August 7, 2018

July 3rd to August 11th comprise the “dog days” of summer.  Late sunsets, beers on the beach, and loose and easy bedtimes for kids all come to mind. It’s usually a time when most of us think of relaxing….

The dog days of summer are named after the rising of Sirius, the Dog Star. Greek and Roman astrologists associated Sirius with heat, drought, and sudden violent thunderstorms. It also connoted lethargy, fever, mad dogs, and bad luck. Now, they are just the hottest days of summer in the Northern Hemisphere.

Summer is also a time of change and flexing. These changes can go unnoticed. For instance, the Eiffel Tower actually grows six inches taller in the summer, due to the expansion in the iron.

The stock market is also bowing and flexing. Sectors are sloshing around. Money is moving in and out of the sectors more quickly. Growth stocks sag on one day and then surge the next. The headline effect on stocks seems amplified. This is all completely normal. Summer brings about heightened volatility with lower trading volumes and more traders focused on their upcoming vacations.

But we are also in the height of earnings season. Some price reactions after earnings reports have been outsized when compared to “normal” earnings reactions. We are witnessing it first hand with stock “re-pricings,” compounded by fears spouted by media outlets. Just remember, fear gets more eyeballs than happy pictures of fuzzy puppies. The more fear, the more eyeballs; the more eyes, the more ad revenue.

That’s why “trade war” stories sell ad space. But instead of asking whether a trade war will decimate economic life as we know it, you should ask: “Are earnings working?” Check these stats…

According to FactSet’s latest report for Q2 2018:

  • 81% of the companies in the S&P 500 have reported actual results.
  • 80% of S&P 500 companies reported a positive EPS surprise (currently the highest since Q3’08).
  • That’s well above the 5-year average of 70% positive surprises.
  • The earnings surprise percentage (+4.9% above expectation) is above the 5-year average.
  • 74% reported a positive sales surprise – well above the 5-year average of 58%.
  • The earnings growth rate for the S&P 500 is 24% (currently second-highest since Q3’10).
  • Ten sectors have higher growth rates (vs. second quarter) due to upward estimate revisions and positive earnings surprises.

In short, earnings are stunning and continue to be very upbeat. One thing is clear: We are not having notable earnings and sales deceleration. Here’s a look at earnings and sales by sector:

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

Sector Rotations are Often More Rapid in Summer Months

We are seeing sector rotations in recent weeks as rate-sensitive sectors like Real Estate and Telecom got a boost. The Fed left key rates unchanged yet signaled a likelihood for future hikes, but the bottom line is that the fears earlier this year of hyper-aggressive rate hikes this year and next were clearly unfounded.

Health Care has been on a quiet tear, rising nearly 11% in the last three months. Strong sales and earnings boosted this sector, which faced headwinds from Trump-talk about unfair pricing.

As we look at our nine-month winners, we see Information Technology and Consumer Discretionary still in the lead, but these sectors have been hit with some profit taking lately. Earnings, as we can see above, have been overwhelmingly positive, which gives a great excuse to take some profits “off the table,” but even negative earnings have been a catalyst to sell positions with gains still left in them. I do believe these sectors will return to favor as liquidity rushes back into the market after the summer ends.

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

I have mentioned before that I believe the trade war rhetoric is overblown and not the major concern it is being made out to be. The EU leadership is working with Trump toward zero tariffs. China is devaluing their currency, which in the face of increased tariffs could offset the tariff by making goods cheaper.

There is also a theory that this is part of a Trump “master plan.” If Trump inflames the trade war situation now, he could come forward in September or October with a solution. This would of course assuage fears in the market and cause a lift in prices. It would also soothe rattled nerves and show a significant victory.

This would come at an opportune time – just before mid-term elections. Either way, the bottom line is this: Sales and earnings are superb for yet another quarter. Interest rates are smoother and more measured than originally anticipated. Trade war fears are a distraction, but Trump’s agenda is ultimately to help America not harm it. Whether or not this rings true with voters will be determined in November.

For now, the market remains strong, with terrific growth metrics. I believe the next two months will see more volatility and, since earnings season ends soon, we will see the algorithmic traders take advantage of low-liquidity environments soon. They will amplify volatility and move stocks around more rapidly, but stay focused on being positioned with the companies having the best sales, earnings, and institutional support. These are the stocks that will lead the market higher into the end of the year.

There are calm markets, and choppy ones. Willa Cather said it best: “There are some things you learn best in calm, and some in storm.”

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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