October 9, 2018

Sometimes, life hands you a bill you don’t expect.

Such was the case for Ernest Thompson Seton, one of the founding members of the Boy Scouts of America. On his 21st birthday, his father presented Ernest with an invoice. It detailed every expense connected with his childhood. His father even included the fee charged by the doctor who delivered him into this world. His dad also applied 6% interest per year.

Seton paid the bill, $537.50 in 1881 ($12,500 in today’s dollars) and never spoke to his father again.

He did learn a vital lesson, though. He described his father as the most selfish person he ever knew, and as “one who knew the price of everything and the value of nothing.” The key words are: price vs. value.

Last week the market faced a late-week round of stiff selling. The Russell 2000 was down 4.6% for the week as of mid-day Friday before rallying to close down 3.8% by the end of the day. The big blue chip indexes fared better, with the S&P down 1% and the Dow declining just 11 points (-0.04%) . This type of behavior is amplified when we dig beneath the surface and look at individual stocks. Some stocks have faced heavy pressure this past week, far more than the indexes. Many stocks that I traffic in have gone up multiples of the market, so it’s understandable that some of them may come down further than the market.

When we see red in the markets, we can get a little edgy. But these are the times to resist acting like Ernest’s dad. Let’s focus on value and not so much on price. This is where we can look at longer-term trends in sectors and the health of the market’s fundamentals to give us some guidance. If we focus on price alone – we might say “it’s time to bail.” That would be a huge mistake.

The fact is that the market is reacting to some new level of uncertainty and markets don’t like uncertainty… Yet, the volatility we’re seeing is normal and necessary. In fact, this dip could be a buying opportunity.

On Monday and Tuesday, we saw selling pressure. The market firmed up Wednesday, and we saw a nice bounce in growth stocks. Then on Thursday and Friday, things got bumpy again. The S&P 500 and Dow both outperformed the Nasdaq and the Russell 2000 for the week because the Nasdaq and Russell are full of domestic, small-cap companies, while the S&P 500 and the Dow are full of large-cap, multinationals.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Three Drivers Behind this Choppy Market

The way I see it, there were three main drivers behind last week’s choppy market…

The “New NAFTA” Trade Deal: The market started soft Monday when Trump announced that he had reached a new free trade agreement with Canada and Mexico to replace NAFTA. If approved, the deal is good news for multinationals, as it will ease trade tensions. The market overreacted to this news – it sold U.S. small caps and bought stocks with international exposure. Small-cap companies generate most of their revenues from home. Tariffs and other trade barriers don’t hurt their bottom lines like they do with multinationals. U.S. small caps have been a safe-haven while investors shunned multinational companies.

Rising Interest Rates: The rate on the benchmark 10-year Treasury note rose above 3.2% last week, a seven-year high. The 30-year bond also hit a four-year high. When yields rise, that signals a possible rate hike. On top of rising rates, there are fewer buyers of U.S. Treasuries. There’s also talk that China—the biggest buyer of U.S. bonds—will stop buying in retaliation against sanctions on Chinese exports to the U.S. Fewer buyers and lower bids mean higher rates, which make owning U.S. stocks less compelling.

Rising Uncertainty: Next, we have media distractions causing rising uncertainty. The main saga last week involved the confirmation vote of Supreme Court Justice nominee Brett Kavanaugh. The next hurdle will be the midterm elections. Meanwhile, the slowly-escalating trade dispute still hangs overhead.

Despite these uncertainties, the major indexes are all still within spitting distance of their all-time highs:

  • The S&P 500 is within 1.3% of its high.
  • The Dow Jones Industrial Average is within 1.2% of its high.
  • The Nasdaq is within 3.1% of its high.
  • The Russell 2000 is within 5.5% of its high.

That’s why you should ignore the headlines and look at the bigger picture. The economy is still firing on all cylinders. Here’s just a short list of what the mainstream press is choosing not to focus on:

The economic news is really good. Both the Institute for Supply Management (ISM) and ADP, the human resources management firm, released strong employment numbers last week. The U.S. Labor Department also reported that the unemployment rate is at its lowest level since 1969. Even Federal Reserve Chair Jerome Powell said that things are “almost too good to be true.” And as far as U.S. stocks go, the story hasn’t changed. We’re about to kick off third-quarter earnings season later this week, in which we expect to see a third straight quarter of 10% sales growth and 24% earnings growth for the S&P 500.

Hoping to beat those very-high hurdles, we focus on stocks which average double-digit multiyear sales growth, earnings growth, and gross profit margins. This was our goal yesterday, and it will be our goal tomorrow as well. But events like the ones I discussed above have caused people to “trade the news.”

I’ve seen it countless times when I sat on trading desks on Wall Street, but panic selling is usually just an excuse to push stocks around. Portfolio managers chase performance based on headline news, but markets usually overreact. Great stocks will still be great, despite the news. The market is either handing us a bill or it’s handing us a gift. One week the prices may say “buy,” or it may say “expensive,” depending on your perspective. The next week, it may say “sell” or “cheap,” depending on your mindset.

Don’t let the media head-fake you into getting bearish. The environment is great and there is much value to be had in this market. Warren Buffett said, “Price is what you pay, and value is what you get.” Don’t be like Ernest’s dad: Know the price of some things but focus on the value of everything.

About The Author

Jason Bodner

Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. *All content of “Sector Spotlight” represents the opinion of Jason Bodner*


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