“Based on my own personal experience, both as an investor in recent years and an expert witness in years past, rarely do more than three or four variables really count. Everything else is noise.” – Martin Whitman
The trading week started off on a negative note as the major indices all opened lower. Two events can be blamed for catalyzing the selloff: the new round of short-range ballistic missile testing activity carried out by North Korea, and much more importantly, a blustering tweet from the President that threatened new rounds of tariffs (25%) on Chinese imports to the U.S. that have so far avoided tariffs, as well as a tranche that have already received 10% tariffs.
There was no doubt what was spooking investors as the week went on; it was all about the trade talks. Sentiment changed quickly as the streak of daily and weekly gains ended with the S&P 500 closing lower this week. End of week headlines announced:
“The worst week of the year for stocks”
The string of weekly gains in all of the major averages is suddenly not part of the equation now. Sentiment is a funny thing; an investor’s mindset can change quickly. That is a negative when it comes to managing money.
Stocks that had the largest runs gave back the most, and that prompted commentary how certain sectors were getting crushed. All very true, but as many times as I have seen these situations, I am amazed why the outsized gains leading up to these pullbacks aren’t thought of now. As you should know by now, the human mind highlights the negatives first with a thought like this:
Heck, I’m losing money and I better do something about it quickly.
In the world of investing, uncertainty is all around us. Learning to accept uncertainty and understand how important it is when developing an investment strategy is key. Just about every strategy that has been developed has failed at one time or another in order to succeed. That includes some of the most well-known strategies developed by the sharpest investment minds out there.
They fail because of human frailties, and that is something we all have to understand and deal with. There is no certainty built into the stock market, but there is always “noise”. Separating “noise” from what really matters isn’t so easy. The best way is to listen to the market and tune out the pundits. This week presented a perfect example of that. Knee-jerk reactions to a headline with the backdrop of an overbought market sent prices lower. Nothing had changed except perception, and in the short term, perception means everything.
If you truly have a diversified portfolio, there will come a time when we look over our holdings and literally hate some of the positions. Accepting those short-term failures will assist in dealing with the long term.
The investor that understands and accepts that there will be failures going into any investment plan has a decided edge. They plan for a wide range of outcomes. There is no such thing as the perfect portfolio at any given point in time. It doesn’t exist, and those that strive for that perfect optimized portfolio usually underperform.
Of course it’s advisable to tweak things now and then once the market trend has been established. An investor should try to make the best decisions based on probabilities, given the data presented. However, over time the market winds will switch from value to momentum, to income, then growth. Anyone trying to precisely capture those gyrations will wind up grinding their portfolios into the ground.
Suffice to say, ignoring a lot of the ongoing noise will go a long way in managing a portfolio without distraction. Jeff Miller’s latest missive warns investors who continue to get themselves wrapped up in the headlines. A source of ongoing uncertainty has been the angst over the trade negotiations and how they will affect what many already see as a fragile situation. Some say the effects of the tax stimulus will surely wear off, and given the state of discord in D.C., it appears not much will get done to help the economy.
For once it would be nice to see partisanship left at the door and take steps to bring the equality so many are talking about by stimulating the economy even more. But I digress, it’s an issue no investor can control, so we play the cards that are dealt. The argument on where we are in this economic cycle will rage on. Suffice to say we did experience a mid-cycle slowdown in 2016/2017. If the recent lift in GDP is sustainable, then we might be tossing all of the theories of this economic expansion ending now right out the window.
I’m no economist, but it seems to me if GDP muddled along at a 2% clip, then experienced a slowdown, only to now shows signs of revival, common sense tells me we are closer to this being a beginning than the end. I assure you very few have that view in mind. An oversimplification would state that equities do quite well during expansions and usually fare poorly during recessions. It is evident how critical it is to correctly identify the environment.
A pro-growth backdrop goes a long way in helping the economy move forward. The graphic below shows the shackles and handcuffs being removed.
Corporate America has and is benefiting from the reduced regulatory environment. Unless we go back to an anti-business agenda, this benefit to the bottom line of corporations remains in place. Another reason why the sugar high theory may have a lot of holes in it.
If the economy stays strong, anyone waiting for a rate cut might be waiting a while. Since 1990, the Fed has cut rates 42 times. Just 9 of those 42 cuts (over four time periods) were in the quarter after a 3+% GDP print.
The knock on the economic recovery has been the absence of productivity growth, despite payrolls and wages starting to grow at a nice clip. There was a noticeable pickup in capital expenditures that started last year. This may have now sparked a resurgence in productivity, which we think could be key to future economic growth.
Economists believe increased productivity yields economic growth. Increased business spending is the primary catalyst for higher productivity, as better equipment and training boosts output per worker, although a tightening labor market has also helped. Labor shortages and accelerating wage growth normally incentivize companies to invest in boosting output with current labor. In turn, workers may get paid more as output increases, which could flow through to higher consumer spending.
Growing productivity also helps offset rising labor expenses, as companies get more output per dollar spent, which can help mitigate inflationary pressures and support healthy profit margins for U.S. companies. First quarter unit labor costs rose only 0.1% year over year, the slowest pace of growth since the fourth quarter of 2013.
The weekly Bloomberg Consumer Comfort Index slipped to 59.8 at the start of May from 60.4 versus a 60.3 average in April. Confidence continues to oscillate at elevated levels.
April CPI rose 0.3% and the core edged up 0.1%, both a little light of forecast, following respective gains of 0.4% and 0.1% in March. On a 12-month basis, the headline accelerated to a 2.0% y/y clip versus 1.9% y/y, while the ex-food and energy component is up 2.1% y/y from 2.0% y/y.
JOLTS: Job openings bounced 346k to 7,488k in March, recouping a lot of the 483k dive to 7,142k. The job opening rate jumped to 4.7% from 4.5%, one tick from the 4.80% all-time high.
Some analysts claim the jobless rate is being artificially suppressed by lower labor force participation, but participation is higher now than it was in the late 1960s, when 3.6% was considered full employment.
The labor force is up 1.4 million from a year ago, and the labor force participation rate has been essentially flat since late 2013. And that’s in spite of an aging population.
The unemployment rate for those with less than a high school degree has averaged 5.6% in the past 12 months, the lowest on record, and well below the previous cycle low of 6.3% reached during the internet boom two decades ago. The Hispanic unemployment rate has averaged 4.6% in the past year, while the African American unemployment rate has averaged 6.4%, both also record lows.
Wage growth is accelerating. Average hourly earnings are up 3.2% from a year ago versus the gain of 2.8% in the year ending in April 2018, and 2.5% in the year ending in April 2017.
The gains in wages are not just tilted toward the rich. Among full-time workers age 25+, usual weekly earnings are up 3.5% for those in the middle of the income spectrum. But wages are up 4.9% for workers at the bottom 10% of earners, while up 1.7% for those at the top 10% of income earners.
Since 2013, the naysayers have doubted the recovery. We heard the stories of workers taking on multiple jobs to keep afloat. Some observers continue to claim that the strong job creation is due to workers taking on multiple jobs. The stats don’t bear that out. Multiple job holders have been just 5.0% of the total number of employed workers; that’s lower than at any point during the 2001-07 expansion, or during the previous longest recovery on record during the 1990s. Part time jobs are down since the expansion started, meaning, on net, full-time jobs account for all the job creation during the expansion.
Investors would do well to look at the facts and question the agendas that are being put forth on this and other topics.
MBA mortgage applications rebounded 2.7% in the week ended May 3, after sliding 4.3% in the prior week. This breaks four straight weeks of declines and was supported by a 4.2% pop in the purchase index, and a 0.8% gain in refinancings.
IHS Markit Eurozone PMI Composite Output Index recorded 51.5 in April compared to 51.6 in the previous month. The latest index reading was the lowest for three months, though a little firmer than the flash reading of 51.3.
Chris Williamson, Chief Business Economist at IHS Markit:
“The final eurozone PMI for April came in slightly higher than the flash estimate, though still indicated that the economy lost a little momentum at the start of the second quarter and that growth remains worryingly lacklustre. The survey is indicative of the economy growing at a quarterly rate of approximately 0.2%, but manufacturing remained mired in its steepest downturn since 2013 and service sector growth slipped lower.”
“In a month in which oil prices continued to rise, it was no surprise to see input cost inflation accelerating for the first time in six months. It is therefore disappointing to see average selling prices for goods and services showing the smallest monthly rise since August 2017, strongly hinting at weakened pricing power and lower core inflationary pressures as firms were often unable to pass higher costs on to customers.”
German new factory orders rose 0.6% month over month in March on a volume basis, a welcome reprieve from declines but much less than the 1.4% improvement expected by analysts.
German Industrial output rose by 0.7%, exceeding expectations of 0.5% increase.
The Caixin China Composite PMI™ data (which covers both manufacturing and services) indicated that Chinese business activity continued to rise strongly during April. This was shown by the Composite Output Index posting above the neutral 50.0 value at 52.7, which was down only slightly from a nine-month high of 52.9 in March.
Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group:
- The gauge for new business dipped marginally from the past month’s recent high, reflecting continued strong demand across the services sector.
- The measure for employment rose to its highest since June, suggesting an acceleration in jobs growth.
- Gauges for input costs and prices charged by services providers rebounded. Faster growth in input costs was negative for companies to improve profits.
- The measure for business expectations fell despite staying in positive territory, reflecting services providers’ weakening confidence in their future prospects. “The Caixin China Composite Output Index edged down to 52.7 in April from 52.9 the month before, partly due to slower growth in the manufacturing sector.”
- The gauge for new orders edged down despite staying in expansionary territory, while the one for new export orders returned to contractionary territory, pointing to weakening demand at home and abroad.
- The employment gauge dipped, but remained in positive territory, suggesting pressure on the labor market was controllable.
- Both gauges for output charges and input costs stayed in positive territory, with the former dipping and the latter rising, implying companies’ subdued profitability. The measure for future output, which reflects business confidence, edged down.
“In general, China’s economy looked resilient in April, especially in the services sector. However, pressure on costs across the services sector remained relatively high, limiting companies’ profit growth potential. Business confidence hasn’t recovered. Market participants must remain patient to wait for the economy to stabilize. We expect that policymakers will slightly restrain countercyclical policies, and focus more on structural and systematic policies.”
A mixed bag on Chinese trade data. Their imports rose 4% while exports fell 2.7%.
Nikkei India Composite PMI Output Index fell from 52.7 in to 51.7 in April.
Pollyanna De Lima, Principal Economist at IHS Markit:
“Although the Indian private sector economy looks to be settling into a weaker growth phase, much of the slowdown was linked to disruptions arising from the elections and companies generally foresee improvements once a government is formed. However, voting was not the only reason cited for the slowdown. In the service sector, competitive conditions and a shift towards online bookings among customers reportedly restricted new business gains and in turn growth of activity. On a more positive note, the labour market is showing resilience as companies hired extra staff at an accelerated pace. “Another key takeaway from the latest results is the lack of inflationary pressures in both the manufacturing and service sectors, which coupled with slower economy growth offers room for a further cut to the benchmark repurchase rate.”
Don’t underestimate an incident that has virtually gone unnoticed; North Korea Has second Missile Test Launch in a Week. With investors already in a nervous state, this development didn’t help the overall fear sentiment.
During the month of April, analysts lowered earnings estimates for companies in the S&P 500 for the second quarter. The Q2 bottom-up EPS estimate, which is an aggregation of the median EPS estimates for all the companies in the index, dropped by 1.0% (to $41.04 from $41.45) during this period.
No need to be alarmed. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 1.7%. Another clue that forecasted estimates may be low.
FactSet Research weekly update:
For Q1 2019:
With 90% of the companies in the S&P 500 reporting actual results for the quarter, 76% of S&P 500 companies have reported a positive EPS surprise and 59% have reported a positive revenue surprise.
The blended earnings decline for the S&P 500 is -0.5%. If -0.5% is the actual decline for the quarter, it will mark the first year-over-year decline in earnings for the index since Q2 2016 (-3.2%).
Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.5. This P/E ratio is equal to the 5-year average (16.5) but above the 10-year average (14.7)
It would appear earnings growth has had something to do with this bull market.
The Political Scene
President Trump announced that he plans on increasing tariffs on $200 billion of goods from 10% to 25% over last weekend, while also threatening to institute a 25% tariff on an additional $325 billion of Chinese goods. The threats came in the wake of reports that China may have backpedaled on some key commitments. The China delegation arrived in Washington for the next round of trade negotiations this past Wednesday.
With no breakthrough in the negotiations, the proposed U.S. tariffs were put into effect on Friday.
One issue that both sides of the political aisle have agreed on is China has not been trustworthy, and it seems there is support for the administration to remain resolute. If investors aren’t already aware, they should come to realize that China doesn’t have the best reputation for upholding its end of any deal. It has repeatedly found a way to work around any negotiated settlement. I remain with a mindset on the trade situation that is not widely accepted.
The entire Chinese trade issue is peanuts in the scope of global trade. It was my belief that there would never be an earth-shattering deal announced. If anything ever gets done, it will come in tiny steps over time. There are far too many moving parts to this situation along with a history that would be hard to overcome in such a short time.
Investors can expect tensions with the Chinese over these issues will go on for many more months, if not years. It will be an ongoing issue as long as the U.S. presses the situation. Investors should not be expecting very much, and at the end of the day, it won’t matter very much. As time goes on, the effects of the tariffs are mitigated. Companies have managed their way through the initial tariffs and are prepared to deal with the next round.
What I may have underestimated is the effect on sentiment. The emotional impact has been far greater than the actual monetary effect. While that is important in the short run, over time that too will dissipate. However, we should not underestimate the effect on the mindset of the trading public. The herd, and when emotion rules the day anything can happen. The fact that both sides are talking is a point that many didn’t focus on during the week. Eventually that will sink in.
What has also gone unnoticed; North Korea Has second Missile Test Launch in a Week. With investors already in a nervous state, this development didn’t help the overall fear sentiment.
For those obsessed with the yield curve:
Source: U.S. Dept. Of The Treasury
The 2-10 spread started the year at 16 basis points; it stands at 21 basis points today.
Investor sentiment, as measured by the AAII’s weekly investor sentiment survey, has yet to blink. In fact, 43.1% of survey respondents reported bullish sentiment up from 39% last week. While still within its normal range by historic standards (within one standard deviation of the historical average of 38.23%), that is the highest degree of bullish sentiment since October 4th of last year.
The Weekly inventory report showed a decrease of 4 million barrels. At 466.6 million barrels, U.S. crude oil inventories are at the five-year average for this time of year. Total motor gasoline inventories decreased by 0.6 million barrels last week and are about 2% below the five-year average for this time of year.
Despite all of the concerns over tariffs causing a disruption in global growth the price of crude oil remained above the 200-day moving average ($60.60). WTI closed the week at $61.54, down $0.31.
The Technical Picture
The message last week:
“Pullbacks should be shallow and well contained.”
My theory on quick and shallow pullbacks was tested no sooner than the ink was dry on that comment. That’s what a headline will do to any plan. This demonstrates why investors have to remain open minded to all outcomes.
In just four trading days, the S&P 500 pulled back from overbought levels over the past week and is now just a notch above its 50-day moving average and teetering on being oversold in the short term.
Chart courtesy of FreeStockCharts.com
We have seen sentiment change drastically over the last five months, and at this point, anything is possible. The concern now, what is probable, and what are the chances the scenario you come up with will occur?
No need to guess what may be in store. 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.
The warning of the week:
“Watch out IPO’s are heating up, a bubble has formed, investors are acting like it’s 1999.”
A prominent media analyst voiced his concerns all week.
Relax, this is not 1999/2000 all over again.
When Jeff Gundlach speaks, people listen; I’m still not sure why. On January 2nd, he was pretty sure we were in a bear market. On March 12, he was sure of it. When the S&P recently took out the old highs, the bull market trend that has been in place for years was confirmed.
His latest commentary on CNBC this past week centers on the fact that the S&P hasn’t gone anywhere in 15 months. It’s funny but that was the argument that many were proposing back in 2016. The comment that typically followed was “the market highs are in and equities are going lower.” Mr Gundlach says the same today.
Many pundits missed an important fact then and they are more than likely missing it today. In 2015/2016 the market was digesting gains of 29% and 12% respectively in the prior two years. Outsized gains do not go on forever. And when they do, it’s called a bubble.
The argument that the market hasn’t gone anywhere in the last 15 months without looking at what has transpired earlier to make a bearish case is misleading. The S&P was up 10% in 2016 and 19% in 2017. From November 2016 to the October 2018 high, the S&P is up 58%. In case the message didn’t resonate, I repeat, outsized gains do not go on forever.
If you choose to avoid the facts that add to the overall picture, you are more than likely spinning an agenda. When you add ALL of the facts to the picture, it may lead to a far different conclusion. I don’t pretend to have made more money than Mr. Gundlach. I don’t pretend to be smarter than Mr. Gundlach. When I offer a market assessment, I don’t pretend by offering an agenda.
Individual Stocks and Sectors
If you believe this next round of tariffs will take down the global economy and the global stock markets like many ascribed to back in April 2018, then you may want to lighten up on your equity holdings. At that time I decided to hold on to my equity positions for the same reasons I cited about the trade situation earlier. The S&P is up 12% since then. Will this time be different now that more tariffs are involved?
“Semiconductors were killed this week down 5%.”
The full story, the group was up 11% since April 1st, up 38% since January 1st.
We can’t discuss the current month and not mention the “Sell in May” strategy. When we look at this bull market, the month of May has been positive in every year since 2013. Plenty will argue that the trade tensions will change all of that. Maybe, maybe not. Many have already dismissed the strength exhibited in the first four months of the year. Funny how emotion makes a person forget issues that matter.
Common sense doesn’t resonate with those that are filled with emotion, the notion that it’s time to give some back is the prominent theme now, and it fits so nicely into the headlines. However, whether you want to believe it or not, Goldilocks is in the house.
The prolonged government shutdown coincided with a spate of ugly economic reports this winter and that led to concerns that the market advance wasn’t warranted. However, economic data from the past month points to renewed growth. I see no recession on the horizon.
The S&P, Nasdaq 100, Nasdaq Composite, Russell 3000 and Wilshire 5000 all made new highs. That price action confirmed what was said in the last paragraph. Given that those indices represent a great cross section of all stocks, the bullish story isn’t falling apart. Yet the bullish Long Term trend is still questioned.
No one should have ever concluded that the indices will just continue to roll higher for months on end. Amazingly how some completely lose touch with reality when stocks falter. Investors should ALWAYS expect drawdowns along the way, and at some point one of those give back periods may be greater than the 2-4%, I initially forecasted in the very short term.
This week the positive price action we have seen turned on a dime. Now it’s back to the negative sentiment outlook. Stocks entered the week in an extreme overbought backdrop and, by the end of the week, are now on the brink of being oversold in the short term. The commentary has started and a “no trade deal” is being extrapolated to a 10%, 15%, 20% correction. No one can ever make a forecast with any degree of certainty when emotion is ruling the day. As you know, prices get stretched far beyond what might be considered rational.
Some perspective please. It’s Deja Vu all over again as many investors have put themselves back in the mindset of early 2018 when initial tariffs were enacted. Market participants have had the Sword of Tariffs hanging over their head since early 2018. The S&P has put in two new highs since then. The talk was that the steel and other tariffs imposed in March 2018 were going to dramatically slow the economy down, and steel prices would rise unabated. When the first round of tariffs were enacted, first quarter GDP then was 2%. First quarter GDP this year was 3.2%, highest since 2015. Guess what, steel prices were lower in the months after tariffs were imposed.
Given those results the next round of tariffs will do what to the economy? What prices are going to go up so much the U.S. consumer will be handcuffed? Of course the tariff escalation can continue. Then again what if it doesn’t? What if negotiations continue?
Strong starts to the year and multi-month gains have a very high probability to lead to further gains in the months ahead. Strength begets strength, but at uncertain times investors are loath to follow that axiom. 2019 marks the 16th time since 1950 the S&P 500 rose in each of the first four months. In the 15 other instances, it averaged a 10% return the rest of the year, with an average 8% pullback along the way. There are precedents for the index to top now, but those are the exceptions. Seems that this week they became the rule.
Many fumbled, stumbled, and bumbled their way to losses when the December lows and the subsequent rally ensued. Market participants need to constantly review their present position in life, their plan, along with their present and future needs. Combine that with keeping an open mind to the data, and one can increase their chances of first, being successful, and second, making any transition in their holdings in concert with what the market is telling them.
Therein lies the key. Aligning yourself with the proper view, then interpreting the message correctly. Something to ponder. At the highs the index was up 17+% for the year, and some 25% off the December lows. The S&P has given 2.5% of that back. In reality there is no issue. What we are witnessing is how a headline and subsequent emotion sparks a pullback that was overdue.
When we consider that the S&P was extremely overbought in the short term, and see a topic of fear being resurfaced, the index hasn’t fared too badly. Then again there are those telling me this time is different.
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!
“Value investors now wonder if this is one big value trap. Momentum players are wondering if the music has stopped and they will be left without a chair. The Macro view is the key to success, and what that view is signaling now with the renewed trade tensions is key to where the stock market goes next.”
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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.