Weekly Market Update
Sunday, November 10, 2019
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The Fed lowered interest rates two weeks ago for the 3rd consecutive time. The Fed stated that they are done lowering rates and will now be data dependent. The market has been okay with the 25 basis point rate cut and the Fed's message that they are done lowering rates.
Q319 earnings season continues where 89% of S&P500 companies have reported. Blended earnings growth currently sits at -2.4%. If this number ends up negative it will represent the 3rd consecutive quarter of negative earnings growth. So far the stock market is okay with these results.
Stocks started to trend higher five weeks ago after Trump announced a "Phase 1" trade agreement with China. The next step is that Trump and China's President Xi are planning to meet in mid-December to possibly finalize the Phase 1 agreement. Investors have been buying stocks in anticipation of a positive outcome of the upcoming meeting. The SPX, NASDAQ Composite and QQQ indexes have broken out to new all time highs.
In general, the economy is in decent shape growing at +1.8%, inflation and interest rates are low, employment is strong, the US consumer is strong and continues to spend, the Fed is dovish and recently lowered interest rates for the 3rd time, and corporate earnings growth has been acceptable to investors coming in with flattish growth mostly beating expectations.
On the negative, the manufacturing side of the US economy that represents about 15% of total GDP output has been weakening and probably is starting to contract based on the last two negative ISM manufacturing reports.
On the positive, the services sector that represents 75% of US total GDP output continues to expand.
On the risk/potential to the upside, the SPX, NASDAQ Composite and QQQ indexes have broken out to new all time highs. Because the SPX has held above its breakout level of 3025 for two consecutive weeks, and that the other indexes have also broken out, it increases the probabilities that the SPX will continue to trend higher with the next target of 3100, with a possible quick pause, and then up to 3160.
On the risk to the downside, in the event that the market sells-off again, the first potential level of support for the SPX is the breakout level of 3025; if this level fails then the next level down is 3000 representing a round number and the 50 day EMA; if this level fails, then there is a high probability that the SPX will hold above 2945 representing the Oct 2018 high.
For the directional stock strategies https://upsideoptions.net/strategies/ we paused in opening any short/hedge positions as some of the breadth indicators where telling us that this market was most likely going higher. Once the SPX touches its next target of 3160 we plan to open some options-based short positions on the SPY ETF. Once the SPX hits 3160 the forward P/E ratio will be 18.0x and this is getting expensive.
For our short positions we do this in a unique way where we can keep the cost of the short positions very cheap, if not free, allowing us to keep them open continuously. Each time the market sells-off -3.5% or more the short trades will typically double in value generating a 10% return for the overall portfolio. For a video on how we do this please go to the following link: https://youtu.be/Hi0Sq9mNQgI The short positions should allow our stock strategies to nicely outperform over the next 6 to 9 months as this market continues to experience spasms of elevated volatility.
For the non-directional, income generating Pinnacle strategy, it booked a 6.8% realized return for the month of October. This strategy sits at a +41.3% realized return YTD after commissions. All returns can be verified as we send the trades to 3 separate brokers for autotrading. Pinnacle is a conservative implementation where allocate only 30% to 40% of the cash to trades, providing sufficient reserve cash in the accounts to maneuver through periods of high volatility. Capital preservation and safety are a top priority. For more on the Pinnacle track record please go to https://upsideoptions.net/iron-condor-roi.
Below is the daily chart of the Dow Jones Industrial Average Index. We can see that the Dow broke above 27,357 to a new all time high, which is bullish for the broad market. The next positive milestone is if it can hold above this level for two consecutive weeks.
Below is the daily chart of the S&P500 index, SPX. We can see that the SPX broke out to a new all time high where it has held above this level for two weeks. This increases the probability that it's going to continue to trend higher, with a possible temporary pause near 3100, and the next upside target of 3160.
Below is the daily chart of the NASDAQ Composite Index representing 3300 stocks. We can see that this index broke out to a new all time high, which is bullish for the broad market.
Below is the daily chart of the NYSE Composite index that represents 1900 stocks. We can see that this index broke above 13,246, which is bullish for the broad market.
Below is the daily chart of the QQQs that represents 100 of the largest mostly technology companies. We can see that this index broke out to a new all time high and continues to trend higher, which is bullish for the broad market.
Below is the S&P400 mid-cap index. This index is back up to 1996 representing the Jan 2018 high, which is constructive for the broad market.
Below is the IWM ETF that tracks the Russell 2000 small-cap index. This index is back up to 160, which is constructive for the broad market. The next bullish milestone is if it can break above 160.
Macro-Level, Fundamental View of US Economy's Underlying Health
Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy. If/when the US economy begins to weaken per deteriorating macroeconomic indicators and corporate earnings, along with increasing stair-step volatility, this information will alert us to: 1) Incrementally reduce our downside exposure, and be more careful and wait for key economic data before opening additional bullish trades; 2) Alert us to increase exposure levels to bearish trades; 3) Tell us when it's time to move to the sidelines.
Initial Unemployment Claims, a weekly report that measures the rate of people being fired from their jobs, decreased 8,000 to 211,000. When initial unemployment claims drop below 400k it's classified to be in the "recovery zone" and the economy will usually add +100k jobs monthly. When new claims are near 350k we'll usually see 150k+ new jobs monthly; when it's near 325k it usually represents strong job growth and a healthy economy that is expanding at a GDP growth rate of 3.5% to 4.0%, historically. When new claims drop below 290k, historically, the economy is usually overheating and inflation becomes a problem. The 2nd chart is the 4 week average going back to 2001 showing how this indicator behaves during good times and bad. Overall, new claims have held below 300k for 244 consecutive weeks, the longest streak since 1969. This tells us that the labor market remains tight and that employers are reluctant to let go employees.
Earnings & Price/Earnings Multiple:
The ISM Non-Manufacturing Index that measures consumer oriented services activity across the US increased to 54.7 in October, from 52.6 in September. Any reading above 50 represents expansion. Consumer oriented services represents 75% of the US economy. Overall, it was an okay report as it's still above 50, but it has been declining telling us that this sector is weakening.
Below is the GDPNow "nowcasting" model provided by the Federal Reserve Bank of Atlanta, and uses a methodology similar to the one used by the U.S. Bureau of Economic Analysis. It is best viewed as a running estimate of real GDP growth based on available data for the current measured quarter and is updated in real time as economic data becomes available. The Atlanta Fed has a good reputation in providing some of the most accurate economic forecasting models. Currently, the model estimate for real GDP growth (seasonally adjusted annual rate) in the 4th quarter of 2019 is 1.0 percent as of Nov 8, 2019, which is below consensus of 1.8% from economists and analysts.
Below is the Citigroup Economic Surprise Index where it has been deteriorating over the last 18 months. Recently it has been rebounding. In general, it tells us that the economic data has been surprising analysts to the downside over the last 18 months.
Overall, the economic data for the US has been gradually deteriorating, other than the jobs market and consumer spending that remain strong. Moreover, global growth has been slowing and this is what caught the attention of the Fed as they decided to lower interest rates for the 3rd time during their FOMC meeting two weeks ago. The gradual deterioration of the US data can be seen through the Citibank Economic Surprise index as it's been negative for the last 18 months; but it recently has been rebounding. On the positive, it looks like Trump is trying to put the trade war behind him, and the Fed is dovish reducing rates three times over the last 6 months. The stock market is anticipating better future economic data by breaking out to new all time highs.
Q319 earnings season continues where 89% of S&P500 companies have reported. Blended earnings growth currently sits at -2.4%. If this number ends up negative it will represent the 3rd consecutive quarter with negative earnings growth. With this said, the stock market is okay with these results and investors have been moving cash back into stocks.
Q219 earnings season is complete. Earnings growth came in at -0.4%, and revenue growth came in at +4.0%. This represents the 2nd consecutive quarter with negative earnings growth.
Q119 earnings season is complete. Earnings growth came in at -0.4%, which was better than the -4.8% expected decline that was estimated by analysts. Revenue growth came in at +5.3%, which was good. With this said, corporate earnings are again expected to experience zero to slightly negative growth for Q2, and earnings growth is what ultimately drives stock prices.
Q418 earnings season is complete. Earnings growth came in at +13.1%, which is slower than in the last couple of quarters, but it's still a strong number; and revenue growth came in at +5.8%.
For Q318 earnings season the S&P500 companies reported earnings growth of +25.9%, and revenue growth at +9.3%, both which are excellent results and the strongest readings since Q3 2010.
For Q218 earnings season the S&P500 companies reported earnings growth of +24.5% and revenue growth of +9.8%, which represents very strong growth.
For Q118 earnings season the growth rate of the S&P500 companies came in at +24.6% and sales growth at +8.5%, which are excellent results and the strongest growth rates since Q3 2010.
Valuation: The current 12-month forward P/E ratio for the S&P500 is 17.7x, based on a price of 3090 (SPX) and a forward 12-month EPS estimate of $175. Stocks are classified as expensive at a 17.7x multiple. Historical P/E averages for the S&P500 are the following: 5-year (13.6), 10-year (14.1), and 15-year (16.1). However, because interest rates are low, such as the 10 year treasury at 1.7%, P/E ratios could/should trade at higher levels. Per past highs, one data point to ponder is that the S&P 500 forward P/E peaked at 21x forward earnings in March 2000, just before the dot.com crash and recession.
Volatility: Below is the VIX fear gauge that declined to 12.1. Volatility (fear) is very low and barring any external shocks in the next week or two stocks will most likely continue to move higher.
Performance of the credit markets, known as the "smart money", which usually has a good track record of predicting the future direction of the stock market:
Below is a chart of the iShares high yield corporate bond ETF, HYG. High yield corporate bonds, also called junk bonds with a grade of BBB or lower, are a proxy for investor appetite for risk. When HYG declines it represents "credit stress" in the corporate debt markets and sends a "risk-off" signal that will eventually weigh on equities. When this index falls it's telling us that corporate bond investors are requiring higher interest rates on the bonds that companies are issuing. That is, investors believe there is more risk with companies defaulting on their debt, so they demand higher interest rates to compensate for the added risk. Currently, HYG is holding steady and looks okay telling us there is no credit stress in the high yield bond sector. On the negative, some analysts believe that high corporate debt levels will exacerbate the next recession when it eventually hits, which could be late 2020 at the earliest.
Below is the iShares iBoxx Investment Grade Corporate Bond ETF - LQD, which represents investment grade corporate bonds with a quality rating of BB or higher. Currently, LQD is pulling back from a technical overbought condition, but still looks okay. As long as LQD holds above 124.5 it tells us that investors feel comfortable with the risk of default for the companies that issue investment grade corporate debt. Investors have been moving cash into these "safer" corporate bonds to get higher yields for most of 2019. However, if cash continues to rotate into stocks then cash will come out of LQD and this could go lower.
Below is the UUP that tracks the relative performance of the US dollar to a basket of currencies. In general, a strong dollar is a positive for US equities, as long as it doesn't get too strong. If it gets too strong it will impact the big-cap, multi-national companies because 35% of their revenue typically comes from outside the US, and a strong dollar makes their goods more expensive and less competitive outside the US. For emerging economies that have borrowed heavily in dollar denominated debt, a stronger dollar is a negative because it increases their interest expenses. Currently, the dollar is holding steady and has paused, which is good for stocks, especially the large caps. One reason the dollar has been strong is that investors from around the world have been buying dollars to buy US treasuries to get a high yield, compared to negative yields offered by Germany.
The yield on the 10 year treasury is back up to 1.93%. Bonds/treasuries represent the "smart money" and it's has been predicting a slowdown in the US economy over the next 6 to 9 months. However, if TNX can break above the Sep 2017 low of 2.04% this will tell us that bond investors are becoming less concerned with the health of the US economy.
Posture of the Federal Reserve on Monetary Policy - The Fed made a 180 degree pivot in January 2019 and went back to a dovish stance where they decided to pause on raising short term interest rates. The Fed then lowered interest rates by 25 basis points in July, 25 basis points in September, and a final 25 basis points in October. The Fed sent the message that they are mostly done lowering rates and are now data dependent. Currently, the Fed funds futures predicts there is a 3.7% probability that the Fed will lower rates again during the December meeting, and the stock market is okay with this.
The Cass Freight Index represents monthly levels of shipment activity, in terms of volume of shipments and expenditures for freight shipments. This analysis is based on the notion that the movement of tangible goods is the heartbeat of the economy, and that tracking the volume and velocity of those goods has proven to be a reliable method of predicting change in the economy. Currently, this index has been negative on a YoY basis for the ninth month in a row. The Cass analysts are concerned about the rate of deterioration and believe that the US is close to moving into contraction.
Performance of world markets, which ultimately affect US markets:
Below is the iShares MSCI Europe Financials ETF (EUFN) - This ETF is back above the 200 day SMA, which is constructive. The weakness over the last year has been from an economic slowdown in Europe. Some of the recent weakness is from the Trade war and Trump's threat that they will impose tariffs on European products such as autos.
Below is EWG, an ETF that tracks a basket of large German stocks. This ETF is back above its 200 day SMA and up to 28.98, which is constructive for Europe. Germany is the largest economy in the Eurozone, so it's a leading indicator for most of Western Europe. The weakness over the last year has been from an economic slowdown in Germany where their economy is actually contracting now.
Below is EWU, an ETF that represents a basket of stocks in the United Kingdom. This ETF is back over the 200 day SMA. The weakness over the last year has been from an economic slowdown in Europe, uncertainty around Brexit, and Trump's threat that they will impose tariffs on European products.
Below is the ACWX, an ETF that represents large companies within mostly developed markets around the globe, less the United States. This ETF is back up to 48.30, which is constructive for worldwide equities.
Below is the EEM, an ETF that represents large companies within emerging markets around the globe. Some of the weakness in late 2018 was from a strong US dollar that was making interest payments higher for the countries that have dollar denominated debt. Also, a strong dollar puts downward price pressure on commodities, which negatively impacts emerging economies because many rely on commodity exports. Recently, the dollar is weakening a little, so this is a positive for this index.
Below is the FXI that represents a basket of large-cap Chinese stocks. This ETF is back above the 200 day SMA after an announcement of the Phase 1 trade deal. Most of the sell-off in late 2018 was from concerns around a weakening Chinese economy, and the trade war that was exacerbating the weakness in their economy. A big concern, in general, for China is if they will be forced to devalue their currency. Most likely the answer is "yes", since China's debt currently sits at 250% of GDP. ($30 trillion of debt for a $12 trillion economy) This level of debt is not sustainable and it will eventually collapse from its own weight, and probably cause the next global recession. But, it could take many years for this to eventually happen.
Below is the EWJ that represents a basket of Japanese stocks. This ETF is almost back up to 60.9, which is a major move.
Performance of certain US sectors, which provides insight into the future direction of US markets (i.e. sector rotation analysis):
Below is the daily chart for the XLF that represents 81 US financial companies. Currently, this index is back up to the Jan 2018 high of 30.2, which is bullish for the broad market. JPMorgan was the first bank to break out to an all time high, and this has been pulling investors into the banks and financials.
Below is the daily chart of the KBE, an equally weighted ETF comprising 60 US Banks, including both regional and diversified banks. This index is back over 45.72, which is constructive for the broad market. JPMorgan was the first bank to break out to an all time high, and this has been pulling investors into the banks.
Below is the daily chart for the XLI that represents 62 industrial companies. Currently, this ETF broke out above 80.14, which is bullish for the broad market.
Below is the daily chart for the XLY that represents 80 companies that are classified as consumer discretionary, or "risk-on" types of companies. Currently, this ETF is above the breakout level of 117.83, which is constructive for the broad market. However, we see downward sloping lower highs trend line, as drawn. If this index can take out an all time higher-high, then it will confirm & reinforce the bullishness of the broad market.
Below is the daily chart of XLP, an ETF that represents 35 consumer staples suppliers, or "risk-off" defensive companies. Currently, this ETF is above the breakout level of 58.77. However, most of these stocks in this sector are getting very expensive, and it looks like some cash is flowing out of this sector. With cash flowing out of this defensive sector, it's actually a bullish sign for the broad market.
Below is the daily chart for the XLV, comprising 55 healthcare companies and it recently rallied. Healthcare stocks in general have a lot of policy risk, as the Democrats are making noise about expanded Medicare for all, eliminating private health care insurance companies, and efforts to lower drug prices. This sector could struggle all the way through the 2020 elections. With this said, certain sub-sectors within this ETF have been working well.
Below is the daily chart of the IYT for the transports (truck, rail, air) that are an important leading indicator for the general health of the US economy and usually needs to be strong to confirm/validate any broad rally in stocks. Currently, this ETF is back up to 199.62, which is constructive for the broad market.
Below is the daily chart for the XLE that represents 41 energy/oil companies. This ETF is below the major support level of 64.5 and the 200 day SMA is downward sloping, so it's bearish. It's still pricing in a possible global recession..
Below is the daily chart for the XLU that represents 30 electric, gas and alternative energy utility companies. Utilities are classified as a safe haven and cash will typically flow into utilities if investors believe that interest rates will stay low. Currently, this sector is rolling over because treasury interest rates recently started to climb. Thus, some investors are booking their profits and moving the cash into stocks. Utility stocks also got expensive and overbought.
Below is the daily chart for the IYR that represents a basket of real estate investment trusts, REITs. REITs are classified as a safe haven and cash will typically flow into REITs if investors believe that interest rates will stay low. Currently, this sector is rolling over because treasury interest rates recently started to climb. Thus, some investors are booking their profits and moving the cash into stocks. REITs also got expensive and overbought.
Below is the daily chart of the SMH that represents the semiconductor stocks, viewed as a leading indicator for economic growth. Currently, this ETF broke out to a new high, which is bullish for the broad market.
Below is the daily chart for the RYT that is an equally weighted ETF that represents technology companies within the S&P500 index. Currently, this ETF is back above 181.6, which is bullish for the broad market.
Biotechnology (XBI) is back up to its 200 day SMA, which is constructive, and some stocks in this sector are breaking out. However, the talk on capital hill by mostly the Democrats about high drug prices and rolling out expanded Medicare could keep these stocks on edge. With this said, the Republicans still control the Senate, so most likely no drug related legislation will make it through both houses. Regardless, there is a lot of policy risk around healthcare and pharma stocks since the Democrats took control of the House. These stocks might be un-investable until we get through the 2020 elections, and the current chart reinforces this thesis.
Materials (XLB) is back above 58.15. The US dollar has weakened a little, and this has boosted commodity prices. Because most commodities are priced in dollars a weaker dollar will boost commodity prices.
Below are the economic calendars for the next 2 weeks:
Week of Nov 11th: Retail Sales on Friday the 15th is closely followed.
Week of Nov 18th: It's a quiet week for economic data.
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