2018 Year-End Letter, Part 3, Sectors: Steep Corrections During Expansions

To put it mildly, the setup going into 2018 was remarkably good. Our PWA Macro Index was scoring near its all time high, with 84% of the data trending positive, only 4% negative and 12% neutral. Again, remarkable!

Well, as we preach herein incessantly, anything can happen in the market. And, my, how anything did in 2018!

On This Morning's Bounce -- And -- Climbing a Wall of Worry??

On the one hand, this morning's bounce makes sense, and the headlines are for sure accurately assessing the cause; The President's Saturday tweet that U.S./China talks are going very well. On the other, a mere ("mere" in light of how hugely positive an end to the trade war would be for economic [and market] prospects going forward) 200-point pop in the Dow, it then meandering above and below that level for the first hour of trading (up 150 as I type), speaks to how legitimately suspicious market players are about the likelihood of a deal in 60 days, and, I suspect, speaks also to concerns over Fed Chair Jerome Powell and what he might hint this Friday -- not to mention to the uncertainty of other political wranglings galore.

Next Week Will Be Interesting

Next week will be interesting, start to finish.

For starters, here's this morning's headline:

This Week's Message: Trader Vs Investor Mentality (video)

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust: 

Machinations of opportune traders...

Our live S&P 500 chart, which is on the screen to my immediate left, just caught my eye. While I can't tell you what it is, I can assure you that a bit of news tripped some switches a few minutes ago (red arrow below):

PWA 2018 Year-End Letter, Part 2: General Conditions and The Technical Setup

Now I did subtitle my September 10 blog post  "Expect a Rough Patch", although I'm certainly not here to say "I told you so".

While that message may have seemed prescient (as the market hit its peak for the year a mere 10 calendar days later), I definitely was not anticipating that by late December we'd be sitting on levels that make this particular "correction" the worst of the present bull market.

Like I Said...

Like I said in last evening's post:

"...make no mistake folks, we are in a most volatile, headline-sensitive environment. Expect more monster moves in both directions for the time being..."

Well, Dow futures tanked to the tune of nearly 400 points last night when the following headline hit:

Quick note on today's action...

If you're wondering if today was simply more of the same algo-driven (to some extent) trading, just in the opposite direction of what we've seen of late, well... could be.

In fact that's how the day began: After a nice 280-point Dow move in the morning, sellers promptly jumped on the opportunity to send the major averages into negative territory. Then, the typical of late battle ensued, offering no reason to believe that once again the bears weren't going to take it to the bulls.

Time Is Of The Essence!

While there are indeed other festering issues in play, the following -- which is the close to our forthcoming commentary on general conditions in our year-end letter -- speaks to what we see as the central issue, and (in the last paragraph) what is necessary if the current rout is going to be merely what amounts to a steep correction (a pause, so to speak), as conditions presently dictate, or something worse. In other words, while those other festering issues could morph into serious market headwinds, they pale in comparison to the long-term structural damage that a protracted trade war would inflict:

PWA 2018 Year-End Letter, Part 1: What Makes Us Tick

I'll begin 2018's year-end letter as I did 2017's, with a brief synopsis of how we operate here at PWA.

For starters, here are what we believe to be the essential characteristics of the best money managers:

Today's Action, And More On Current Conditions (video)

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust: 

Log Entry: The Gift That Keeps on Giving

12/24/18 Monday

The market picked up where it left off this morning with a 400-pt Dow decline near the open; that was to be expected. Stocks are presently 100% at the mercy of short-term swing traders who are playing the headlines along with the intraday support and resistance levels.

Dad

When our family gathers at our home, Judy always sets the head of the table for Dad. You clients know him as Len; the proud, friendly elderly gentleman who, if you were so fortunate as to cross his path while in our office, well... you know what I mean by friendly, and boy do you know what I mean by proud! Our staff affectionately call him Dad, or, in the case of two, Granddad.

This Week's Message: Bull Market In Tatters

If you had told me at the beginning of this year that come year-end we'd be within a stone's throw of the deepest correction of the current bull market, while I would have told you that anything's possible, and that corrections are common affairs, I'd be surprised (by anything other than your garden variety -10% to -12%), based on the state of general conditions at the time. 

Well, here we are, a stone's throw from something along the lines of 2011 and, yes, I'm surprised. Although I did state emphatically at the beginning of the year -- and many times since -- that the one thing that would put my then bullish thesis to the test would be protectionism (read trade war). 

While I recognize that other concerning factors are currently in play, I guess I'm just surprised that the trade issue has been allowed to get this far. 

So here we are, trade war (etc.) intact, bull market in tatters! Now what do we do?

Well, we step back, we breath, we turn off the media and we reassess general conditions. 

We are forever in search of the signs and signals that say "warning! Recession ahead!" As, typically, bear markets are things of recessions. 

So how do we do that? We do that by testing the data that matter against the periods that led up to past recessions. And as we perform that function here today, the character of the data on balance (per our proprietary macro index) does not yet signal recession, and remains notably more positive than it was during the whopping 2011 correction, and slightly better than the 12+% draw down of early 2016, yet somewhat worse than conditions during the 2015 correction.

Here's a small sampling of the data we track (shaded areas are recessions, I circled the areas around the 2011 correction and the back-to-back corrections of 2015 and 2016). I of course cherry-picked examples that emphasize my point, and those that most folks are familiar with and/or can relate to:

First, here's the S&P 500 Index itself:   click charts to enlarge...



Yes, right now the present price action in stocks rivals the worst of what we've seen since the last bear market.

But take a look at retail sales:



Online sales (purple) haven't missed a beat since the last recession, although, as you can see, brick and mortar (white) has definitely had its ups and downs. Presently, however, it remains in a definable up trend. Nevertheless, we currently score it neutral, as it has yet to make a higher high after the last dip. That said, its trajectory looks notably better than it did during the past three corrections, let alone the periods leading into the past two recessions.

For the rest I'll simply throw up each chart and let you judge whether or not the data should have us running for the exits.

Weekly Jobless Claims:



Unemployment Rate:



Job Openings:



Consumer Confidence:



Institute for Supply Management Purchasing Manager Surveys (manufacturing purple, services yellow):



Small Business Optimism:



Industrial Production:



Truck Tonnage



Rail Traffic



As you no doubt noted in the above, as it relates to the featured charts, present conditions do not remotely resemble recessions past, or even the 2011 and 2016 market corrections. 

As for the remaining data we follow (which include indicators of credit risk, commodities trends, financial market conditions, etc.), and score, while we've seen marked deterioration since the beginning of the year, the overall result still has odds favoring continued expansion (and, thus, bull market) over recession (and a protracted bear market) for the foreseeable future: Our index presently scores +20, versus +8 during the 2011 correction, +29 in 2015 and +18 at the bottom of the 2016 correction. As for the past two bear markets, the back tests scored -29 at the 2000 market peak, and -33 at the 2007 S&P 500 all time high.

In summary, our assessment of the present state of stock market affairs is that the price action deviates from the underlying fundamentals. Of course the question here would be, will the price action ultimately reverse and reflect present fundamentals, or will the fundamentals ultimately roll over and reflect the action (the message?) in stock prices?

History suggests that this -- a correction amid an ongoing economic expansion -- is the stuff strong rallies are made of. And we've seen albeit minor hints recently of what might be in store -- such as Wednesday's initial, and extremely short lived, 400-Dow point surge in reaction to the Fed decision, and Friday's 400-point pop on Fed governor Williams dovish commentary. Not to mention the +1,500-point week we had leading into the President's untimely, and rally-killing, "I'm a Tariff Man" tweet. 

The sentiment expressed in the latter, as I stated at the top of this message (and for months now), is in my view the central issue that explains the utter mess the market finds itself in. 

Not to discount other pressing issues -- government shutdown, the shocking James Mattis resignation, Fed rate hikes, and so on -- but if the trade war makes its way too far into the not too distant future (which, thankfully!, would be a political nightmare [read incentive] for the players), I suspect that we'll ultimately be staring down some ugly looking charts and a negative score for our index: A scenario that will have us committedly moving to a defensive posture within client portfolios sooner, alas, than we otherwise would have. 

In the meantime, as nerve wracking as it may be, we stay the course. Although, having said that, we are now readying ourselves to begin getting incrementally defensive should conditions deteriorate further from here. 

If, in your case (if you're our client), us moving incrementally to a defensive posture if the data further deteriorate is an uncomfortable proposition (i.e., not careful enough under present circumstances); i.e., if you can relate to the highlighted portion of the following, call me right away. My cell number is 559-313-3612...

My 10/25/18 post:

The "Best" Move

Had a nice email conversation with a dear old friend yesterday. One of the questions he asked me was if, in light of the huge hit to recent paper profits, I saw any point in exiting the market with what recent (let's assume he means that which was accumulated in the latter half of last year) profit is left, "even for yourself"?

Here's from my response to that question:

".... nope, with general conditions not pointing to a recession I'm holding tight with my long-term money. I never let volatility shake me up, I only (other than tweaking sector weights) adjust when general (economic, etc.) conditions suggest that a contraction going forward is more likely than a continued expansion, which isn't the case currently. When general conditions remain constructive, pullbacks should typically be bought, not sold (I make no guarantees, however)." 

"All that said my friend, as we've discussed before, in my view this stuff isn't worth losing sleep over. A few times over the years (can count them on one hand) I have suggested that a client sell at a time when I did not feel it was the best investment move, but rather when it was the best emotional move... which is most important in my view...."

I left him with this Jesse Livermore quote:

"That is about all I have learned—to study general conditions, to take a position and stick to it. I can wait without a twinge of impatience. I can see a setback without being shaken, knowing that it is only temporary. I have been short one hundred thousand shares and I have seen a big rally coming. I have figured—and figured correctly—that such a rally as I felt was inevitable, and even wholesome, would make a difference of one million dollars in my paper profits. And I nevertheless have stood pat and seen half my paper profit wiped out, without once considering the advisability of covering my shorts to put them out again on the rally. I knew that if I did I might lose my position and with it the certainty of a big killing. It is the big swing that makes the big money for you."

Ah....

While I did suggest in an earlier post that we should not hold our breath on this morning's 400-point rally (inspired by dovish Fed commentary), I wasn't expecting quite an 800-point decline from that level (Dow closed down 414). 

Clear Assessment of Immediate Conditions

I mentioned the other day that the market is presently at the mercy of traders and their algorithms. To help you put this moment into its proper perspective, here's a clear assessment of immediate conditions directly from where that occurs.

 

Clearly, this seeming craziness is not yet about investment fundamentals... Otherwise there'd be no talk of buyers coming back after the beginning of the year.

Next week, alas -- barring a catalyst -- could be every bit as ugly; which at this juncture would be meaningless in terms of general conditions...

Conditions Necessary For This To Morph Into A Protracted Bear Market

At this juncture, for the current decline to end up being more than a steep correction in an ongoing bull market there’d have to be a willingness on the parts of Trump and Xi to together bring on the next global recession. And, in Trump’s case (Xi is president for life), to see his political career end in the most unflattering fashion (yes, recessions murder political careers).

Quick Note on This Morning's Action: Don't you dare hold your breath!

Fed governor Williams sounded a dovish tune in a CNBC interview this morning; essentially stating what the market wanted Powell to state on Wednesday -- that the Fed is listening to the market and stands ready to adjust policy if conditions do deteriorate heading into 2019.

Quote of the Day: Logical Optimism (and the silver lining to Wednesday's Fed move)

The underlying data (slowing growth, yet still low recession risk) makes, per the following, for some upside risk for the market heading into 2019 (no guarantees of course):

"Global stocks, as proxied by the MSCI World Index, are heading for their worst December on record. The dollar is also set for its biggest December loss against the euro since 2015. Some investors, including UBS, drew a parallel to the 2015-2016 episode when the Fed wasn't early enough to identify risks of tightened financial conditions. That later forced the Fed to take a long pause on rates. That similar inflection point has probably arrived. If that happens, risk assets including stocks should have decent room for gains. After all, key data are not pointing to an imminent recession."

Anchalee Worrachate Markets Reporter

I would add that an early-year alleviation of the U.S./China issue would be hugely bullish -- in fact absolutely necessary if the bull market is to continue -- as well. 

Ironically, the market's disappointment over the Fed's move on Wednesday contains an all important silver lining: it increases the incentive for a trade deal -- which would essentially establish a markedly more bullish setup going forward: I.e., renewed optimism resulting from a trade truce will be met with a more accommodative Fed. That's a compelling recipe for higher stock prices... We'll see...

Quick note on this morning's action...

In case you're wondering, the market this morning was flirting with gains until the headline hit that the President is likely to do a 180 and now veto a stopgap measure that would keep the government open at the end of this week.

"Irrational Despondence"

Bloomberg Market's Cameron Crise nailed my view of how this year has played out (my emphasis in the last two paragraph captures the essence of what you've been reading all year on this blog):

Should We -- At This Juncture -- Trust the Market's Message? (video commentary)

Per the close to this evening's video, the stock market can send ominous signals about the prospects for general conditions going forward, but reacting to that sentiment in the face of an albeit slower ongoing expansion can be quite dangerous:

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust: 

Fed Blues

Well, so much for odds favoring a sustainable rally this morning.

On the announcement of a .25% rate hike and potentially 2, instead of 3 or 4, hikes next year the Dow shot from around 300 points higher to nearly 400 points higher.

As the statement was digested, however, the rally quickly evaporated. For a brief stretch thereafter the market turned around, trading nicely higher leading into Chairman Powel’s press conference, where he proceeded to literally tank it with his commentary. The sharp selloff began when he suggested that the Fed has no plans to curtail its current $50 billion a month rolloff of its balance sheet.

Today's Log Entry

Thought I'd share this morning's entry to our market journal (where I essentially record my thoughts on the current state of general conditions). This morning I pretty much, in brief fashion, touched on the main global issues of the moment:

Brief Commentary on Today's Action, And the Fed (video)

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Quote of the Day: What's Ailing The Global Economy

For good reason, Fed Ex's business results are considered a barometer for the global economy. Therefore, CEO Frederick Smith's comments from last night, where he lowered the company's 2019 earnings guidance, is something we should not take lightly.

Within The Range of Probabilities

I know how present conditions seem like the definition of uncertainty, but, as a friendly reminder, here's what we said back on September 29th (just off of this year's peak) about the then coming weeks:

Quote of the Day: Data Dependent

I couldn't agree more with Bloomberg Market's Anchalee Worrachate this morning. In fact, it basically sums up how we approach the investment process (i.e., data dependent):

Read Between the Lines

While this is simply an observation, not a complaint, as the media is what it is, I never cease to be amazed at how the media can spin a headline to incite angst. Yep, angst sells!

Quote of the Day: Yet Another Sign???

The major averages had just struggled their way to the plus column on the morning when this headline hit the tape:

Chart of the Day: Again, Bearishness Can Be Bullish

Bespoke Investment Group echoes (with the data) what we've been saying herein about how bearishness among individual investors like we're seeing presently can be a bullish indicator:   emphasis mine... (and don't forget to watch this morning's video commentary)

A Quick Look at This Morning's Action, And The Characteristics of Market Bottoms (video)

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Bonus Chart of the Day

Each week I track the Commodity Futures Trading Commission's (CFTC) Commitment of Traders (COT) reports, across currencies, commodities and financial markets to get a feel for what some of the world's most sophisticated traders think of the near-term prospects for various asset classes.

Chart of the Day: How Bad Is It So Far? Comparatively speaking...

"Recency bias" often has us seeing present circumstances as somehow more impacting than similar occurrences in the past. The present correction being no exception.

This Week's Message: Why We Remain Growthy

Question: Why, with all of this volatility, aren't we moving client portfolios to a defensively biased allocation?

Bonus Quote of the Day

According to Bloomberg's Michael Regan, Johnson and Johnson's specific woes -- as well as maybe triggered electronic sell programs -- are notably contributing to today's decline in the major averages:

Quotes of the Day: Yet Another Source of Volatility

While the headlines this morning suggest that today's rout is all about global growth fears, there can be little doubt that the legal issues facing President Trump are yet another contributor to market volatility. 

Quick note on current conditions...

As I type, Dow futures are pointing to a 220-point hit at the open. Headlines credit weak data out of China overnight, followed by weakening sentiment readings out of Europe.

Of course this weakening of conditions comes as no surprise to you (regular blog-reader), as that, as we've been preaching since the very beginning of this year (before, actually), is an unavoidable condition/consequence of the uncertainty fostered by any threat of a protracted trade war between the world's two largest economy.

Quick Note on Present Conditions: A Market in Limbo

As I type the Dow and the S&P 500 are barely clinging to gains this morning, while the Nasdaq Comp is down .27%.

As we've stated multiple times herein over the past few months, current  macro conditions do not allow us (so to speak) to move to a markedly defensive posture within client portfolios -- despite the presently heightened level of downside volatility. In other words, general conditions suggest that stock price action presently deviates from fundamental reality.

Brief Note On This Morning's Action

As I type, Dow futures are, once again, pointing to a 300+ point jump at the open. While the Charlie Brown risk is still huge, there is -- at this very early point in the trading day -- a hint that the headline support may be a bit better in the near-term.

Bonus, And Untimely, Quote of the Day

The market is sending a clear signal (as this morning's 470 point Dow decline [+370 to -100] attests) that the time for public browbeating is over, and that serious negotiations that lead to a lasting solution need to begin.

Quote of the Day: EXACTLY!

Institutional investor hall of famer Richard Bernstein, in a CNBC  interview this morning, perfectly echoes what we've been preaching here on the blog:

Quick Note On This Morning's Action: Legit or Lucy?

Dow's up 300+ as I type on news that China is considering lowering its tariff on U.S. made automobiles from 40% to 15%.

Video Commentary: A Brief Look At Today's Action

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust: 

Data of the Day

So here's the thing about this idea that we should coerce U.S. and foreign companies to "bring those jobs to America". America doesn't need them, literally! We currently have 1 million more job openings than we have people seeking work to fill them. 

Quote of the Day

There's clearly concern factored into Japan's latest GDP number, yet there's optimism in the expectations captured by the surveys. Bespoke's assessment below speaks directly to my view of the potential of, and the risks to, the global economy going forward:  emphasis mine...

Quick Note on This Morning's Action

Dow's down nearly 500 points as I type. The session this morning has been all over the place. At one point the Dow was up high double digits, then meandered its way lower, accelerating the minute Britain's Teresa May began addressing parliament on her latest Brexit maneuvers.

A Deeper Dive Into Current Conditions and the Longer-term Setup (video)

If you haven't already, be sure to read this week's message posted yesterday. This morning's video takes you on a deeper dive into current conditions and the general long-term setup:

This Week's Message: Crazy Market

I'm thinking the below, from my response this morning (edited for your reading pleasure) to a client's email with the subject line "Crazy Market", could be instructive (particularly the last two paragraphs) to those of you who may be feeling (literally) the latest volatility:

Video Commentary: A Look At Today's Action

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A Chart To Go With Our Quote of the Day

This goes with our earlier Quote of the Day:

Best Headline in Months

Best, most promising, newsflash I've seen in months:

"President Donald Trump has been consulting with his advisors to see if his trade policies are responsible for the volatility that has hammered markets in recent weeks, according to The Wall Street Journal."

I'm certain that, hopefully among others, Mnuchin and Kudlow are confirming the President's fears. Navarro, on the other hand, has made a career out of being clueless on trade and the markets. Hopefully the President will take to heart the former two's guidance... 

Quote of the Day: It's All About Noise and Reaction

I noticed (awhile after the fact) in this morning action precisely what Bloomberg's Arie Shapira noticed:

What's Inspiring This Morning's Action? And Charts of the Day: Technical Green Shoots

Yesterday, Fed Chairman Powell sounded an optimistic tone on the economy -- on the labor market in particular. Today's jobs and hourly wage numbers came in shy of expectations, which some would say inspired the early 140+ point rise in the Dow. If that's the case, traders quickly woke up to the fact that while the numbers missed expectations, they were anything but weak, and, therefore, they offered virtually no incentive for the Fed to not hike a quarter point week after next. 

Video Commentary: A Brief Look At Today's Action

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust:

Quote of the Day: The Sky Is Not Falling

Bloomberg Markets reporter Anchalee Worrachate makes some sense:

Chart of the Day (What We Expected)

Yes, a 1,500 Dow point decline in two trading days is dramatic. But if you've been with me here are on the blog, you'll recall that roughly 3 weeks ago I suggested that at least a test of the October low was highly likely. I pointed again to that likelihood last evening.

Quote of the Day, And a Brief Video Commentary

Bloomberg's Cameron Crise echoes my present view on the latest market action:

Video Commentary

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust:

Bonus Quotes of the Day

The President really needs to walk this one from this morning back:

On This Morning's Selloff (makes perfect sense)

The Dow's down 700 points as I type. If you'll recall there was a day last week when the Dow closed up 600 points. Such is the market during volatile periods.

Quote of the Day

The following from Econoday's commentary on yesterday's release of the November Manufacturing Purchasing Manager's Index (along with other data points) speaks to why we presently remain relatively growthy in our sector weightings (green highlights), and yet to the concerns we've been expressing herein and why we may find ourselves shifting to a somewhat more defensive posture in the months to come (yellow highlights):

Quick Thought On The Weekend's Big News

The Trump/Xi meeting happened over the weekend, and they did call a truce. What I can confirm from the commentary (there’s been notable differences between China’s and U.S.’s official responses, and Trump’s comments thus far conflict with both) is that there’ll be a 90-day delay in tariffs on new items, and no increase in existing tariffs, pending further negotiations.

This Week's Message: Wild Week Coming

The coming week is bound to be a wild one for the markets: Fed Chair Powell reports to Congress on Wednesday and we get the November jobs number on Friday. And while either, or both, could indeed shake up the market, both, in terms of potential impact, utterly pale in comparison to the Trump/Xi meeting happening today. 

Underneath Today's Rally

Today's monster rally was the biggest in 8 months. Here's my take:

Virtually without exception you'll find the media's explanation to be that today's move was entirely about Fed Chair Jerome Powell stating that rates are sitting "just below" what the Fed presently deems neutral. That would be the rate consistent with present economic conditions; i.e., a fed funds rate that would stick for awhile (no further hikes in the near-term offing).

Quote of the Day: "Tariffs Are Bad"

Notes from the Dallas Fed Manufacturing Survey released this morning speak volumes about why we said at the beginning of the year (and have stressed repeatedly since) that protectionism is the looming threat that could put our bullish thesis to the test:

This Week's Message: Gloom is Good

In last Monday's post I wrote:

"Sometimes immediate conditions are such that the would-be buyers decide to sit on the sidelines for days, weeks, even months, waiting for things to shake out a bit -- and waiting for the average investor to panic."

Yes, a classic characteristic of a stock market bottom is that ultimate capitulation when the last holdout seller -- typically the individual investor -- succumbs to the pain, and the recency bias, and turns his/her shares over to bargain hunters who suffer not the affliction of believing that what's occurring today will occur forever.

Chart, and Message, Of the Day

As we anticipated, and have expressed herein, the Dow is highly likely to, at a minimum, test its recent intraday support level. Today it came within a hair:

Well, We Told You So!

We're generally not ones to say "we told you so", but today's worse than expected durable goods orders report is consistent with our somewhat party-pooping post back on July 27th, when that whopping 4.1% second quarter GDP number was announced.

Video Commentary: The Correction For What It Is -- For Now

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust:

Bonus Quote of the Day

While White House Econ Adviser Larry Kudlow tried his best this morning to talk up the market by talking up the U.S. economy, he clearly didn't give traders what they wanted.

Quote of the Day

Today's quote below (from Bespoke's morning message) nicely follows yesterday's quick thought:

Quick Market Update, and Chart of the Day

If you've been with us consistently here on the blog, this morning's selloff should come as no big surprise. In last week's video I suggested that the near-term technical setup suggested that a test, and possible breach, of the recent low was very much in the cards.

Charts of the Day: Consumers Are Keeping Current

As we stress herein ad nauseam, in our view the key to long-term investment success is to allocate in accordance with general conditions. Therefore, the majority of our research time is spent assessing the present state of macro affairs.

Being that consumer spending accounts for 2/3rds of the U.S. economy, we are keenly interested in the fiscal health of the American spender.

Quick Thought

I recall earlier this year, during a period when virtually every dip in stocks was getting quickly bought, pushing the major indexes past prior highs, a friend commented to me how he comforts his wife when she's nervous about a big down day: He'd say "Honey, I'll betchya it'll snap right back up tomorrow", and he told me he was virtually always right.

Quick Note On This Morning's Action

Here's the last paragraph to this week's message; posted Saturday:

This Week's Message: Seeing Some Stress, Seeing Some Strength, Seeing More Near-Term Uncertainty

We absolutely have our concerns over the present trajectory of the global economy. However, as our direct experience, as well as our study of economic/market history, instructs, long-term trends are forever interrupted by counter-trend fluctuations. 

Two News Flashes Sum Up Today's Action, As Well As THE Issue Presently Plaguing the Market

The Dow went from the red to up nearly 300 points this morning on this:

Market Commentary (video included)

So when will the market calm down? Is this a correction or the beginning of a bear market? If the economy's so good, why is the market so bad lately?

Three very good questions that we can address by answering a single, simpler, yet deeper, question:

Quick note on today's action...

Headline reads: 

"Dow turns negative, giving up 200-point gain, as Apple rolls over"

Bonus Quote of the Day: Consequential (on trade) Conflict in Washington

Last post for today:

Per the below, there's serious (and consequential) conflict on trade going on in Washington.

Quote of the Day

Yes, that elephant in the room we talked about in our weekly message  is absolutely the issue:  emphasis mine...

Be Careful What You Ask For!

If you're at all inspired by the politically-popular (in some circles) notion that China's economic pain (say, when -- due to U.S. tariffs -- producers en masse move their manufacturing facilities elsewhere), somehow equates to U.S. industry's gain, consider the following:

Quick Note on Present Conditions

Personal circumstances do not allow me to flood your inbox as I typically do during volatile periods, however I was able to perform our weekly macro analysis over the weekend.

Quote of the Day: 'Maybe' A Silver Lining

Stock index futures were in good shape this morning (Dow future up triple digits) until this showed up in the Wall Street Journal (Dow future down triple digits):

This Week's Message: A strong finish is in the historical cards, but there's this issue...

History favors the odds of a strong 6 weeks to come, particularly in that this is an election year. 2018, however, has an issue coming to a head that can -- good or bad -- make its year-end one to remember...

Save for communications, and despite Friday's ugly session, every major sector made up some technical ground last week, which makes sense given the unsurprising mid-term election results and the -- until yesterday -- somewhat friendlier rhetoric around foreign trade.

If you followed, and, worse yet, believed the financial headlines over the course of Friday's trading session you might've gone from feeling concern over a heating economy (the producer price index [reported 5:30 a.m. pt] was way hotter than economists expected) and, therefore, Fed rate hikes galore, to, by the afternoon, all out angst over a weakening global economy, as that then became the reason du jour.

Frankly, in my view, both narratives essentially focus on the cart, while ignoring the elephant-sized horse pulling it along. 

While I'm certainly not the only observer who sees the present core issue as being the U.S./China trade dispute, for whatever reason it pretty much remains, again, the elephant in the room that folks who should know better seem content to tiptoe around. And as my metaphors suggest, if indeed inflation and global growth are legitimate worries (they indeed are), well, you might imagine how a protracted trade war can only make matters worse. Much worse!

As for Friday morning’s rhetoric, White House trade adviser Peter Navarro made the rounds, fielding questions on the latest U.S./China trade developments. Two headlines summed up his message:

"White House Trade Adviser Navarro Says China Deal Will Be On Trump's Terms, Not Wall Street's"

And:

"Peter Navarro Blasts China and Wall Street Globalists"

Of course his statements exacerbated an already weak trading session.

I think Peter's a bit peeved at a market that he clearly does not understand. Here's me quoting him, and exposing his naiveté, in my March 20th blog post:

“I don’t think there’s anybody on Wall Street that will oppose cracking down on China’s theft of our intellectual property.”

Wanna bet, Peter?

Honestly, I agree with the sentiment of his March statement; let's crack down on intellectual property theft, but let's not do it by implementing an asinine (tariff) scheme that history has proven over and over again hurts the U.S. economy at every conceivable rung!

As for Friday's outbursts, well, okay, the China deal will be on the President's, not Wall Street's, terms, but make no mistake my dear friends, Wall Street will judge it based on what it portends for the economy. And as we've learned over the years, nothing can lay waste to a political career like a weak economy and a bear market in stocks.

So I'll taunt once again (can't help it); wanna bet, Peter?

And as for the political football term "globalist", which by some miracle gains negative traction in this great melting pot of the world, well, when you consider that so many iconic U.S. companies generate better than half of their revenue from outside our borders -- i.e., from where the remaining 96% of our human family lives -- it's probably not a term/concept we should be at all railing against.

Here's a video we shot back in July of 2016 that we'd like all of our clients to watch (again) -- part one (3 minutes) in particular. Virtually all of the return, valuation, etc., comparisons that I illustrated in part 2 are as, if not more, pertinent today than they were 2+ years ago. 

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust:

Checking One Headwind Off Our List

Assuming sufficient races are decided, by this time tomorrow we will have crossed one market headwind off of our list. Judging by yesterday's and today's action, market players in the aggregate are comfortable with a Democrat-led House and a Republican Senate. As you know, polls strongly favor that outcome.

This Week's Message: Last Week's Medley and the Short-term Character of the Stock Market

I knew I was active herein last week, but (just counted), geeze!, 15 posts... yeah, that's a bit much. But, you know, it was a crazy week and it's tough to stay quiet when I know that the media is killing itself to grab the attention of our clients with all manner of noise and, often, hyperbole.

Unfortunate -- for really short-term bulls -- Headline of the Day

This one (just released), plus the one we featured earlier this morning, was good for a 530-point plunge in the Dow (from last night's futures trading to this moment):

Bonus Quote of the Day: The Expansion Has Legs

As clients and regular readers know, our assessment of conditions instructs that -- barring a protracted trade war -- the present economic expansion has legs.

The Economist agrees:    emphasis mine...

Good job: America’s labour market

Jobs are plentiful, as today’s figures on non-farm payrolls from the Bureau of Labour Statistics should confirm. ADP, a company that publishes its own estimates a couple of days before the BLS posts official numbers, tends to track the official numbers reasonably well. On October 31st it estimated an increase of 227,000 jobs, though some of that strength may be because last year’s employment was depressed by hurricanes. The trillion-dollar question is how long these good times can last. The ratio of prime-age employment to population was 79.3% in September, still a full percentage point below the level seen in 2009. That suggests there is still scope for a hotter economy to draw more people into the workforce. And although it looks likely that average hourly earnings growth will top 3% for the first time since 2009, that is not strong enough to think that this recovery is anywhere near its last gasps.

Quote of the Day: Apple's Other Announcement

Per my earlier post, Apple's feeling some pain this morning due to its decision to no longer report iPhone unit sales in its quarterly numbers. Thing is, per the snip below, there were two changes to the company's plans for reporting the internals going forward: Along with the notably negative iPhone decision, the company will also be disclosing the costs borne within its ever-growing services division. 

Not So Hugely Positive News, But, Actually...

Just crossing the wire:

Should We Worry About Apple?

I purposely jumped onto the Apple earnings call a half hour late this afternoon so as to miss Tim Cook and company tell the world how phenomenal last quarter's numbers were. Not that they weren't wonderful, in fact they were, it's just that that's not where I find value in listening in on earnings conference calls. What I am interested in is the Q&A. That's where, through their demands for explanation and clarity, the blokes who get paid the big bucks to know what's what with a company express their concerns.

More Hugely Positive News

Futures were looking ugly this evening after Apple posted stellar numbers, but a conservative outlook, and a heads up that they won't be reporting iPhone unit sales numbers going forward (I have thoughts on that that I may follow up with in another post). But then the following hit the wires: 

Hugely Positive Headline

While the cynic would say that the below is simply an attempt to engineer a pre-midterm election market bounce (Dow was up 20 before the headline, up 203 as I type), it absolutely does speak to how the equity market is influencing the discussion. 

Manufacturers Still See Expansion, But (and that's a hugely concerning "but"!)

The Institute for Supply Management (ISM) monthly surveys are hugely telling about the state of the economy; they are important constituents in our PWA Macro Index. Readings over 50 denote economic expansion.

The Fed's On The Right Track

As you may know, we believe that the Fed -- while causing consternation among politicians and some players in the market -- is on the right track. This morning's release of the Employment Cost Index (ECI) confirms our view.

Thoughts On Foreign Equities

I'm thinking my reply to an emailed question on Monday regarding foreign exposure would be instructive.

About Today's Rally

Two things about today's rally in stocks:

Hold Your Horses Folks

Stocks are staging a bit of a comeback this morning that might (big "might") actually stick for a day or two.

Regular readers know that I remain bullish longer-term, but notably skeptical shorter-term on the path for equities. That said, in the very short-term it wouldn't surprise me to see the market sustain a brief rally.

When will it end, and is this a good time to buy?

My reply to an emailed question this morning states our current view in a nutshell. 

My friend inquired as to when I thought this downdraft would end, and if this is a good time to buy.

Here's my reply:

All you need to know about his morning's selloff

The following CNBC headline is all you need to know about this morning's selloff. 

The market tanked instantly (giving up a 280-point Dow rally) upon this hitting the wires:

Quote of the Day and This Week's Message

Bloomberg Market's Kyoungwha Kim's view of present market and economic conditions is right in line with our present assessment. 

Stocks Are Beginning to Look Cheap

Here's our forward (12-month estimated) price-earnings chart as of October 1st:

The Character of Today's Bounce (video)

What volume said about today's action, and some commentary on underlying conditions.

The "Best" Move

Had a nice email conversation with a dear old friend yesterday. One of the questions he asked me was if, in light of the huge hit to recent paper profits, I saw any point in exiting the market with what recent (let's assume he means that which was accumulated in the latter half of last year) profit is left, "even for yourself".

So Now What?

Here's from our September 29 blog post:

"The next few weeks (leading into mid-term elections), are, at best, likely to see a notable pickup in volatility. At worst, a pullback in the mid-single to low-double-digit % range."

Market Commentary: This is What Needs to Happen (video)

This morning selloff is of course no surprise, and, thus, no worry to regular readers/viewers. But, just in case, here's a brief reminder:

Another Note on Financials

Here's Bloomberg Markets this morning on the financial sector, with my comments italicized in red added:

Way Too Soon To Buy China's Bounce!

Chinese stocks just turned in their best evening in years! And while there was globally good news to be found in So. Korea's October-so-far export numbers, China's rally was all about positive/calming jawboning by the powers that be. Unfortunately, history shows us that big bounces are most common during decidedly down markets, and, yep, they're generally sparked by the promises of panicky politicians.

This Week's Message: Expect more of the same for now (video)

This week's message is a quick and easy (but worth watching) video.

Quote of the Day: This Is What We're Talking About!

We recently (multiple times) cited the risk to forward earnings outlooks due to U.S./China trade relations as being a huge near-term headwind.

The following is what we're talking about:   emphasis mine...

Headline of the Day

This is the kind of headline that'll likely lead to some upside volatility:

Chart of the Day: Expect a Test

Yeah, a test of the recent low (normal btw) -- at a minimum -- is highly likely. At least that's what the graph I marked up last evening points to.

Note On the Financial Sector

My reply to an inquiry last evening regarding the somewhat surprising lackluster of financials this year, and on the impact of rising interest rates:

Bonus Quote of the Day: Irrefutable Wisdom

Here's the irrefutable wisdom of a well-economically-tutored acquaintance of mine:

Quote of the Day: THE Headwind

Per last night's video commentary, there's reason to doubt the "good news" of yesterday's bounce. This morning was already looking a bit ugly, but on the Commerce Secretary Wilbur Ross headline regarding trade negotiations with China below, things got notably uglier.

Did Today Offer Up The All Clear Signal? (video)

So was today's strong rally the all clear signal? Well, it may very well have been; it was certainly impressive, as my comments in the video regarding breadth suggest. But when we consider the existing headwinds and the inconclusiveness (too soon to tell) of our volume study, I dunno...

Quote of the Day: Again, Be Careful What You Ask For!

We've stated a number of times herein that the somehow popular in some circles notion that the U.S. is "winning" when the world's second largest economy appears to be "losing" is, to put it mildly, grossly mistaken.

Quote of the Day: What it Takes

Yep, pull backs and corrections are never fun, particularly if you're constantly monitoring your portfolio. Thing is, they're part and parcel to the business of investing -- there's simply no escaping them. If you find yourself stressed every time the market takes a multi-point dip, you might want to sit yourself down and come to terms with reality. Do you want to spend the rest of your life emotionally at the mercy of the market? If you determine that there'll be no peace for you while the market's in apparent turmoil, then you must do yourself a favor and either get out of the market altogether, or sell down to a point that you can emotionally manage. 

Analysts Not Liking the Earnings Prospects for Financials and Materials, and That's a Good Thing!

Financials and materials are currently two of our top three sector weightings. As it turns out, Wall Street analysts are, on balance, presently not with us on those two picks. And, guess what, that's a good thing.

This Week's Message: Should We React?

Statistics such as the ones below provided by Bespoke Investment Group speak to why long-term investor-types tell you to never to sell into the kind of plunge stocks experienced last week.

Quote of the Day: A Billion Bucks and Tens of Thousand of Jobs (just one company)

While not all clients and regular readers totally agree with me on the tariff topic, they do know exactly where I stand. Which is with Ford's Jim Hackett and United Technology's Gregory Harris:

Inflation Expectations Rising Among Businesses

Businesses (and they should know) see inflation rising going forward. Which supports the Fed's current stance, and, all else equal, bodes poorly for bonds and utilities, and well for financials (read higher interest rates) going forward:

Don't Call Your Friends Over Just Yet

As I type the Dow's up 300+ points, Nasdaq's up 2%, S&P 500's up 1.3%; very nice rally! Question is, should you believe it?

What's 'Actually' Going On, minute by minute (video)

Watch this video if you're thinking too much about the market this week.

Looking at the volatility, and knowing how traders think, I planned to do a quick video for you this morning, but then I remembered I did one with the same message earlier in the year, just as, we know now, the market was bottoming after a 10+% dip.

Correcting the Narrative

You're hearing in the media -- not just from the President, but from no small number of market actors as well -- that the Fed essentially gets the blame for the latest turmoil in the markets. This morning's bounce in the pre-market on less than expected inflation news may embolden that narrative. While, in fact, it debunks it. 

Market Commentary: Underneath Today's Selloff (video)

You may find my comments on rotation (in the back half of the video) particularly interesting.

Once playing, click the icon in the lower right corner for full screen. Focus should occur after a few seconds; if not, click the wheel to the left of the YouTube icon to adjust:

Touching Base

To help you keep the latest in perspective, recall the note I sent to you last week, when the present decline was just getting underway:    emphasis mine this morning...

Outlooks Challenged (right out of the gate)

In this week's message we said the following about a potential headwind developing from forward outlooks this earnings season: 

Ceding Influence to China

While I know I am somehow at odds with a few of my friends, colleagues and clients on the U.S.'s present positioning among its global partners, I suspect we can all agree (that is, if we are "all" paying attention) that while the U.S. pulls in, China is reaching out, big time.

This Week's Message: Rough Road Ahead, Amid Still Bullish General Conditions

The ugly short-term setup exhibited in our last analysis played out as odds indicated, as equities tumbled to close the week.

This week's analysis, while nuanced as discussed below, shows near-term conditions only getting worse.

Here's last week's chart character and volume snapshot (right 2 columns):   click any insert below to enlarge...

Here's this week's:

Unlike the previous week, however, overall ETF flows to U.S. equities didn't confirm the ugly volume trends depicted in this week's charts, as U.S. ETFs, in the aggregate, saw net inflow.

Although, zeroing in sector by sector, last week's fund flows indeed confirm most of what the present charts indicate (right column is weekly flow):

On a positive note, per the above, retail and financial stocks, while experiencing net outflows on the week, saw strong reversals (one-day net inflows) on Friday (center column).

Bucking the weekly negative trend were communication services and industrials:

Long-dated treasuries saw investors screaming toward the exits:

I'm near-term bearish, intermediate-term neutral, long-term bullish on tech:

As I've been reporting the past several weeks, the internals for tech have been growing more and more suspect. Plus, my intermediate-term macro thesis does not allow for tech to continue the strong leadership it exhibited last year, and so far in 2018; with or without a protracted trade war. Per last week's action, it looks as though the "smart" money is beginning to agree. I.e., last week's drubbing of the tech sector (tech down 2.2%, vs financials, industrials and materials; up 1.6%, 0.68% and down 0.5% respectively) made perfect sense to me.

Non-US remains a mess, as, clearly, global growth has slowed and the world stresses over the threatened, and now occurring, disruption of long-held trade arrangements and strongly-rooted global supply chains.

While headline data suggest that the U.S. economy has remained immune to tariff effects thus far, our deeper analysis suggests otherwise, per my macro notes following the excerpts below.

I sympathize with the following published yesterday by Bloomberg:     emphasis mine...

Global manufacturing is growing at the weakest pace in almost two years and exports shrank last month for the first time since 2016. “The U.S. may be booming but the global economy is starting to slow,” said Janet Henry, chief economist at HSBC Holdings in  London.

The trade war is raising the biggest red flag. In the past few weeks alone Panasonic Corp., Ford Motor Co. and BP Plc have all highlighted the dangers of the escalating tensions, and those worries are starting to filter through into the broader economy.

Emerging market stresses from Argentina to Turkey, political uncertainty in the U.K. and Italy, and rising oil prices are among the other threats. While there’s no sense of growth coming to a halt, the crystallization of risks means the synchronized expansion of last year is a fading memory.

HSBC this week lopped its forecasts for 2019 world growth, mainly prompted by a downgrade for emerging nations struggling with the rising dollar. 

“About 50 percent of the value added that’s in Chinese exports to the U.S. comes from the rest of Asia,” said Fabiana Fedeli, global head of fundamental equities at Robeco. “Clearly other countries will also be impacted if the trade war continued to escalate.”

The confluence of factors may be enough for the IMF to trim the forecasts it’s maintained so far this year for the world economy to expand 3.9 percent in 2018 and 2019. The fund will update its World Economic Outlook from Bali on Oct. 9. It hasn’t revised projections down for a year ahead since October 2016.

.... even the U.S. may not be immune. Recent data showed the trade skirmish shaping up as a clear drag on growth last quarter, prompting economists at JPMorgan Chase & Co. and Amherst Pierpont Securities to pare their estimates for expansion.

Macro Readings:

Our PWA [Macro] Index sank 9.53 points to a yearly low of 28.57. The financial markets subindex was the culprit; plunging 41.61 points to a net score of -9.53, with the following 8 (of 23) data points deteriorating on the week:

• Individual Investor Bullish Sentiment sprang to 45.7% (we consider 50+ to be dangerously optimistic on the part of the predominantly untutored, emotional, reactionary and inexperienced individual investor community). 

• The VIX Curve moved from positive to neutral as volatility spiked markedly during the second half of last week. 

• The Put/Call ratio (option trader sentiment reading) sprang 20 bps to 0.84. 

• The consumers staples/discretionary ratio turned notably in favor of consumer staples. 

• Overall breadth plunged (accounting for 4 of the 8 lower readings), with the S&P 500's advance/decline line rolling over, its % of members trading above their 50-day moving average falling below 50% (49.2), and sector readings showed marked deterioration among the cyclicals (save for energy). 

On the bright side, the economic subindex actually gained 4 points, as auto sales improved in September (moving to neutral on our chart, from negative), the chemical activity index, after flattening for a stretch, resumed its positive trajectory, rail traffic turned higher in similar fashion, and the Citi U.S. economic surprise index moved into neutral territory (from negative). Two readings detracted from the subindex's overall score; they were, Global PMI falling for the 4th straight month to a still expansionary 52.8 (moving from positive to neutral), and Citi's Japan economic surprise index moving from neutral into negative territory.

Summary:

Presently the market is facing headwinds from multiple fronts:

1. While Q3 earnings reports will reflect the strong profits that come with strong business conditions, I expect that they will be marred notably by uncertain outlooks due primarily to global trade concerns, which will exacerbate the otherwise typical inflation concerns that accompany a mid/late-stage economic expansion.

2. Rising inflation, as noted in #1.

3. An appropriately hawkish Fed (read rising interest rates).

4. Iran sanctions taking effect on November 4th, thus hampering the distribution of the world's fourth largest store of oil reserves. I.e., higher prices at the pump are likely during the coming holiday shopping season.

5. Uncertainty over mid-term elections.

6. Coming to terms with a slowing global economy and the inevitability/realization that the U.S. is in no way immune to the conditions impacting the other 96% of the world's population.

7. The real potential for further deterioration in U.S./China trade relations.

All of the above said, while our macro index is plumbing new 2018 lows, it still presents a scenario where odds favor continued expansion over recession going forward. Presently 49% of its components read positive, 20% negative and 31% neutral; with 53% of this week's negative readings occurring within the financial markets subindex. I..e., recent equity market volatility -- as opposed to current economic weakness -- has much to do with the overall index hitting this year's low.

The begging question -- for the experienced long-term investor -- of course being, will a near-term uncertain investing environment ultimately drag the economy into a recessionary state, or will generally strong economic conditions ultimately pull the market further into all-time high territory?

The receding conditions illustrated by our macro index that have prevailed since its peak on January 15 have (until, as noted above [and last week], very recently) had little to do with stock market conditions, and lots to do with the rising headwind against global trade flows. It appears as though, finally, investors are taking note of those risks; which is what we've suggested from the get-go is needed to inspire all sides to come to the table with the aim of hashing out a legitimate, working "solution".

Our analysis says that there remains ample time (ample conditions, that is) for a treaty to be fashioned and for stocks to resume their bull market march, which, therefore, dictates that we stay the course with our generally growthy sector weightings for the time being.

Just how long conditions will support such a thesis, as well as our present allocation strategy, of course remains to be seen. Which is why we perform our analyses religiously, week in and week out, and remain open to all possibilities.