started last Thursday, the same day that treasury yields started to rise. Despite the index looking somewhat overbought in the short term, once price moved above Mondays high of 2988, the rally continued.
The index has stalled approaching the old highs, as market participants cautiously weigh whether it will be new highs or a pullback ahead.
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.
There are plenty of anxious investors worrying if the Russell 2000 small cap index (RUT) is signaling trouble ahead. I continue to believe most are making way too much of an issue over this, BUT I also think the technical situation might be about to change. Prior to this week’s trading, the advance-decline line reached a new high, and the RSI is trending high. A sign that momentum is entering the small cap space.
On August 27th many thought the RUT would fail at support and roll over. Instead the index bounced off support and rallied. This week the index was an outperformer as the small caps have posted four 1% rallies in six trading days. That momentum may continue to build and help to get the index over resistance as it gets closer to the old highs.
Investing in the fixed income market has been profitable lately. However, there has been a swift trend shift for bond yields since the month of September began. After hitting 3.25% last October, the 10-Year Treasury yield got all the way down to 1.43% at the start of this month. Since its low, however, the 10-Year yield has jumped 47 basis points up to 1.9% over the last 10 trading days.
As long-term interest rates have risen, of course bond prices have fallen sharply. The 20+ Year Treasury ETF (TLT) was up more than 20% year-to-date coming into September, but it has quickly fallen more than 7% from its highs over the last couple of weeks. A look at the charts notes that TLT's price has moved below its 50-day moving average, which would break a streak of exactly 100 trading days of closes above its 50-DMA.
I’ve called the Treasury Bond market a bubble for a while. The latest spike higher was parabolic. We now see that no asset is immune to what takes place in EVERY market. Reversion to the mean. Many will now wonder whether this is just a pause in that bullish trend, or a severe crack that sends bonds much lower. While I don't expect rates to skyrocket from here, history tells us once a bubble bursts, it takes a LONG time to re-inflate it. With everyone piling into that trade over the years, (that continued last month), an exodus may be just the thing to keep the Secular Bull Market story in place.
Individual Stocks and Sectors
The switch from momentum stocks to value this week can be viewed as an overall positive for the market. It adds "balance", as more sectors and stocks join the rally. This recent move back into Financials, Small & Mid-Cap stocks, Materials, etc. is an encouraging sign.
When that was occurring, analysts couldn’t wait to tell us the “momentum” trade is dead. When we see a shift like this taking place, I always caution people not to get caught up in the frenzy. We don’t know how long this trend (if it is a trend), may last. I do know one thing. and it may be the most important issue to remember. The momentum names will be where the growth in earnings will be, and that is where I want to be as well.
It was noted earlier that hedge funds are loath to be involved in anything cyclical. While that may have worked with other cyclical sectors, it has been a losing proposition when it comes to semiconductors. One of the indexes I watch closely for a sign that the economy may be faltering is the semiconductor sector, which of course is very cyclical in nature. The Philadelphia Semiconductor ETF (SOXX) is up 38+% this year, easily outperforming the S&P 500.
The following quote from a Senior V.P. at Federated Research says it all.
“I’ve never heard so much talk of a recession in my life, and yet there was no talk of recession in 2007.”
That is the backdrop market participants are dealing with these days. So let me get this straight, the majority is calling for a recession, and I’m supposed to sell my stocks. When the discussion turns to the "R" word these days, the buzzwords start flying. Now we get a daily dose of "Chances are increasing". "Chances" were increasing in 2016 as well. More indicators were flashing yellow back then, and the economy did not roll over.
Then there is the incessant complaints about tweets, trade headlines, a Fed chair that can't convey his message, etc. All leading some to conclude they simply can't invest with that backdrop, so they leave the market. The S&P closed 20 points from an all time high today. I wonder when some market participants and analysts will finally “get it”. None of what they complain about matters. Perhaps many don't realize where the major indices are trading at these days because they are obsessed with the noise.
Noting that people are leaving the stock market isn't an opinion. The statistics confirm the exodus, as the turmoil of macro data and sentiment over the summer led to a record reallocation of assets out of equities by investors. They have sold $200 billion of equities so far this year and bought $700 billion of bond and money market funds.
August alone saw one of the biggest outflows from equity exchange-traded funds in years, and the American Association of Individual Investors (AAII) surveys have been bearish for years now, and expectations for the next six months continuing to trend that way.
Contrarians cannot stop smiling, yet many do not use these tidbits of data to form an investment strategy. After all, it‘s always easier to worry about the news headline of the day, or the words from the Fed, than to understand the role emotion plays in investing.
We read the sentiment data week after week, and see the herd running from equities. If an investor wants to see how herd mentality works, one simply needs to go back and look at the euphoria in 2000. Simply put, the mindset now is the reverse of the year 2000. That leaves investors to ponder whether these are truly all time market highs, or is the Bull market run going to continue.
When investors look at the landscape they take in the economic data, form their conclusions, and come up with their short to intermediate strategy. I continue to believe that many do not take into consideration what has been reviewed week after week and mentioned here today, "investor sentiment". In addition to that, there is another dynamic that many aren't paying attention to, "the alternatives".
With the 10 year treasury yielding 1.8%, a 10-year U.S. government bond is wildly “expensive”. If it was a stock one would start using the “bubble“ word. However, we hardly hear that description from anyone. Instead, it is considered the “safer” alternative.
The present and expected PE ratio for the S&P is approximately 17-18x expected earnings. It also has a current dividend yield of 2%.
History tells us that those dividend payments will increase over time. The bond's interest payments are fixed. S&P 500 earnings and dividends are likely to increase over time. So despite where one looks, after weighing all of the alternatives they have in the present environment, it would appear that the stock market is a pretty good alternative. Surprise, many are running away from stocks.
That is because the volatility scares most investors. Ultimately it is my opinion that a broad spectrum of investors will reach the same conclusion that I and others who have been bullish reached long ago. After ten years of generally rising stock prices, we still have NOT seen the broad, enthusiastic participation that generally indicates market tops. Instead we hear it’s been 10 years since the last bear market and we are “overdue” for a big corrective phase. One view has been correct, the other has cost investors a fortune.
While stocks may not be cheap relative to where they trade at stock market bottoms, (and they shouldn’t be) they remain very cheap relative to the other outlets for our hard earned cash. Add the negative sentiment into this picture, as many loathe the stock market at these levels, and the contrarians are salivating over what may lie ahead.
When stocks were retreating and re-testing their lows, the critics were loud and clear on their message arguing against ANY bullish scenario. There were two instances where the skeptics voices were the loudest. February of 2016 (S&P 1800) and December of 2018 (S&P 2350). Surprise! They were horribly incorrect on both occasions.
Anyone that has stopped by to read the articles here in the last month or so shouldn't be confused, nor should they be surprised at what is taking place in the equity market. A sample of commentary that was written to close the most recent articles;
“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 like to make decisions based on facts, rather than emotions. The long-term trend is in place. Savvy investors know how to proceed.”
“Monitor, assess, then reassess. Following that strategy has kept me “long” equities with no hedges in place. Those that have followed along are the only investors in the pilot's seat. 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.
We will never forget. Take a moment, pay tribute, and remember the 9/11 victims.
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? You should be. Many were calling for a bear market in August. The S&P has rallied back to the old highs. When an investor assembles their market strategy, they need to follow someone that has made the correct market calls month after month, year after year. All in an effort to increase their chances of success.
The Savvy Investor Marketplace is here to help. Top notch research info from well respected sources, only scratches the surface of what is offered.
Please consider joining one of the most successful new ventures on Seeking Alpha and see how SAVVY members are navigating the markets today.
Disclosure: I am/we are long EVERY STOCK/ETF IN EVERY SAVVY PLAYBOOK. 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.
I am short the Treasury market via TBT and TAPR
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.