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Weekly Market Update
Sunday, March 17, 2019


Investor sentiment has recently turned positive on stocks. The SPX closed above 2815 on Friday breaking above a key level of resistance. Investors also have started to move cash into technology and semiconductor stocks. This will motivate more investors to step in and buy stocks over the next couple of weeks.

One source of uncertainty that will continue to weigh on the markets are the China/US trade agreement and the slowdown in China (and somewhat globally) that is being exacerbated by the US tariffs. The good news is that it seems that both the Trump team and Chinese officials understand that this needs to get done and they seem to be on track to finalize a deal by mid-April.

On the negative, we've been basically experiencing continued "shots across the bow" from the 13% correction in Jan 2018, a 20% correction in Nov/Dec 2018, an upward sloping 4-week new claims chart, a Fed that has decided to pause on raising interest rates, the European Central Bank that abruptly decided to pause on their monetary tightening program, an almost flat yield curve, a bad retail sales number, a negative Philly Fed reading, continued weak capital spending since Aug 2018, a new report showing increasing auto loan delinquencies, analysts' projections of negative to anemic earnings growth for Q1 and Q2 2019, and now a very weak February jobs report. With this said, deterioration of an economy is not an event, it's a process, and it takes many quarters to unfold. However, the stock market looks forward 6 to 9 months so it will become more volatile if the negative data continues to trickle in.

Once we get a China/US trade deal, we hope by mid-April, the market will probably rally for an additional 4 to 6 weeks pushing the SPX up to its Jan 2018 high of 2874, possibly up to the all time high of 2940, and the Dow up to its all-time high of 26,824.  At this point the party for the US economy and stock market will probably be over. That is, there is a very low probability that the major indices are going to break above these highs and this is when we'll need to be very nimble with our holdings and start to over weight on bearish trades.

Analysis

Below is the daily chart of the Dow Jones Industrial Average. We can see that the Dow continues to hold above the 200 day SMA and the 50 day EMA has crossed back above the 200 day SMA, which is a positive for the broad market.



Below is the daily chart of the S&P 500 index (SPX). We can see that the SPX closed above 2814 representing a major resistance level. This is a positive for the broad stock market.  If the SPX can hold above 2814 for the next week it will increase the probabilities that the SPX is now going to trade in the 2814 up to 2875 channel for the next month or two.  There is a low probability that the SPX is going to break up through the Jan 2018 high of 2875.



Below is the daily chart of the NASDAQ Composite Index representing 2550 stocks. This index is back over the 200 day SMA and it closed above 7577 representing a resistance level.



Below is the daily chart of the QQQ that represents 100 of the largest mostly technology companies. This index broke above 177.54 representing a significant resistance level.  This price action is a positive for the broad market.



Below is the S&P400 mid-cap index. This index is back below its 200 day SMA.



Below is the IWM ETF, that tracks the Russell 2000 small cap index. This index is back below its 200 day SMA.



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, increased 6,000 to 223,000. 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 300k 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 300k, historically, the economy is usually overheating and inflation becomes a problem. The 2nd chart is the 4 week average going back to 2000 showing how this indicator behaves during good times and bad. Overall, new claims have held below 300k for 210 consecutive weeks, the longest streak since 1970. This tells us that non-farm job growth should continue to exceed 150,000 per month and the labor market is classified as "tight".





Headline Retail Sales grew 0.2% in January, after plunging 1.6% in December. On the positive, after stripping out sales from auto & parts dealers, gasoline stations, building material suppliers and food services sales, core retail sales grew a solid 1.1%. Consumer spending is important because it represents 2/3rds of the US economy. Overall, it was an okay report and we'll need to wait for the February report to see if consumer spending is still strong.





The Consumer Price Index (CPI) is a measure of the prices paid for a fixed basket of goods and is a widely cited inflation indicator. Core CPI (orange line) represent the CPI less food and energy. CPI edged down to 1.5% for the 12 months ending in January, and core-CPI edged down to 2.1% for the 12 months ending in January.  Overall, based on these numbers the Fed will most likely feel comfortable in continuing to pause on raising interest rates.




Earnings & Price/Earnings Multiple:

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%. On the negative, analysts are now projecting -3.2% earnings growth for Q119 and an anemic +0.3% earnings growth for Q219.

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.

For Q417 earnings season quarter over quarter S&P500 earnings growth came in at +14.8% and sales growth at +8.2%. These results are excellent and represent the strongest growth rates since Q3 2011.

Valuation: The current 12-month forward P/E ratio for the S&P500 is 16.3x, based on a price of 2743 (SPX) and a forward 12-month EPS estimate of $168. Stocks are classified as fairly priced at a 16.3x 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). 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. We can see that implied volatility for the S&P500 (VIX) fell to 12.88, telling us that fear is back down to very low levels; this points to a market that most likely will trend higher this week.



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 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, the corporate debt markets have bounced back sending a more optimistic signal about the health of US companies and their current debt levels. On the negative, some analysts believe that high corporate debt levels will be the cause of the next crises that will push the US economy into the next recession.



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 come 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 will increase their interest expenses. Currently, the dollar has moved higher that sends a more positive signal about the prospects of the US economy.



The yield on the 10 year treasury is at 2.59%. The bond market is telling us that investors believe that the Fed will pause their interest rate hikes for most of 2019, and that the US economy will most likely slow. Unfortunately, this is flattening the yield curve, which is not a good leading indicator for the US economy, and not good for bank stocks.



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 are now pausing on raising short term interest rates. The Fed futures predicts there is a 98.7% probability that the Fed will leave short-term rates unchanged during the next FOMC meeting scheduled for March 20, 2019 and a 96.7% probability that they will leave rates unchanged during the May 1, 2019 meeting.  There is a 3.2% probability that they might cut rates during the May 1 meeting.



Performance of world markets, which ultimately affect US markets:    

Below is the iShares MSCI Europe Financials ETF (EUFN) - This ETF looks like it has found a bottom. This weakness is from an economic slowdown in Europe and because the European Central Bank was starting to tighten their monetary policy.



Below is EWG, an ETF that tracks a basket of German stocks. This ETF looks like it has found a bottom. Germany is the largest economy in the Eurozone, so it's a leading indicator for most of Western Europe. This weakness is from an economic slowdown in Europe and because the European Central Bank was starting to tighten their monetary policy.



Below is EWU, an ETF that represents a basket of stocks in the United Kingdom. This ETF looks like it has found a bottom. This weakness has been from an economic slowdown in Europe, the uncertainty around Brexit, and because the European Central Bank was starting to tighten their monetary policy.



Below is the ACWX, an ETF that represents large and mid-cap companies within mostly developed markets around the globe, less the United States. This ETF tells us that developed markets outside the US are recovering, and this positive sentiment will help drive and reinforce positive sentiment within the US markets.



Below is the EEM, an ETF that represents large companies within emerging markets around the globe. This ETF looks like it's ready to break up through 43.45, but it might take a few more weeks. Some of this weakness has been from a strong US dollar that is 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.



Below is the FXI that represents a basket of large-cap Chinese stocks. This ETF is back above 43.58. Most of this sell-off was from concerns around a weakening Chinese economy, and the trade war that has been 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 has been weak and it needs to get back above 56.



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. The Fed is on track to raise rates possibly one time in late 2019. Higher rates usually translate into higher profits for the banks, as long as the yield curve continues to have a positive slope. Currently, this ETF is weak because the yield curve is almost flat. Moreover, investors are worried about slowing loan growth, based on the assumption that the US economy will start to slow down.



Below is the daily chart of the KBE, an equally weighted ETF comprising 60 US Banks, including both regional and diversified banks. Higher interest rates usually translate into higher profits for the banks, as long as the yield curve continues to have a positive slope. Currently, this ETF is weak because the slope of the yield curve is almost flat. Moreover, investors are worried about slowing loan growth, based on the assumption that the US economy will start to slow down.



Below is the daily chart for the XLI that represents 62 industrial companies. Currently, this ETF is back over the 200 day SMA, it hit resistance at 76.68, which was somewhat expected, and it's pulling back a little to take breather.  Overall, this is a positive for the broad market, as long as it stays over the 200 day line.



Below is the daily chart for the XLY, which represents 80 companies that are classified as consumer discretionary, or "risk-on" types of companies. Currently, this ETF is back above the 200 day SMA.



Below is the daily chart of XLP, an ETF that represents 35 consumer staples suppliers, or "risk-off" types of companies. Currently, this ETF is below the 200 day SMA.



Below is the daily chart for the XLV, comprising 55 healthcare companies. Currently, this ETF is back above the 200 day SMA and 91.61 representing a major resistance level.



Transports (truck, rail, air) 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 still below the 200 day SMA, but it's back over 181.38, which is slightly positive.



Below is the daily chart for the XLE that represents 41 energy/oil companies. This ETF is holding near a major support/resistance level of 65.



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, it's taken out new highs and tells us that investors have interest in moving their cash into safe utility stocks and that they believe that interest rates will stay low.



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, it's taken out new highs and tells us that investors have interest in moving their cash into safer REIT stocks and that they believe that interest rates will stay low.



Semiconductor stocks, viewed as a leading indicator for economic growth is back up to the highs, which is a positive for the broad market.



Below is the daily chart for the XLK that represents 75 equally weighted, broad technology companies. This ETF is back above the 200 day SMA, which is a positive for the broad market.



Biotechnology is back above the 200 day SMA. Investors have had concern about how the Democrats took the House after the elections; the Democrats will start to talk about legislation to address high drug prices. Regardless, the Republicans still control the Senate, so most likely no drug related legislation will make it through both houses. Thus, this sector should start to trend upward once we get through this rough patch.



Materials hit resistance at 56.01 and remains below the 200 day SMA. The strong dollar is part of why materials have been weak because most commodities are priced in dollars. Concern about a global economic slowdown is the other reason that commodities have been weak.



Below are the economic calendars for the next 2 weeks:

Week of March 18th: The FOMC Rate Decision on Wed the 20th is closely followed and can move the markets. The probabilities are very low that they will raise interest rates.



Week of March 25th: Personal Income and Spending on Fri the 29th are closely followed.



In summary for the economic data, it's starting to get choppy as we are getting some weak surprises. The most recent February jobs report had a very weak reading, along with a weak Philly Fed reading for the first time since 2016, and another weak reading on capital spending.
Copyright © 2020 QTR Capital Management LLC, All rights reserved.


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