July 30, 2019

This “summer of love” for the stock market has been well-oiled by the assumption of a locked-and-loaded rate cut by the Fed – presumably to be announced tomorrow – and generally better-than-expected second-quarter earnings results. According to “FactSet For Q2 2019,” with 44% of the companies in the S&P 500 reporting results so far, 77% of S&P 500 companies have reported a positive EPS surprise and 61% of those companies have reported a positive revenue surprise.

For Q2 2019, the blended earnings decline for the S&P 500 is -2.6%. If -2.6% is the actual decline for the quarter, says FactSet, it will mark the first time the index has reported two straight quarters of year-over-year declines in earnings since Q1 & Q2-2016. Looking forward to Q3 2019 results, 28 of S&P 500 companies have issued negative EPS guidance and 10 companies have issued positive EPS guidance. The forward 12-month P/E ratio for the S&P 500 is 17, slightly above the 5-year average (16.5) and well above the 10-year average (14.8). The market is clearly trading at the upper end of the historical range.

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

There is also a very high level of complacency, as measured by the CBOE Volatility Index (VIX), which closed the week at 12.16, approaching the lows of the past 30 years, amid the belief the Fed has the market’s back; that President Trump and his pro-business, pro-stock market agenda is a shoe-in for a second term; that foreign capital will continue to aggressively flow into U.S. stocks and bonds; that the debt ceiling was raised with a two-year no-cap provision; and that the dollar will remain currency king.

I don’t have a problem with this scenario. We’ve heard from enough leading companies that dominate the index weightings that business conditions are healthy and therefore any correction that comes along will be just another buying opportunity. This is probably a true assessment. Who is to argue with how the semiconductor sector has traded so bullishly, usually a sign of an economic virtuous cycle in the making?

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

But here’s the catch, at least from my point of view. The current rally is built on over three out of four companies beating earnings expectations – but the success bar was set lower than that of a speed bump. Currently, there are a large number of headlines to fuel the animal spirits on a daily basis. Be it the Fed rate cut, earnings, another meeting of the U.S./China trade teams, the ECB pumping up QE again, and data showing the U.S. consumer taking full advantage of nearly-free 2% money, it all sounds good.

That means it’s panic time for under-invested professional fund managers that do not want to answer to their clients for why they are so woefully underinvested when their July brokerage statements become available. There is wild, almost desperate rotation occurring within many widely-held stocks that reflect the passion to be in the right names by month’s end. But when major company’s stocks spike to new all-time highs because year-over-year declines in sales and earnings “weren’t as bad as first thought,” then we’re in a market that is banking ferociously on the future of the economy picking up meaningful speed.

Stock Selection is at a Rising Premium

This bullish scenario I’ve painted here may play out as scripted, and it has a good chance of doing so, but probably not before the market catches a summer cold sometime in August. From the chart below, the number of stocks within the NASDAQ trading above their 200-day moving average has probably peaked in the near term. As the bull market matures, market leadership narrows and though some of the heavily weighted names like Microsoft are marching to higher highs, market breadth has probably peaked for now. We saw this is October, in late April, and again this month, per the chart below.

Navellier & Associates owns Microsoft in some managed accounts. Bryan Perry owns Microsoft in personal accounts.

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

Once the Fed cuts rates this week, the market will have to endure a time where bullish headlines will be fewer and farther between. The months of August through October are seasonally the most difficult time for padding heady year-to-date gains, and if the dollar takes out its 52-week high, which looks inevitable, there will be a lot of chatter about third-quarter EPS forex headwinds for S&P multinational companies.

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

One thing I’ve learned in my 35 years in this business is that when stocks run out of fresh oxygen (bullish headlines), they fade, not because the future has lost its luster, but because greed gives way to the fear of not booking profits in technically overbought conditions. This is where I think the market stands going into August – vulnerable to seasonal selling pressure. Nothing major, but selling pressure, nonetheless.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry


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