Deadlock Derailed the Market

The Fed and Political Deadlock Derailed the Market Yet Again

by Louis Navellier

December 26, 2018

TheFed.jpg

Stocks rebounded only briefly last Tuesday and intraday Wednesday, until a shocking Federal Open Market Committee (FOMC) statement derailed the overall stock market and resulted in high-volume “capitulation” selling to set new annual lows on three consecutive days last week, but if you look at a chart of each index, it is evident that all three major indices initially “retested” on light trading volume on Monday and then subsequently on higher trading volume on Wednesday, Thursday and Friday.

Unfortunately, on Wednesday, the FOMC statement was not dovish, as I had anticipated. The Fed not only raised its key interest rate 0.25%, but also signaled two additional key interest rate hikes in 2019. At his press conference, Fed Chairman Jerome Powell did nothing to calm financial markets. Although the Fed lowered its inflation forecast, their forecast was still way too high, ignoring all of the recent commodity price deflation. Here’s a link to my podcast on Wednesday, and yet again on Thursday.

So even though the Fed is providing guidance of higher rates in 2019, Treasury yields were falling in the wake of its FOMC statement. Confused?  I cannot say enough how perplexed I am about why the Fed is ignoring obvious market forces and a lack of inflation. It is very odd for Treasury yields to move in the opposite direction of the Fed’s guidance, so I will be rooting for falling market rates to continue to derail the Fed’s intended interest rate hikes in 2019 – since the Fed does not like to invert the yield curve.

In This Issue

We all had a wonderful Christmas break with families, but there’s no getting around the mountains of coal Santa left all over Wall Street and Washington DC. Bryan Perry begins Income Mail by lacerating the Fed for their “bait and switch” double-talk and deceptive language following last week’s FOMC meeting. Gary Alexander follows with harsh words for those citing some mythical “global economic slowdown” for causing this latest panic selloff. Ivan Martchev wonders why others are talking about a coming recession with 3.7% (and falling) unemployment and 3% GDP growth. Jason Bodner takes a much closer look at the machinations of ETF traders and finds some new causes for the recent volatility there. Then, I’ll wrap it up with a call for a some more sanity at the Fed and Wall Street in coming weeks.

Income Mail:
No Way to Sugar Coat How the Fed Blew It
by Bryan Perry
The Writing is on “the Wall” (and other charts)

Growth Mail:
What “Global Growth Slowdown”?
by Gary Alexander
Is the Market Really Fearing a “Great Earnings Slowdown”?

Global Mail:
2019 is the Year of a New Economic Expansion Record
by Ivan Martchev
Can the Stock Market Go Down in a Good Economy?

Sector Spotlight:
What One Word Would Best Describe This Market?
by Jason Bodner
The Role of ETFs in Creating Selling Panic Loops

A Look Ahead:
Treasury Secretary Steve Mnuchin Goes on the Warpath for Fiscal Sanity
by Louis Navellier
Most Economic Indicators Point Toward Fed Restraint (If They’re Listening)

Income Mail:

*All content of "Income Mail" represents the opinion of Bryan Perry*

No Way to Sugar Coat How the Fed Blew It

by Bryan Perry

There were two clear paths the Fed could have taken last week, and they clearly chose the wrong path. How a central bank can, on the one hand, lower their own growth forecast for the economy and then, on the other hand, rationalize raising interest rates against a frayed market landscape, escapes my understanding. Even worse, Fed Chairman Jerome Powell laid an 800-pound egg at his post-FOMC news conference in his Q&A, where few, if any, sensible questions were asked by the financial media. Instead, it was a Swedish meatball session, similar to an Obama press briefing. Why so remains anybody’s guess.

Powell ‘deep-sixed’ the stock market during his press conference, when he said, policy does not need to be accommodative now, and that he doesn't believe the current policy is restrictive. He added that he does not see the Fed altering its approach to balance-sheet normalization and sees the preferred policy method being the use of the fed funds rate.

This poppycock runs counter to what both the bond and stock markets are voicing out loud. Doubleline’s “bond king”, Jeff Gundlach, laid it out very clearly in a long interview on CNBC before the FOMC met. He noted that ever since the Fed began its Quantitative Tightening (QT) initiative in October 2017, the Fed has shed around $365 billion of its $4.14 trillion off its balance sheet. His models suggest that every $100 billion in QT is the equivalent of a quarter-point rate hike. So, adding up the nine rate hikes since QT began, plus the impact of QT, the market has had to absorb the equivalent of around 13 rate hikes.

QuantitativeTightening.png

Why the Fed hasn’t factored in the negative effects of that “sucking sound” of money coming out of the system truly escapes not only Gundlach, but anyone who has a working knowledge of the economics of liquidity. Without a full-blown white paper to back up my assertion, it seems to make obvious sense that the sinking S&P 500 seems at least somewhat linked to the Fed's balance sheet policy. After all, from 2009 to 2012, the Fed was slowly growing their balance sheet as stocks were moving significantly higher.

When the Fed really embraced QE in late 2012, the balance sheet expansion (blue line below) increased dramatically and stocks diligently rallied. From 2015 to September 2017, the Fed stopped growing the balance sheet; but then in October 2017, the Fed started decreasing their balance sheet by up to $10 billion per month, which changed to $20 billion/month in January 2018, then $30 billion a month in April to $40 billion a month in July and then to its present rate of $50 billion per month in October.

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And then it got worse. As last week went on, the Fed trotted out New York Fed President John Williams on Friday morning, when the 25-year Fed veteran offered a seemingly more dovish-minded perspective by saying in a CNBC interview that the Fed is listening to the market and that a balance sheet runoff is not ‘inflexible.” Those remarks triggered a brief rally, but true to recent form, there was selling into strength. Clearly, the Fed was trying to walk-back their dot-plot-robot mentality, displayed fully on Wednesday, but all that did was give the impression of “Amateur Night at the Chinese Fire Drill.”

The Fed’s credibility went straight out the window and stocks tumbled again, making it the worst week on Wall Street in 10 years. This ranks right up there with the worst plays ever, right up there with Miami Dolphins kicker Garo Yepremian’s epic attempted throw in Super Bowl VII. This was especially true for me when Dallas Fed President Robert Kaplan made a big deal on a CNBC interview on December 6, stating that “one of the key tools we have with the Central Bank is patience, and I think we ought to be using that tool.” Being that Kaplan is a voting member, investors took his comments to heart. What a Benedict Arnold move on his part, talking up a Fed that is “feeling the market” and then voting behind closed doors in “lockstep fashion” to raise interest rates. The retail world calls it “bait and switch.”

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How arrogant and hypocritical – and most of all, damaging to the public trust. This kind of shameful public display is akin to “deep state” machinations, sandbagging the investing world to create upheaval.

There is no way I can be convinced that waiting on further economic data and corporate guidance from fourth quarter results – all of which is crossing the tape in the next 45 days – wouldn’t have been the intelligent move. Even former Treasury Secretary Larry Summers, a big Trump opponent, agrees.

The Writing is on “the Wall” (and other charts)

You’d think for just one time that the Fed would have taken a more macro view of the economic situation. Some other chafing elements that weighed on investor sentiment last week included the likelihood of a government shutdown due to disagreements over funding a border wall, which happened late Friday.

Add to that a bothersome sense that the U.S. and China aren't going to be able to reach a trade agreement on structural issues in their prescribed 90-day window and the growing understanding that credit markets appear to be anticipating a growth slowdown due to tighter monetary policy that is being heavily priced into falling oil price ($45.59/bbl) and copper ($2.67/lb), which fed into those growth concerns.

All this uncertainty, and the inability to sustain any rebound effort from short-term oversold conditions, ultimately held back any sustained buying interest and led to a flight to safety in U.S. Treasuries. The Fed-sensitive 2-year yield and benchmark 10-year dropped 10 basis points each to 2.63% and 2.79%.

At this juncture, there are two charts that matter from my perspective. First is the 5-year chart of the S&P 500. The major bull-trend line that is still rising comes into play at 2,350, which the market could very well test in the days ahead. That’s about 2.7% lower than where the S&P closed on Friday (2,416).

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The second chart is that of the CBOE Volatility Index (VIX), which closed at $30.11 Friday, signifying sentiment moving from concern to fear to panic. Market technicians will state that such a spike in the VIX marks capitulation and, given how some of the best-of-breed stocks traded late last week, I would agree.

Because the final week of the year is going to be where trading could be thin, further high levels of volatility are almost a given, and if the S&P tests 2,350 the VIX will likely trade higher as well, or a post-Christmas bargain hunting scenario unfolds that would likely begin to define a bottom.

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And now for some year-end numbers to stew on.

According to the latest weekly FactSet Earnings Insight report (December 21, 2018), the forward 12-month P/E ratio for the S&P 500 is now 14.2, assuming the S&P will earn the consensus forecast of $175.50 a share. This P/E ratio is below the 5-year average (16.4) and below the 10-year average (14.6).

For 2019, the estimated earnings growth rate for CY 2019 is 7.9%. The estimated (year-over-year) revenue growth rate for CY 2019 is 5.3%. All 11 sectors are expected to report year-over-year growth in revenues, led by the Communication Services and Healthcare sectors.

The Industrials sector is expected to report the highest year-over-year earnings growth of all 11 sectors at 11.4%. The Consumer Discretionary sector is expected to report the second highest year-over-year earnings growth at 9.8%. Despite concerns of rising costs, the estimated net profit margin (based on aggregate estimates for revenues and earnings) for the S&P 500 for 2019 is 11.8%. If 11.8% is the actual net profit margin for the index, it will mark the highest (annual) net profit margin for the index since FactSet began tracking this metric in CY 2008. Eight of the 11 sectors are projected to see higher net profit margins in CY 2019 relative to CY 2018.

Numbers can, and will, change going forward, but using the current data, equity valuations are pretty compelling at these levels. Now is when investors should consider seriously upgrading their portfolios – selling any second- and third-tier companies and buying into the thoroughbred blue-chip dividend-growth stocks that have been taken down with the broader market. This is a time-tested ‘cut-and-build’ strategy that only comes along once about every five to 10 years. And now is one of those times.

Growth Mail:

*All content of "Growth Mail" represents the opinion of Gary Alexander*

What “Global Growth Slowdown”?

by Gary Alexander

“…the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror.” – FDR, 1933.

We are suffering through the sixth correction of 10% or more in the nearly-10-year history of this bull market. The last correction of this magnitude struck in January-February, 2016. The cause of that correction (as this) was fear of a global slowdown. Some of the headlines of that time were:

“World Bank Downgrades Global Growth in 2016” (UN News, January 5, 2016)
“5 Reasons the IMF Says Global Economic Growth is Slowing” (NPR, April 12, 2016)
“These 9 Charts Explain the Global Economic Slowdown” (Forbes, May 6, 2016)
“World Economic Growth is Slowing” (The Economist, May 19, 2016)
“We’re in a Low-Growth World. How Did We Get Here?” (New York Times, August 6, 2016).

What happened next? The world never stopped growing. Suddenly, stories of a global growth slowdown were replaced by stories of “coordinated global growth” in 2017. Every nation among the top 50 covered by The Economist each week (except Venezuela) was growing, and the growth rate surged from 3.2% in 2016 to 3.7% in 2017. The chart below (published in early 2018) shows real numbers for 2012-16 and projected through 2022, showing 2016 to be a low-water mark for the decade and no real “slowdown.”

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With the magic of compound interest, if the world actually grows as fast as the IMF projected earlier this year, the global GDP would be 48% greater in real terms (adjusted for inflation) in 2023 than in 2012.

But now, with renewed concerns for another “global growth slowdown” arising in late 2018, the IMF has lowered its forward projections for 2018 and 2019 growth from 3.94% to 3.7%, but that’s hardly a slowdown when compared to 2016 or even 2017. It’s the same fairly-rapid 3.7% annual growth rate.

A world growing 3.7% each year doubles its output every 19 years. Anyone want to complain about that?

Look at the top-line growth rate for the whole world – Christmas past, Christmas present, and Christmas future. Only a Scrooge would look at those numbers and call consistent 3.7% growth a “slowdown.”

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The formerly poor countries of Asia continue to lead the pack. From this point of the view, the poorest of the world are getting richer faster than the richer nations are accumulating more wealth. In this way, the global “wealth gap” is being rapidly closed, even if it is not being closed in each specific rich nation.

Fastest Growth Rates in 2019
India  7.4%
China  6.2%
ASEAN-5  5.2% (Indonesia, Malaysia, the Philippines, Singapore and Thailand)
Low-Income  5.2% (Formerly called “Developing Countries”)
Source: IMF, World Economic Outlook, October 2018

 

Meanwhile, the slowest growth rates are still positive, not negative, so there are no recessions, anywhere:

Slowest Growth rates in 2019
Japan  +0.9%
Italy  +1.0%
South Africa  +1.4%
U.K.  +1.5%
France  +1.6%
Source: IMF, World Economic Outlook, October 2018

 

There’s been a lot of talk about a Eurozone recession, but you’ll notice all those slow-growth numbers have a plus-sign preceding them – no recession in sight. Recently, ECB President Mario Draghi cut growth forecasts for the Eurozone by just 0.1% to 1.9% in 2018, down from 2.0% in September. Also, estimates for 2019 GDP growth were revised to 1.7% from 1.8%. That’s just a SINGLE TENTH lower.

Is the Market Really Fearing a “Great Earnings Slowdown”?

More likely than a GDP slump, the market may fear an earnings slowdown in 2019. That’s only natural after a year with a 23%+ projected earnings gain for the S&P 500, reflecting the first year of the corporate tax-rate reduction, but projected earnings growth rates for 2019 and 2020 are still 8%+ and 10%+. Ed Yardeni wrote last week that the 2019 earnings estimates are now +8.3%, and 2020 estimates are +10.4%.

AnnualGrowthForecasts.pngYardeni adds that “the growth rate for Q4-2018 has been reduced from 18.2% at the end of September to 14.5% currently. That’s not unusual. They often do so only to find that the earnings season was better than their downwardly revised estimates.”

Another overblown worry is the supposed decline in capital spending because businesses are “spending all their tax windfall on share buybacks.” Partly true, in that share buybacks may reach $1 trillion this year, but capital spending may reach $3 trillion and is growing just as fast. As Yardeni wrote last Tuesday (in “The True Story: Capital Spending at Record High”), nominal capital spending rose to a record high of $2.8 trillion (saar) during Q3-2018. Over the past year through Q2-2018, S&P 500 buybacks totaled $646 billion. That’s a lot, but it wasn’t enough to slow capital spending.” He charted the two together:

SpendingVersusBuybacks.pngThe market is terribly worried about something – maybe Fed policy or the government closing down. Whatever it is, scared investors are creating the worst December since 1931 (so far), and the worst fourth quarter since at least 2008 (we’ll have the final post-mortem next week). Maybe we desperately need to worry about something, no matter how good the statistical realities look. Perhaps investors would rather be worried, but I believe that the vast bulk of the world will continue to work hard and keep growing.

Global Mail:

*All content of "Global Mail" represents the opinion of Ivan Martchev*

2019 is the Year of a New Economic Expansion Record

by Ivan Martchev

I will say, flat out, that I didn't think December would be a down month, and it is shaping up to be the worst December since 1931. Needless to say, the economic environment today is very different than the time of the Great Depression, so the parallels are difficult to draw, despite the similarity of the stock market performance. Based on the latest consensus estimates from Factset, EPS growth for the S&P 500 is going to be 20.6% in 2018 with another 7.9% in 2019, along with 5.3% revenue growth to boot. If the S&P 500 ends 2019 where it is today, that would mean that share prices would have failed to respond to a compounded EPS growth rate of over 30% in two years (1.206 x 1.079 = 1.301).

If the economy is still growing in the second half of 2019, this will become the longest economic expansion in the history of the United States. I think it will continue for all of 2019. This means that, with a growing economy and growing earnings, this latest selloff is unlikely to be the start of a bear market.

My 2018 annual prediction – that the U.S. dollar would rally in 2018 – has worked out well, despite a very poor performance in the first quarter (for my full prediction, see December 18, 2017 Marketwatch article “Ivan Martchev’s 2018 predictions: Gold will sink, and the dollar will rally”). It needs to be noted that the dollar is up a lot more against emerging markets currencies than the old U.S. Dollar Index, which contains only developed market currencies. This more notable outperformance against emerging markets currencies for the dollar is likely to persist in 2019.

Recessions do not start with unemployment at a 49-year low of 3.7% (charted, below) and the economy growing at around 3%. Before a recession can start, the economy needs to slow, and the unemployment rate needs to stop falling and begin turning higher because of the economic slowdown. That takes time.

UnemploymentRate.png

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

While a slowdown is likely to begin in 2019, the recession will most likely happen in 2020 or 2021.

Can the Stock Market Go Down in a Good Economy?

Yes, a stock market can go down in a good economy, as it is has been doing recently. For a protracted bear market, we need to see a shrinkage in earnings per share for the S&P 500 Index. The more the EPS for the Index shrinks, the more the index goes down. This happened in the recessions of 2001 and 2008

In the year 2000, the stock market was overvalued but it took a while for the air to come out of the bubble before it bottomed in March 2003. In the year 2007, the financial system almost blew up with unregulated mortgage lending and repackaging of no-documentation loans into fascinating securities with oxymoronic names for AAA-rated sub-prime CDOs. The 1929 and 2008 declines were most similar, as they had to do with financial system leverage and cascading losses as the leverage was unwinding. Unfortunately, there were also serious mistakes on the fiscal side (tariffs that caused a collapse in global trade) and monetary front (tightening that caused banks to fail) in the 1930s. The 1974 decline was due to a big oil price shock.

While there is monetary tightening at present, it is not being done in a weak economy. And where tariffs are concerned, they are, so far, being used as a negotiating tactic. The Trump administration would argue that there has been progress on the trade front with Canada, Mexico, South Korea and even with the European Union, so this does not seem to be a full-blown global trade war, at least for now.

The most extreme example of the stock market going down in a good economy would be 1987.

DJIAversusFundsRate.pngThe 1987 market was the new Fed Chairman Alan Greenspan’s trial by fire, where he felt compelled to jump in with a few interest rate cuts, the same way he cut interest rates after the market sold off 25% in August and September of 1998 at the tail end of the Asian Crisis and the Russian sovereign debt default. Regrettably, the fortitude displayed by the famous Time magazine cover (below), dubbed “The Committee To Save The World,” is hopelessly missing at this very moment.

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I think the present volatility of the stock market is not due to the hiking of the fed funds rate alone, but also to the more disruptive overall quantitative tightening, which demonstrates itself via the rising Fed balance sheet runoff rate, which went from $20 billion in January to the present $50 billion/month rate.

BalanceSheetVersusDJIA.pngLetting bonds mature (and not reinvesting the proceeds) also results in large repurchase agreement activity, which sucks excess reserves out of the financial system. Sucking electronic cash out of the financial system may be the simplest possible explanation as to why the stock market is doing what it is doing. (Enterprising minds are urged to carefully read the paper “The Federal Reserve’s Balance Sheet and Earnings: A Primer and Projections” by Fed economists Seth Carpenter, Jane Ihrig, Elizabeth Klee, Daniel Quinn, and Alexander Boote. There are other similar papers available from the Federal Reserve.)

ExcessReserves.png

In my experience, sharp selloffs in a good economy tend to reverse themselves as the economy keeps growing and so does the earnings-per-share (EPS) for major stock market indexes like the S&P 500. Some of those “good economy” sharp selloffs – as in 1987 and 1997 – required active government intervention in order to stabilize the market, while others took care of themselves.

Still, in the present uncharted territory of quantitative tightening, I would have felt a lot better if Gary Cohn were the Fed Chairman. He ran a large investment management organization (Goldman Sachs Asset Management) and had extensive experience as a trader before becoming an executive and a CEO-in-waiting. One certainly needs a lot of theoretical experience to be a successful Fed Chairman, like Ben Bernanke proved, but in the situation that we have now, practical experience would also count for a lot.

Sector Spotlight:

*All content of "Sector Spotlight" represents the opinion of Jason Bodner*

What One Word Would Best Describe This Market?

by Jason Bodner

Wow!

I’m sure a lot of people are saying that word these days. It seems to be an appropriate utterance, but I’ve been using others words – like “abysmal” and “ugly” in the recent weeks of weekly reflections, but this week’s selling was also dreadful, terrible, and awful. Those were the Microsoft Word synonyms that came up for abysmal: One week, MTD, and YTD performance for the major indices are as follows:

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Depending on how you are invested, this is catastrophic. The sector performance was also atrocious. The sad truth is that now we only have two sectors with positive performance for the year, and one is clinging on by a thread. Utilities are +2.2% and Healthcare is +0.2%. Opening my sector performance screen is like peeling back the bandage in the scene from Castaway; it’s gruesome and uncomfortable.

We all know this. So, the question is why?  We’ve gone from a period of relative optimism to extreme pessimism in a few short months. Talks of slowing global growth and a possible recession dominate the headlines. If there’s one thing that gets markets moving, it’s fear.

The news attributes this latest panic to global slowdown and the Fed. Parts of Europe are dipping into fear of a recession (Germany and Italy). But in the U.S., the data has been rosy. Plainly, we have hit peak sales and earnings growth momentum. But does this supposed slowdown (which we have no concrete data for) really warrant a -25% haircut from the highs, as we are seeing in the Russell 2000 (since 8/31)?

Clearly, my answer is “no,” as my tone has been bullish on U.S. stocks, even in the face of this drastic selling action. I have cited data, fundamentals, and some technical action that was indicative of a bottom. I was right for a while and the bounce I accurately predicted gave way to this recent disgusting plummet.

Many say we can thank Jerome Powell for the levee breaking last week. The rate hike we saw was expected, but less expected was the implied commitment to hike twice more next year. Even less expected (and more disliked) was his reference to “further gradual increases.”

“The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective over the medium term.”

The issue was a future commitment to tightening and removing liquidity from the system. This was the last straw and caused the deluge of selling that came after.

We can also blame the government shutdown. We can blame the Mueller investigation seemingly getting closer to president Trump and potential charges. We can blame what we want in the headlines, but my belief is there is a clear technical catalyst and follow through. We should also be looking at ETFs.

The Role of ETFs in Creating Selling Panic Loops

Back in October, I wrote about how I saw the world of High Frequency Traders. These algorithmic trading firms use news as one of their inputs into trading decisions. When liquidity dried up on the bid-side of the market, they used bad news days as an opportunity to short into weak bids. This broke open volatility and began a domino selling effect.

I then wrote about how ETF model managers would eventually be forced to sell. When they need to sell hundreds of millions of dollars of a not-so-liquid ETF, they call up dealers (or interact electronically) and source bids. When dealers price a market where spreads are already widened due to heighted volatility, their bid/offer spreads widen. When they end up owning the ETF sold by the customer, they in turn must hedge by selling the stock components of the ETF. This pushes stocks down further.

The more I thought it through, the more I realized that ETFs may be causing the massive spikes in UI sell signals that we see, not vice-versa. This idea of the tail wagging the dog is what I’d like to discuss now.

As ETFs trigger sell points, I believe they actually drive stock action, especially on the down side. The number of ETF assets has grown dramatically over the years as well as the number of available ETFs. What we observed is that as the number of available ETFs and total assets they controlled ballooned, so did our signals counts. This was true for both ETF and stock signals.

As ETF managers execute redemption requests, the pressure on stocks is massively amplified. One stock may be in dozens or even hundreds of ETFs. At market pressure points, ETF dumping amplifies the selling of stocks. Furthermore, illiquid ETFs can have a major swing effect on stocks that comprise them.

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28YearsRussell2000VersusETF-Signals.png

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I believe that as assets fly out of ETFs, the forced selling started by model managers, in-turn started by HFT firms taking advantage of what was believed to be a temporary absence of buying, the pressure on stocks is rocking the entire market, and thus world markets.

While this theory may seem a bit far-fetched, we have begun work on an in-depth study which will become a larger report. So far, the preliminary data supports that thesis. So, for now, I’m going to go ahead and blame ETFs! Lipper came out Friday and said that month-to-date ETFs outflows are the largest on record since record-keeping began in 1992.

I also believe that it’s important for long-term investors to keep a cool head. We’ve seen irrational markets before. I’ve watched investors throw in the towel at the worst possible times. The herd is rushing for the exits. But know that if market sentiment can turn from positive to negative on a dime… it can also just as quickly change from negative to positive.

It may sound crazy, but I still expect a big bounce. The breadth of the market is terrible, with just 9% of S&P 500 stocks trading above their 50-day moving averages as of Thursday. Surely that number is lower now. Naturally, the S&P is in extreme oversold territory by many measures. Its 10-day advance/decline line has dropped to its lowest level in at least a year. The trailing 12-month P/E ratio for the S&P 500 has a 16-handle on it. That’s the lowest in multiple years. The dividend yield on the S&P 500 is around 2.2% while the 10-year bond is below 2.8%. Those two keep getting closer, which is bullish for stocks.

Finally, our MAP-IT ratio is cratering closer to 25%, which is oversold territory. We are at 26.9% as of Friday.

Russell2000.png

One last thing… we took a hard look at how extreme sell signals correlate to forward returns of SPY. The future returns for the market seem quite promising after we witness abnormally high sell signals. Of the 48 days that displayed unusual sell signals of the 400 or more since 2000, the market was positive three months later 70% of the time. If you had patience to wait 24 months, 76% of the time the market was higher, with an average return of +27%. (Naturally, the financial crisis of 2008 skewed the results.)

FinancialCrisis.png

Rest assured, this volatility will pass. I believe we’re 90% done with the sell-off in prices, and 75% done with the sell-off in terms of time. That means we’re close to a bottom. The bounce could be swift and fierce, but I realize that sitting through it and waiting for it to end is tough for everyone involved.

I know the volatility is brutal (another good word) but hang in there… The end is in sight.

A Look Ahead

*All content in this "A Look Ahead" section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.*

Treasury Secretary Steve Mnuchin Goes on the Warpath for Fiscal Sanity

by Louis Navellier

Treasury Secretary Steven Mnuchin has said he wants to conduct an inter-agency review of the current market structure. Specifically, on Tuesday in a Bloomberg interview, Mnuchin said,a normal trading day now is a 500-point range. A lot of that has to do with market structure, and that’s something we’re going to take a look at.”  Mnuchin added that he will ask the Financial Stability Oversight Council, which he heads, to study stock market volatility. The most revealing statement was that he said, “In my opinion, market structure has led to a lot more volatility,” blaming it in part on “high-frequency traders.”

Also interesting was that Treasury Secretary Mnuchin essentially dismissed the significance of a flattening yield curve, saying that, “I don’t necessarily believe that the yield curve at this time is an adequate predictor of future economic issues.”  When asked how much he looked at the yield curve as a reliable signal of the economy, Mnuchin replied by saying, “Not at all. Not at all.” 

Even more interesting, Mnuchin said that, “I’m a big believer in general that markets are not always efficient,” adding that he looks at a variety of market information, including federal funds futures, the stock market and oil prices. Mnuchin was diplomatic, refusing to address the Fed, but his boss, President Trump urged the Fed to “feel the market’’ and avoid “yet another mistake” by raising rates.

Lastly, Treasury Secretary Mnuchin added that China and the U.S. have had several rounds of talks in the past few weeks. Formal face-to-face meetings are now being scheduled in January, which gave the stock market hope that the Chinese trade spat may finally be resolved in the upcoming months. Mnuchin said that “We’re in the process of confirming the logistics of several meetings, and we’re determined to make sure that we use the time wisely, to try to resolve this” adding that both sides are now focused on trying “to document an agreement” by the March 1 deadline for their current tariffs truce to run out. Clearly, Treasury Secretary Mnuchin went on Bloomberg to try to calm financial markets last Tuesday.

Most Economic Indicators Point Toward Fed Restraint (If They’re Listening)

ForSaleByOwner.jpg

On Wednesday, the National Association of Realtors announced that existing home sales rose 1.9% in November to a 5.32 million annual pace compared to October. In the past 12 months, however, existing home sales have declined 7%, so a lot more improvement is needed before affordability issues can be resolved. In the Northeast, Midwest and South existing home sales surged 7.2%, 5.5% and 2.3%, respectively, but in the West, existing home sales declined 6.3% as that previously hot market cooled.

The Commerce Department announced Friday that durable goods orders rose 0.8% in November, after a sharp 4.3% plunge in October. A 67% surged in commercial jets and a 31.5% surge for military aircraft caused transportation orders to surge in November. Auto sales declined 0.2% in November and was the only weak transportation component. Excluding transportation, durable goods declined 0.3%. Core capital goods (excluding defense) declined 0.6%, while shipments declined 0.1%. In the first 11 months of 2018, durable goods have risen an impressive 8.4%, but the deceleration in the past couple of months is obvious, especially as autos and housing sales remain lackluster due to higher financing costs.

I should also add that on Friday the Commerce Department revised down the third quarter GDP growth to 3.4% (annual rate) in the third quarter, down slightly from the 3.5% previously estimated. The Atlanta Fed on Tuesday revised down its fourth quarter GDP estimate to 2.9%, down from 3% previously estimated, so it is apparent that GDP growth is slowing as higher interest rates impact key industries.

Finally, energy prices were sliding in tandem last week as both natural gas and crude oil prices have fallen due to weak seasonal demand. Natural gas is very weather-dependent and could spike when the next cold front envelops the Midwest and Northeast. Gasoline inventories naturally build in the winter months due to a lack of demand, but crude oil record production from Russia, Saudi Arabia and the U.S. continue to weigh on many energy stocks. Ironically, energy stocks are forecasted to have the strongest earnings announcement in January and February, so their guidance moving forward will likely be closely scrutinized. Overall, falling energy prices are further evidence that deflationary forces are widespread, and that inflation has fizzled. Longer-term, this lack of inflation should help put pressure on the Fed to stop raising key interest rates, but I’m frankly getting tired of saying that, since they aren’t listening.

The good news is that all (1, 2, 3, 5, 7 and 10-year) Treasury yields meandered significantly lower last week, which I thought would make the Fed “rethink” the long-term course of their interest rates policy. In fact, the 10-year Treasury bond yield hit a 4-month low below 2.8%, which is a good sign that market interest rates remain soft as inflation has fizzled. The Treasury yield curve is now the flattest it has been in 11 years, as a strong U.S. dollar continues to attract foreign capital, pushing Treasury yields lower.

In summary, as I said in my Thursday podcast, the stock market could be up 10% or more in short order in some future week, but we first need a “spark.” Frankly, I thought that Wednesday’s FOMC statement would be that spark, but the Fed did not have the dovish statement that I anticipated. President Trump is furious with the Fed. In fact, Bloomberg reported on Friday that the President would like to fire Fed Chair Jerome Powell, but knows he can’t. Also on Friday, CNBC interviewed UBS’s Art Cashin, where he said that the Fed may not raise key interest rates in 2019 at all and added that there is an outside chance that the Fed might have to cut rates. Frankly, we need more bullish comments from seasoned market veterans like Art (and Warren Buffett, and others) to inspire confidence and spark this next “market melt-up.”  

Let’s hope that spark happens right after Christmas!

I hope you had a wonderful Christmas and can look forward to a Happy New Year!


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