August 28, 2018

The Kansas City Fed’s annual conference at Jackson Hole last week provided some market clarity, since after Chairman Jerome Powell’s speech on Friday, the stock market rallied on his assurances that the Fed would only raise key interest rates “gradually.”  After Chairman Powell’s reassuring comments, I expect we’ll see a dovish Fed statement in mid-September, since the Fed does not want to invert the yield curve.

Since other major central banks have not followed the Fed’s series of key interest rate hikes, especially the European Central Bank (ECB), I suspect that the FOMC will eventually have to concede that due to rising uncertainty, the Fed may pause raising key interest rates after its September FOMC meeting.

To back up this theory, the last FOMC meeting minutes were released on Wednesday. These minutes implied that if the U.S. economy performs in line with expectations it would “soon be appropriate to take another step” in raising rates, but the FOMC minutes also discussed changing its monetary policy to “accommodative.”  This would be a welcome change in policy, since the Fed would essentially admit that it is now “neutral” and unlikely to raise key interest rates if inflation remained within the FOMC’s 2% inflation target range.

One big reason for the Fed to pause raising rates after its next FOMC meeting is that the National Association of Realtors on Wednesday announced that existing home sales slipped 0.7% in July to a 5.34 million annual pace, the slowest rate in 2½ years (since February 2016). Existing home sales have now declined for four straight months, caused partly by higher mortgage rates. Currently, there is a 4.3-month supply of existing homes for sale, a very tight supply that could cause median home prices to keep rising.

Speaking of housing, the Commerce Department announced that new home sales declined 1.7% in July to an annual rate of 627,000, the slowest pace since last October, led by a huge 52.3% sales decline in the Northeast, the biggest one-month decline since 2015. Growing affordability problems and a lack of inventory continue to weigh on new home sales. Since itemized deductions, like mortgage interest, have been capped at $750,000, it will be interesting to see if this weighs on the sales of high-cost properties.

On Friday, the Commerce Department announced that durable goods orders declined 1.7% in July, much worse than economists’ consensus estimate of a 0.8% decline. Due to some order cancelations at Boeing, which caused new orders for commercial aircraft to plunge 35.4%, new transportation orders declined 5.3% in July. But excluding transportation, durable goods orders rose 0.2% in July. Even better, business investment, excluding aircraft, rose a robust 1.4% in July. Overall, durable goods orders have risen 8.6% in the first seven months in 2018 compared to the same period in 2017, so GDP growth remains strong.

(Please note: Louie Navellier does currently hold a position in BA in Mutual Funds. Navellier & Associates does currently own a position in BA for client portfolios).

The trade talks that resumed last week between China and the U.S. have not yet resulted in any meaningful progress, so trade fears may resurface in the upcoming weeks, but outside of the Fed, virtually no other major central banks seem to want to raise key interest rates. Because of that fact, I expect the U.S. dollar to remain strong, causing the Fed to postpone further interest rate hikes after its September meeting.

As soon as the Fed signals that further interest rate increases are not likely, I expect a big resurgence in dividend growth stocks. Bespoke issued a report last Wednesday (“Dividend Model Portfolio Update”) that reports that year-to-date, the stocks in the Russell 1000 with the highest dividend yields (top decile) are down 3.8%, while the stocks in the Russell 1000 with no dividend yields are up a whopping 18.2%!  Many of these stocks with no dividend yields have benefitted from short-covering rallies. Since short-covering rallies typically do not last more than six months, I expect that many of these heavily-shorted stocks, like Tesla, will roll over and allow dividend growth stocks to resurge in the upcoming months.

Reflections on What Happened 3 Years Ago and its Impact on ETF Trading

Friday marked the 3-year anniversary of an “intraday flash crash” that had devastating consequences.

On August 24, 2015, 1,278 stocks “gapped down” more than 5% at the opening, so the NYSE stopped trading those stocks. However, ETFs containing those stocks continued to trade without investors knowing the value of the stocks within that ETF. Some ETF specialists abruptly dropped their bids approximately 35%. The apparent reason the ETF specialists dropped their bids 35% was that in the May 6, 2010 5-minute “flash crash,” all trades that dropped 40% or more were reversed, as if they never happened, so ETF specialists knew that if they did not cross that 40% threshold, their trades would hold, so they picked off everybody by 35% instead! The chart below shows the carnage.

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

The reason I showed the iShares Select Dividend ETF (DVY) being hit 34.95% intraday on August 24, 2015, is that I wanted to prove that a big, well-respected ETF, with high Morningstar ratings and a nice dividend yield was not immune to intraday Wall Street specialist shenanigans. Furthermore, on the chart below, I chart a high dividend stock, KKR, plunging 58.82%, apparently fueled by margin calls from investors that unwisely bought KKR and other high dividend stocks on margin.

(Please note: Louie Navellier does not currently hold a position in KKR. Navellier & Associates does not currently own a position in KKR for client portfolios).

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

The moral of the August 24, 2015 intraday flash crash is that Wall Street is only liquid at a deep discount and that stop loss orders cannot protect you from intraday ETF and stock price anomalies. (On September 13, 2015, The Wall Street Journal published an excellent analysis of what went wrong in the structure of ETF trading on that fateful day in an article entitled: “Wild Trading Exposed Flaws in ETFs.”)

When you look at the prices of ETFs at the end of the day, it tends to show a very pretty picture, but our friends at Bespoke Investment Group recently published a fascinating article called “Fear the Day,” in which they pointed out that if you bought the biggest and most liquid ETF, namely SPY, at the opening and sold it at the close every day since January 1993 between January 1993 and January 2018, you would lose 11.9%. On the other hand, if you bought SPY at the close and covered it at the opening every day since January 1993, you would make 565%!  This amazing 577% return differential is due to the fact that Bespoke’s research proved that more than 100% of SPY’s gains since 1993 happened after market hours.

If you want to be a successful ETF investor, you apparently have to stop trading ETFs during the day!  Well, not exactly. If you can successfully buy or sell an ETF at or near its net asset value – or what Morningstar calls its Intraday Indicative Value – then go ahead and trade during market hours. However, as too many ETF managers have learned, moving big blocks of ETFs during market hours can be problematic

The moral of this story is that managed ETF success comes from (1) waiting to trade ETFs during orderly markets with minimal premiums/discounts relative to net asset value, (2) avoiding poor trading platforms that prohibit “step out trading” to more effectively move big ETF blocks, and (3) naturally buying great smart Beta ETFs.

About The Author

Louis Navellier
CHIEF INVESTMENT OFFICER

Louis Navellier is Founder, Chairman of the Board, Chief Investment Officer and Chief Compliance Officer of Navellier & Associates, Inc., located in Reno, Nevada. With decades of experience translating what had been purely academic techniques into real market applications, he believes that disciplined, quantitative analysis can select stocks that will significantly outperform the overall market. *All content in this “A Look Ahead” section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.*

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