July 31, 2018

The past week started out with great fanfare and high expectations for a big week for stocks. After all, the cream of the crop of earnings was to be reported, European Union President Jean-Claude Junker was scheduled to visit the White House, the first read on second-quarter GDP was to be released, along with several juicy data points, including numbers on the housing market, inventories, and consumer sentiment.

The week was all teed up for record-breaking gains and, although it started out strong, with the S&P 500 trading to within 24 points (0.8%) of its all-time high of 2,872, the animal spirits fizzled out on the heels of some big earnings disappointments from the biggest integrated oil companies, a couple of FAANG companies, and various other Wall Street darlings that failed to exceed the ‘whisper’ numbers or couldn’t muster the kind of glowing upward sales and earnings guidance that investors had come to expect.

While second-quarter GDP came in at an impressive 4.1%, it was still light of the 4.3% (or higher) figure the market was looking for. Housing data continued to sorely disappoint with New Home Sales for June coming in at 631,000, well below the 670k consensus, and Existing Home Sales declining for a third straight month to an annual pace of 5.38 million. From my vantage point, the weaker housing data overrode the generally good news surrounding earnings and improved tariffs relations with the EU.

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

This week’s Pending Home Sales and Construction Spending data will shed more light on this all-important sector, which for the moment is a chink in the bull’s armor. But the summer months can spit out some squirrely data because it is also well documented that Americans are spending more on vacation travel this year than at any time in history. So, it stands to reason that there are just a lot of unengaged buyers and sellers in July and August, but the pace should pick back up before school starts in the fall.

A second chink in the bull’s armor was the widespread rash of selling in the Information Technology sector on Friday. What started out as a ho-hum day turned into a waterfall selloff from what I would call an illogical correlation. Just because a couple of social media stocks got trounced, that doesn’t mean that all of tech-land is suddenly sick. Conversely, Q2 results from the majority of global high-profile tech companies have been quite impressive and should continue so during the current quarter.

Product innovation, a strong global economy, and U.S. tax reform are stirring CIO investment in IT infrastructure. This has been a unique year for IT spending trends. Gartner Group predicts that global IT spending will reach $3.7 trillion by the end of the year – a staggering 6.2% increase from 2017, which is an unsustainable Compounded Annual Growth Rate (CAGR). Going forward, Gartner is forecasting something closer to a CAGR of 3% for the next five years, which is still a bullish investment proposition.

The optimistic outlook for IT spending got a big boost from tax reform. The corporate tax cut will have two effects, one short-term and one long-term. Companies will receive a windfall from the cut on existing investments that they can return to shareholders through increased dividends and buy-backs. But at the same time, companies face a lower tax burden for new investments, which encourages more capital spending that eventually translates into higher productivity and wage growth.

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

Business investment in the United States is on the rise. Bloomberg Markets reports that among the S&P 500 companies that have reported results for the first quarter of 2018, capital spending increased by 39%, the fastest growth in seven years. And once the second-quarter data is compiled and released, I’m assuming the pace of spending might be comparable. Again, tax reform provided a huge short- and long-term jolt to corporate spending plans on IT and we’re only in year one of results from the tax rate cut.

Beware of Seasonal Market Volatility in August and September

Regardless of the rosy outlook from Gartner that the bullish chart above paints, the very best tech stocks can go from being among the most highly-touted names in the universe to ones where investors can’t exit them fast enough. Careful stock selection includes how to avert the trap doors in highly crowded trades. Those seeking yield should consider using any rallies during August and September to sell covered call options against underlying tech stocks. Friday’s tape was (in my view) a sign of near-term overhead resistance that comes after the most influential companies have reported their Q2 numbers.

We’re now better than halfway through earnings season and, after hearing that the economy is cruising along at a 4%+ pace of growth, some selling on the news last Friday should have come as no surprise. The Nasdaq had made a big run (nearly 15% YTD through last Wednesday), so some well-deserved backing-and-filling seems to be in order. I expect the overall market to consolidate on seasonally lighter trading volume for the next four to six weeks and then get back into gear as the third quarter comes to a close. It could be quite choppy between now and then, but the economic fundamentals are too strong to derail the bull trend as I expect to see foreign money continue to flow into U.S. equities as a global safe haven.

With that understanding, any pullbacks will be constructive, relatively short-lived, and met with fresh buying interest on any meaningful dip. There is just too much global liquidity that wants to own the biggest, fastest growing, and most trusted market in the world. America’s economic prosperity should do much to lift the global markets as a whole and relieve much of the tension that has beset emerging markets. When the 800-pound gorilla does the heavy lifting for the rest of the world, everyone wins.

Any armor-piercing threats to the bull case will be much larger in scale than a summer slowdown in housing or a knee-jerk sell-off in an otherwise powerful tech sector. A few chinks here and there from headline risk are to be expected along the way when the investing world goes on vacation, leaving few to mind the affairs on Wall Street. When the heat of August and market volatility subside, however, the armor of this bull market can repel any and all attacks. And what if there is a meaningful breakthrough with China on trade talks, for if there is, the market may simply take off, declaring, “I am Batman!”

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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