Things done well and with a care, exempt themselves from fear.
…… William Shakespeare
According to the pundits, the big story of the day this past week was the S&P closing below the 200 day moving average The streak of 442 days is over. When an index’s price crosses below its 200-day moving average, it is generally thought to have “broken” its long-term uptrend. This is considered a negative trading pattern, some technicians would tell you it’s a sell signal. History shows that this typical knee jerk reaction isn’t the way to proceed.
What we do know, is that past breaks below the 200 day moving average for the S&P 500 after long periods above it have not necessarily been bearish. As shown in the table below, one week returns after these breaks are somewhat weak, but after that the market normally bounces back.
Contrary to popular belief, when the index closes below this level, it does not mean the long term trend has ended. The August 2015, and the January/February 2016 time frame saw the S&P seesaw below, then back above the support level numerous times. The bull market remained in place. This latest breach of the 200 day moving average lasted one day. That doesn’t mean the index can’t go back and retest that level once again, but the quick retake of that support is a positive.
I also take that sign along with the intraday reversal on Wednesday as more evidence to support the idea that we are likely getting closer to the end, or at least through the worst of the bottoming process that has been in place. No, this isn’t the beginning of a bear market.
We find ourselves in a negative feedback loop now. One issue after another is highlighted, then regurgitated. If anyone is wondering why they feel like a punching bag these days watching the markets, here is an observation that explains why. Jack Bogle the legendary founder of Vanguard, says this is the most volatility he has seen in the markets during his 66 years in the business. That is saying something. He then goes on to say, its all “noise” related.
U.S. construction spending increased 0.1% in February versus the unchanged reading from January, while December was revised sharply higher to 1.6% (doubling the prior 0.8% gain). Spending on residential projected edged up 0.1% from 0.1% (revised from 0.2%, with December boosted to 1.5% from -0.5%). Nonresidential spending was up 0.1% too, from -0.1% (December was nudged down to 1.7% from 1.8%).
March ISM Manufacturing Index is on target as it comes in at 59.3 vs. consensus of 60.0.
ISM non-manufacturing index fell 0.7 points to 58.8 in March after slipping 0.4 points to 59.5 in February. These are down from the 59.9 reading in January which was a 12-year high.
Markit manufacturing PMI rose 0.3 points to 55.6 for the final March reading, versus the 55.3 in February. Highest reading since March 2015.
Chris Williamson, Chief Business Economist at IHS Markit;
“US factories reported a strong end to the first quarter, with the PMI advancing to a three-year high. The goods producing sector should therefore make a positive contribution to economic growth in the first quarter, as rising demand fueled further improvements in factory production. Optimism about the year ahead has meanwhile also risen to its highest for three years, generating yet another solid payroll gain and suggesting strong growth momentum will be sustained in the second quarter. Companies cited rising demand at home and abroad plus recent government policy announcements as helping shore up confidence in terms of their future production levels.”
Markit final services PMI dropped 1.9 points to 54 after rising 2.6 points to 55.9 in February, and compares to the 54.1 in the preliminary March print. Nevertheless, the index continues to point to a strong expansion in the service sector as it’s not far from the 56.0 print from August, which was the highest going back to November 2015. The index was 52.8 last year.
U.S. Factory orders increased 1.2% in February, largely erasing the 1.3% January drop. Durable goods orders were revised down slightly to a 3.0% gain from the 3.1% jump in the Advance report. Transportation orders climbed 7% after the 9.8% January decline (revised from -10.0%).
Liz Ann Sonders posted this graphic during the week. It shows GDP rebounding from the first quarter to the second quarter during this recovery.
Source: Factset, Federal Reserve Bank of Atlanta
March non farm payrolls increased 103k, with earnings up 0.3% and the unemployment rate at 4.1%. The 313k February jobs surge was revised higher to 326k, but January’s 239k knocked down to 176k for a net 50k decline. Analysts were “disappointed”. They shouldn’t be, Job growth was a paltry 73k back in March of last year.
U.S. vehicle sales totaled 17.48 M in March on an annualized basis, according to seasonally adjusted numbers, compared to 17.08 M in February. This report surprised analysts, and might be another indication that consumers are in good financial shape.
Cyclical housing peaks usually arrive when they reach the 800,000 level, The recent data stands at around a 500,000 pace, so there is plenty of runway left for expansion. This adds credibility to my views that the present recovery is not ‘overdue” for a recession. The recent results for one of the nation’s largest home builders, Lennar (LEN) seems to confirm that view.
The current Job, Housing and Auto Sales reports do not reflect a slowing economy.
J.P.Morgan Global Manufacturing PMI now sits at a five month low, coming in at 53.4 in March. The February reading was 54.1.
Eurozone manufacturing PMI came in at 56.6 down from the prior month report of 58.6, an eight month low. Chris Williamson, Chief Business Economist at IHS Markit;
“March saw the biggest fall in the manufacturing PMI since June 2011 and the third successive slowing in the pace of expansion. We should not be too worried by the fall in the PMI as some moderation in the pace of growth from the surge seen at the turn of the year was inevitable, not least because short-term capacity constraints limit the economy’s ability to grow so quickly for long periods. This has been clearly evident in the recent lengthening of supply delivery times. Some of the slowdown has also been attributable to temporary factors such as bad weather.”
Caixin China General Manufacturing PMI slipped to a four month low with a reading of 51, down form the February reading of 51.6. Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group;
“The Caixin China General Manufacturing PMI fell to 51.0 in March. The sub-indices of output and employment both fell from the previous month, while new orders increased at a slightly slower rate, highlighting that the deceleration in the manufacturing sector was mainly driven by the supply side and that demand has remained relatively stable. Output prices rose at a faster pace in March than in the previous month while the increase in input costs weakened markedly, which will help shore up manufacturers’ profits.”
Caixin China General Services PMI also fell from the February reading of 54.2 to 52.3 in March. Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group;
“ Both new business and employment grew at a slower rate last month, pointing to cooling demand. However, the ability of service providers to make a profit improved as input costs increased at a weaker pace while output prices edged up. The sub-index gauging service company’s expectations towards business activity over the next 12 months declined to the lowest reading since September, suggesting that weakening demand has affected firm’s confidence.”
“The headline Caixin China Composite PMI dropped to 51.8 in March, the lowest reading in four months but remaining in expansionary territory. The slowdown of output growth in the services sector was faster than that in the manufacturing industry. The increase in input costs slowed while that in output prices picked up, improving chances for companies to gain a profit. Overall, the growth momentum of the Chinese economy weakened in March.”
Nikkei Japan Manufacturing PMI showed to a reading of 53.1 in March down from the february report of 54.1.Joe Hayes, Economist at IHS Markit;
“Latest survey data presented a second successive decline in the Manufacturing PMI for Japan. That said, the overall picture remains upbeat. The reading of 53.1 still indicates a fairly solid pace of improvement in business conditions. Moreover, the average across Q1 is consistent with a robust growth rate and bodes well for official data. On a further positive note, new orders have now expanded in each of the last 18 survey months. This sustained upturn in demand has appeared to impact supply chains, with delivery times slowing to the sharpest extent since the aftermath of the 2011 earthquake. This could create headwinds for the manufacturing economy if further capacity pressures begin to impact production capabilities.”
Nikkei Japan Services PMI declined to 50.9 in March from 51.7 in February, a 17 month low. Joe Hayes, Economist at IHS Markit, which compiles the survey;
“The Japanese service sector lost further momentum during March, with overall business activity growing at the weakest pace since October 2016. New order receipts rose, albeit only slightly and at the softest rate in a year-and-a-half. That said, despite PMI data signalling disappointing output and demand conditions, prospects appear upbeat. Incoming new business has grown for 20 successive survey periods, and firms expect this trend to continue, as indicated by a solid degree of optimism towards future activity. This sustained upturn in demand led to capacity pressures however, with backlogs of work rising for a third month running. In turn, recruitment picked up, further suggesting confidence among firms that new sales will continue to be secured over the coming months.”
Canadian Manufacturing remained steady at 55.7 , up slightly from the 55.6 reading in the prior month.
Clearly the global data has leveled off in the last 3- 4 months. The growth spurt and trajectory that we saw in the latter half of last year was unsustainable. I believe the stock market has recognized that and this is a contributing factor to the overall market weakness lately. This should come as no surprise, I spoke to this very situation when I published my outlook for 2018;
“One issue that could help answer how long we might expect the fundamental data to provide support to the equity market is perception. How the investment community perceives the economic data going forward. There exists a possibility that the Macro data will under perform expectations. Why? Positive data is now the norm, it is expected. Some of the recent reports have indices at multi year highs, at some point there has to be a leveling off.
“When that does take place, it could also usher in a pause in the uptrend. The key will be to watch and see if a pause is just that, or the leading edge of a more serious issue, a downturn in growth. I always advise anyone to forget about trying to position for something like that; it can turn out to be a huge mistake. Watch, wait, then act.”
I see no reason to overreact now. Of the 30 countries which Markit reports a manufacturing PMI for, 21 declined month over month. However, let’s not jump to conclusions. It is important to keep in mind that 90% (27) of the PMI’s are above 50; in other words, the level of activity is rising almost everywhere. It’s also worth noting that only 12 of 30 Manufacturing PMI’s are down versus a year ago. So while PMI’s are starting to move lower from recent highs, they’re still indicating a relatively healthy global economy. That’s evidenced by an average reading for all 30 countries above 53. Remember any reading above 50 is considered expansionary.
Earnings Observations and Valuations
The chart posted below shows five sectors in the S&P 500 Index are trading with PEG ratios below 1.0, even the S&P 500 Index itself has a PEG less than 1.0. In July of last year, only one sector had a PEG ratio less than 1.0 and that was the Energy sector.
Ok, so the PEG ratio is not the “be all and end all’ measure, but it does provide a quick and dirty yardstick for identifying potentially under or overvalued securities. When only looking at earnings growth, vis-à-vis valuations or the P/E ratio, stocks broadly appear more attractive today than they did as recently as mid year last year. I also have noted the S&P forward P/E multiple has fallen to its lowest point since Brexit.
Factset Research weekly update;
Earnings Growth: For Q1 2018, the estimated earnings growth rate for the S&P 500 is 17.1%. If 17.1% is the actual growth rate for the quarter, it will mark the highest earnings growth since Q1 2011 (19.5%).
The estimated year-over-year revenue growth rate for Q1 2018 is 7.3%. All eleven sectors are expected to report year-over-year growth in revenues. Three sectors are predicted to report double-digit growth in revenues: Materials, Energy, and Information Technology.
Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.5. This P/E ratio is above the 5-year average (16.1) and above the 10-year average (14.3).
Of the 105 companies that have issued EPS guidance for the first quarter, 52 have issued negative EPS guidance and 53 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 50%, which is well below the 5-year average of 74%. If 53 is the final number of companies issuing positive EPS guidance for the first quarter, it will mark the highest number of S&P 500 companies issuing positive EPS guidance for a quarter since FactSet began tracking EPS guidance in Q2 2006.
The number of companies issuing positive EPS guidance in the Information Technology sector for Q1 2018 is 26, which is well above the 5-year average (11) for the sector.
The Political Scene
Stock traders woke up on Wednesday, read the headlines and hit the sell button. The U.S. announced plans for new tariffs on Chinese goods was met with a swift response from China as they announced tariffs of their own. These trade proposals may be opening salvos and are generally seen as leading to negotiations at some point. Well, that one way to look at it , the other way is to act, then put some thought into what you just did.
Friday saw a repeat of that action when it was announced that the U.S was going to look into another 100 billion in tariffs on China. That was the headline, here is the message.
Source: Chris Ciovacco
It’s always better to see the message and take in some of the details before acting. As an example, Bloomberg columnists David Fickling and Shuli Ren:
Boeing planes largely excluded from China’s tariffs.
“Details of China’s latest list of countervailing duties suggest a more moderate approach than at first glance. The duties on aircraft exclude all planes with an operating empty weight above 45 metric tons, a provision that “looks to spare every aircraft that matters”
Perhaps its better to quantify what the ENTIRE tariff situation means before making any portfolio decisions. You might be surprised what you are going to find. I suggest it will be more of what you just read regarding the Boeing situation.
The Fed and Interest Rates
Ryan Detrick, Senior Market Strategist;
“One of the bigger conundrums we have seen during this recent cycle of higher rates is how both stocks and rates can trend higher at the same time. As we illustrated in a recent Weekly Market Commentary, bond yields and stocks tend to trade together until the 10-year Treasury yield gets up around 5%. Going back to the early 1960s shows that when the 10-year Treasury yield goes higher, stocks tend to follow along. In fact, out of 23 periods of rising rates, the S&P 500 Index gained 19 of those times. Things were even more pronounced recently. Since 1996, stocks gained all 11 times we saw higher rates.”
Cut and paste that, keep it near your keyboard the next time you hear someone tell you it’s time to lighten up on stocks because of rising interest rates.
I will now add, the current period of higher rates began in September 2017 and the S&P 500 is up another 11% since then. History suggests higher rates may be a good thing and should the 10 year Treasury yield break about the critical 3% area, this could be further support for the bull market.
The Fed made clear that it remains on a gradual course. So as long as core inflation does not pick up, the Fed should not be an issue for stocks. For those obsessed with the 10 year treasury yield, I maintain it is not signaling the end of the bull market.
A recent post on twitter – April 3rd.
The AAII surveys individual investors on a weekly basis, and this week the bullish sentiment reading took a very small dip to 31.9%. At the same time, the AAII bearish sentiment ticked up very slightly to 36.64%. Given that sentiment readings are generally viewed as contrarian, it’s bullish to see more bears than bulls.
Crude Oil inventories saw a decline of 4.6 million barrels in the past week. The report also revealed that Gasoline inventories also dropped by 1.1 million barrels. The price of WTI drifted with the wind. On the days where traders thought the globe was going to stop rotating because of a potential trade war, the price of crude dropped to a fresh two week low in the $62 range. On the other days the price rallied to the $64 range. As long as the earth doesn’t stop revolving on its axis, we may see more consolidation before a run back to $70. WTI closed out the week at $62.05, down $2.86.
The Technical Picture
We take a look at the daily chart to once again review the bottoming process and a search for a low that is occurring.
Chart courtesy of FreeStockCharts.com
Notice that the index broke the 200 day moving average (pink line) this week. Contrary to popular belief, when the index closes below this level, it does not mean the long term trend has ended. The August 2015, and the January/February 2016 time frame saw the S&P seesaw below, then back above the support level numerous times. The bull market remained in place. Could this time be different? Of course, but the preponderance of evidence, suggests that this time will not be different.
This latest breach of the 200 day moving average lasted one day. A quick retake of that support was a positive development. The index went right back and tested that level (2593) on Friday, and we can’t rule out that a retest of the February lows (2533) might also be in the cards.
It is all about S&P 2553 now, Monday’s S&P low. That is THE area that I will be watching. That level held on the subsequent tests this week. For the bulls its will be important for that “higher” low to hold. First resistance is around the 2700 level. If volatility wasn’t so high I might conclude that we could be caught in a range between the 100 and 200 day moving averages. S&P 2590- 2690. However, 100 point moves on the S&P can be achieved in two days now.
Forget the noise and watch the price action, it is telling us what to do now. The analysts are telling us that the market is saying there will be a trade war, interest rates are ready to spike. I suggest if one really steps back and looks at the price action, the market is telling us something very different. It tells me this is a simple bottoming process, during a corrective period. A period that has come after we saw the S&P increase from 2135 to 2870 in a matter of 15 months.
Ii is always best to keep an open mind. In a time where fear and emotion are calling the market moves, I remain open to the possibility that the February lows may not hold. In that event it could open the door to another 5% move lower. A decline that still would not violate the Long term trend. One day, one week at a time. We watch, assess, then reassess.
Guggenheim is the latest to announce a stock market crash. They join what is now becoming a good sized marching band trumpeting the end of the bull market. Are they all going to be right ?
Individual Stocks and Sectors
What is going on with Energy stocks? The S&P 500 Energy sector has diverged from the price of oil recently. In general they haven’t performed in line with the price of crude oil. For the year WTI is up 8%, the broad based Select Energy ETF (XLE) is down 7%.
Below is a chart that highlights price trends for the Energy sector (oil stocks) versus oil. Up until the stock market correction started at the end of January, the two were tracking relatively closely. Since the correction, though, oil stock prices have sold off hard and haven’t recovered, while the price of oil has bounced back to the very top end of its 52-week range.
Major explorers and producer’s profits are now in line with what they were when oil was trading for $100 a barrel and more.
Does that mean the beaten down Energy sector is a buy? In select E&P companies with solid balance sheets and strong presence in productive areas here in the U.S., a resounding YES.
There’s just not much positive news to help balance out the daily onslaught of fear-producing headlines about trade wars and Technology crises, especially since we are still currently in between earnings seasons. That starts to change next week. We see plenty of issues that concern investors, providing fodder for the naysayer arguments. When I look around now, the one issue that has been resolved in favor of more market appreciation is the valuation argument. Ironically anyone putting together a bearish thesis now conveniently forgets to mention this issue. Why? It blows up their narrative, and trumps a lot of their negatives.
I do not believe corporate growth is peaking here. Companies are just at the beginning of loosening purse strings. So on one hand we have issues that might occur, and maybe impact the economy and the stock market. The other hand holds corporate earnings which to date have shown real improvement. They are expected to be very strong. This entire issue was put on the shelf as investors grappled with the “noise” of the day. Now it gets resurfaced. The S&P is trading at P/E multiples of 16 and 15 on 2018 and 2019 forward earnings, respectively.
Economic data here in the U.S. has changed little from the Goldilocks scenario that has supported and maintained this bull market. Furthermore, the U.S. economy is doing better by growing more slowly but with greater stability. It is also has become much more diverse over time which has reduced its dependency on any specific industry.
With all of the headlines about financial Armageddon, the S&P was off 1.3% this week. That recent price action is telling me to remain in the camp that says the risk/reward continues to be to the upside. It has to be understood that will come with frustration and will require patience. The next few months will likely contain multiple “ups and downs”, as volatility remains in place. Each bump will feel like the fundamental backdrop is at risk, and if one looks around they will again realize that the tailwinds still exist.
I will follow the advice of Shakespeare. When we view the situation looking at all of the moving parts, and formulate a plan using common sense and care, that plan is exempt from fear.
to all of the readers that contribute to this forum to make these articles a better experience for all.
Best of Luck to All !
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Additional disclosure: This article contain my views of the equity market and what positioning is comfortable for me. Of course, it is not suited for everyone, 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.