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)

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 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.