Market Returns to “Normal”

The Market Returns to “Normal” After Christmas Lows

by Louis Navellier

January 15, 2019

After falling nearly 20% in the fourth quarter, the S&P 500 is now up over 10% since Christmas, in the best three-week market stretch since December 2016, right after President Trump’s upset election victory.

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I think the best way to describe the market recovery in the past three weeks is a “return to normal,” or “normalization.”  I was especially encouraged to see many small-capitalization stocks “melt up” after suffering from liquidity woes in the fourth quarter. It was also rewarding to see some of the best stocks on the board rising strongly, even before their fourth-quarter earnings announcements come out. For instance, analyst upgrades from Raymond James and UBS helped Netflix (NFLX) steadily appreciate last week. The next big test will be the actual fourth-quarter earnings announcements – which begin this week.

Navellier & Associates owns NFLX in managed accounts and or our sub-advised mutual fund.  Louis Navellier and his family own NFLX, via the sub-advised mutual fund and in a personal account.

In This Issue

Bryan Perry offers a fascinating analysis of the changing dynamics of Chinese and neighboring Asian manufacturing plants, which portend a Chinese compromise on trade. Gary Alexander follows with an equally fascinating analysis of the “clean, green, and unseen” nature of GDP growth, the opposite of the belching steel mills of old. Ivan Martchev offers an encouraging message from the junk bond market, which never confirmed any “bear market” warnings during the recent stock slide. Jason Bodner gives an equally vital analysis of recent stock market actions in light of his unique “unusual institutional buying” indicators. Then I’ll take a look at “normalizing” ETF spreads, Treasury yields, and economic indicators.

Income Mail:
The Sino-U.S. Trade War is Adding Fuel to The Chinese Exodus
by Bryan Perry
Companies to China: “We’re Outta Here!”

Growth Mail:
Most Growth is Clean, Green, and Unseen
by Gary Alexander
The Internet Increases Productivity Without Boosting GDP Much

Global Mail:
The Dichotomy Between Junk Bonds and Stocks Continues
by Ivan Martchev
It’s the Market (before the Economy), Stupid!

Sector Spotlight:
What Happens When Stocks Fall 15%+ Then Rapidly Rise 10%
by Jason Bodner
ETFs are the “Tail that Wags the Dog”

A Look Ahead:
ETF Spreads and Treasury Yields Have “Normalized” in 2019
by Louis Navellier
The Market Recovery Has Coincided with the Partial Government Shutdown

Income Mail:

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

The Sino-U.S. Trade War is Adding Fuel to The Chinese Exodus

by Bryan Perry

Long before the first rounds of tit-for-tat tariffs kicked in early last year, the global manufacturing industry had already been relocating from China to other Association of Southeast Asian Nations (ASEAN) nations, including Indonesia, Thailand, Malaysia, Singapore, Philippines, Vietnam, Cambodia, Myanmar, Brunei, and Laos. Collectively, these 10 nations comprise over 650 million people with a nominal GDP of roughly $3 trillion and a per capita annual income of $4,600.

By comparison, China’s per capita GDP ended 2018 at around $7,400 per year and is expected to rise to over $8,300 in 2020. It is no secret that Beijing has a master plan to transform China’s once-dominant manufacturing juggernaut – formerly known as the “world’s factory” – to a more consumer-driven, service-oriented economy. Undertaken on a massive scale, that transition is curbing China’s GDP growth.

At the same time, household debt in China has risen from around 30% of GDP back in 2006 to over 50% of GDP now (chart, below), even while large employers of factory workers move out of China to other neighboring countries, where the cost of labor is substantially less. Though foreign business began leaving China long ago, the U.S./China trade war has now ramped up the pace of these corporate exits.

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

During the past 10 years, manufacturing wages in China have more than tripled while taxes and fees have also risen sharply. Back in 2004, production costs in China were roughly 6% lower than those of Mexico, but by 2014 the costs of production for identical products were about 4% lower in Mexico than in China. That’s a dramatic swing. Today, because of advances in factory automation technology, the average manufacturing costs in the U.S. are only 5% higher than in China (source: Boston Consulting Group).

Some multinational companies have relocated labor-intensive industries – like shoes and apparel – to the cheaper inland locations, away from high-cost coastal locations, but the impact of tariffs imposed by the Trump administration has directly affected this strategy, leaving companies with little alternative but to leave China and set up shop elsewhere, which for low-tech companies is an easy move.

Companies to China: “We’re Outta Here!”

The statistics of the volume of companies leaving China are pretty glaring. To date, more than 60% of Japanese companies operating in China have moved operations out of China to other countries, while the remaining companies are pulling out their capital due to the currency risk. Sayonara, China!

According to the American Chamber of Commerce in China, which has more than 900 member-companies operating across China, over one-third of the companies within their ranks have already made the move or have plans to relocate production outside the Middle Kingdom.

The Japanese newspaper Nihon Keizai Shimbun reported on September 16, 2018 that factories in China that manufacture shoes for Adidas, Nike, and Under Armour have moved manufacturing to Southeast Asia and India. Additionally, Asia’s largest shipping and logistics company, Kerry Logistics Network Ltd, based in Hong Kong, is currently moving its production lines from China to neighboring Asian nations.

Since the next layer of tariffs, set to be imposed on March 1, could apply to iPhones and other electronics imported into the U.S. from China, Apple and some of its suppliers are starting to explore other alternative locations within Southeast Asia for production of key components. It is estimated that Apple provides and supports over 4.7 million jobs in China with Foxconn being the largest private employer, at 1.3 million jobs.

While it is not conceivable that Apple could rapidly move its production of over 300 million devices per year to another country, requiring one million new skilled workers and billions of dollars in new capital investment, the fact that the subject is being talked about sends up a caution flag to Chinese trade officials.

Though the “Made in China” initiative is President Xi Jinping’s legacy project, as he seeks to dominate in areas of technology, aerospace, and electric vehicles, massive government spending over recent years has created a debt-to-GDP ratio of 260%. According to Bloomberg Economics analysts Fielding Chen and Tom Orlik, China’s total debt will rise to 327% of GDP by 2022, coupled with annual GDP slowing to 5.8% – and these estimates were made in November 2017, well before the current tariff war began.

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

Seeing as how the stock market is taking to heart the latest progress report from the U.S. delegation that held talks with high-level Chinese officials last week, we know that Chinese officials pledged to increase “substantially” the purchase of U.S. exports within energy, agriculture, and industrial goods. If they follow through, that promises to be kind of like a one-time “Black Friday” buying event for the U.S. economy.

This strategy is intended to entice the Trump administration, eager to reduce the trade deficit for political purposes, to agree to the sale of a big export package to China in return for the U.S. reducing the pressure on China over long-term structural issues – like forced technology transfer, IP theft, American ownership of Chinese companies, cyber intrusion into U.S. institutions, etc. The main takeaway from the talks from the Chinese Ministry was that “they established a platform for future discussions.”

Both President Trump and President Xi are under mounting pressure to reach a wide-ranging accord, but the U.S. delegation of Trade Representative, Robert Lighthizer, Treasury Secretary Steven Mnuchin, and White House Office of Trade and Manufacturing Policy, Peter Navarro, have all been eerily quiet on the talks since their return. It makes me suspicious that a less-than-ideal deal for the U.S. is in the works.

Basically, President Trump said last Thursday that the U.S. was having “tremendous success” in its trade talks with China. Our trade “tough guy,” Peter Navarro, who has a Ph.D. in economics from Harvard, has been muzzled, but even a senior Democrat, Richard Neal (D- MA), chairman of the House Ways and Means committee, which oversees U.S. trade policy, said that American negotiators have “an obligation to look beyond the political pressures of the moment and the easy, one-off transactions, and secure real and lasting change to China’s anti-competitive behavior” (source: Financial Times, January 12, 2019).

This input from Mr. McNeal is important because if Trump settles for a deal short on long-term structural substance to avert the March 2 deadline for hiking tariffs to 25% on Chinese imports, he will definitely be cheered by Wall Street, but scorned by his voting base for not taking the high road.

Thankfully, earnings season will take center stage starting this week while trade officials work the back channels and come up with a formidable plan heading into the next round of talks scheduled for later this month. The end result may be that China will elect for the first time to join the global neighborhood, where its actions and intentions are accountable to its people and to the rest of the world.

Growth Mail:

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

Most Growth is Clean, Green, and Unseen

by Gary Alexander

Whenever I share my columns with friends or family, they may like some of the things I write, but they are turned off by the word Growth. Their instinctive knee-jerk reaction is, “We don’t need more ‘things’ in this world – more pollution, more consumerism. We need smaller, sustainable, cleaner growth.”

Our universities and media have inculcated these Pavlovian reactions deep in their sub-cortex. Words like “growth” once represented greater health, wealth, and life expectancy, but now they conjure up visions of congestion, pollution, or even cancerous growth. I can’t explain in Twitterese why most growth is good, but maybe I can start to clean the closet of some misperceptions of the term “growth” in this short essay.

Most growth comes from greater productivity with fewer materials – like the miniaturization of our hand-held computers, offering more computing power in a smaller device through Moore’s Law. The Internet also offers us more opportunities to meet through telecommunication rather than via fuel-burning travel.

Although America keeps growing, our greenhouse gas emissions sank to a 25-year low in 2017. That, plus the decline in the cost of energy, means that the amount we spend on energy hit the lowest levels since the federal government started tracking such data. We spend less than 4% of our household budget on energy. From 2007 to 2016, GDP grew 12% (including the Great Recession of 2008) while energy consumption fell 3.6%. Over the past 25 years, according to the Business Council for Sustainable Energy, 92% of new electricity capacity built in the U.S. has been powered by natural gas or renewable energy.

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

The long-term story of growth is toward greater cleanliness of energy sources, not through subsidies but through innovation. John D. Rockefeller saved the whales by making kerosene far cheaper than whale oil. Henry Ford saved our city streets from tons of horse manure by making a “horseless carriage” affordable to the masses. Someday soon there will be cheap and less-polluting energy sources than fossil fuels.

One story on 60 Minutes last weekend profiled amateur scientist Marshall Medoff, 81, who invented a way to unlock energy inside plants to create clean fuel for cars and a plastic substitute that disintegrates in as little as 11 weeks. He is also converting some “junk” plant residue into ethanol, gasoline, and jet fuel that emits 77% less greenhouse gas than traditional gasoline. Maybe this is the next clean energy breakthrough but, if not, somebody just as creative will find a replacement to fossil fuels this century.

You may have seen last week’s report that carbon monoxide emissions increased in 2018 for the first time in seven years. This is supposedly one of the downsides of our phenomenal GDP growth rate (3%+) in 2018. In reporting this news last Wednesday, The Wall Street Journal printed this dramatic chart:

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

However, if readers would take the time to read the full report and the cause of the one-year reversal, the news is far better. Prior to 2018, the U.S. had been one of the world’s few success stories in moving away from coal-fired power. U.S. utilities had retired nearly 14 gigawatts of coal-fired power generation by the end of 2018, which may be a record, according to the report, issued by the Rhodium Group last Tuesday.

Meanwhile, natural gas generation grew four times as fast as wind and power combined through the first 10 months of 2018, the report said. While there was a 3% increase in diesel trucking and jet fuel used last year, the biggest demand surge came from unusually cold weather – yes, cold weather, not warming. The use of fuel oil, diesel, and natural gas to heat buildings rose 10% in 2018 to the highest level since 2010.

Longer-term, carbon emissions in 2018 were still down 11.2% from 2005 levels. The Wall Street Journal could have printed the following chart next to the above chart – just to put the two trends into perspective:

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

The Internet Increases Productivity Without Boosting GDP Much

Here’s how productivity and growth make life easier: In the mid-1990s, when I first began editing Louis Navellier and several other market analysts, they would need to fax their editorial copy to me. I would drive 20 miles a day, each way, to a brick-and-mortar office, where I would edit the copy, send it to a typist, who would load it into a primitive word-processing computer, then I would edit a few more iterations, send it back to the analyst for approval, then send it “camera-ready” to a printer, who delivered it to a mailer, who sent it to the subscriber. The whole process took about two weeks, 10 business days.

Today, I work in my home office. I receive copy electronically Sunday morning, edit in the afternoon, send it in the evening to editors on both coasts for review and approval, including legal compliance on Monday, and we send it to readers Tuesday morning. Many Internet publishers (without much fact-checking or legal compliance) publish their ideas in minutes. Today, I don’t commute (or burn gas) two hours a day and customers don’t wait 10 days to hear from their analyst, with outdated prices or advice.

None on this progress is reflected in the rising GDP. We charged $100 or more per year for those letters. That became a part of GDP. The gasoline I burned was part of GDP. So was the mail postage, the printing cost, and the word processors. How to value the Internet in GDP, in fact, is quite an accounting challenge!

More examples: An airline ticket in the 1970s cost $900 through a travel agent. I can buy the same route today for $350 on my own, online, and pick my own aisle seat. My convenience is sky-high, but GDP has fallen. I used to buy encyclopedias for $500. Now, Wikipedia has far more data, constantly updated, free.

None of that adds to the GDP. GDP was born in a manufacturing era, but today’s U.S. economy is over 70% in services or intangibles. It’s easy to measure “things you can drop on your foot,” but it’s very hard to value a service, especially those invisible electrons that make our life easier and more convenient.

I don’t mean to be overconfident or cocky about mankind’s progress. There is still much work to be done, and we all need to do as much as we can to improve our environment and to help others in our orbit.

A good place to start would be for multi-millionaires who preach about global warming to do away with their private jets and take fewer trips, then own fewer homes that are kept warm or air-conditioned year-around. I’ve got nothing against wealth – only against those who hector us about anthropogenic global warming and then fly around in their gigantic private jets to lecture Mr. and Mrs. Jones in their small home on 123 Elm Street that they should drive a costly, tiny electric car and recycle their paper straws.

Are you listening, Al Gore, Barbra Streisand, Leonardo DiCaprio, and Michael Bloomberg?

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A Dassault Falcon burns an average 318 gallons of fuel per hour, whereas a modern Boeing 737 MAX-8 or MAX-9 burns only two liters of fuel per 100 kilometers per passenger, which equates to 115 miles per gallon per passenger. Meanwhile, Mayor Bloomberg’s Dassault 900 gets less than two miles per gallon.

Global Mail:

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

The Dichotomy Between Junk Bonds and Stocks Continues

by Ivan Martchev

Mike Lanier, who has spent over 35 years in the trenches of the bond market, told me a while back that junk bonds “read like a bond but trade like a stock.” As the most volatile sector of the bond market, they offer significant opportunities to either make or lose a lot of money. The siren song of their much-higher yields only goes so far, as this is the price that must be offered for their much-lower credit quality.

Because of their volatility and intricacies between individual issues, it is my opinion that most individual investors should not buy and hold junk bonds, yet most investors should keep major ETFs and index spreads on their radar screen as they offer valuable insights on the prospects of the economy and stock market. Typically, the prospects of the economy and the stock market are intertwined, but as Nobel Prize laureate Paul Samuelson famously said in 1966, “The stock market has forecast nine of the last five recessions.” We appear to be in one of those famed dichotomies at present, as the stock market decline last quarter appeared to be predicting problems that the junk bond market did not (and still does not) see.

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

Many investors don't know that there is a heavy correlation between an index like the S&P 500 and a broad junk bond ETF like Barclays High-Yield Bond (JNK) or HYG. While the S&P 500’s rebound off the horrific Christmas Eve lows at the end of 2018 has certainly been impressive, the rebound in junk bond prices has been even more so. The JNK ETF is today where it was when the S&P 500 was near 2,800. For the sake of argument, if one were to use JNK as an indicator – and no single indicator should be used as a master key – one could reasonably expect another 200-point rally in the S&P 500, wiping out most of the fourth-quarter losses – i.e., those that were not driven by a deteriorating economy.

In hindsight, these fourth-quarter losses in stocks were driven by: 1) Federal Reserve overzealousness, 2) White House Twitter feed attacks on the Fed, 3) Mueller and other investigative bombshells, and 4) the trade negotiations. The minute we saw positive headlines on some of those fronts, and a notable change of tone by the Fed and the White House, the stock market and the junk bond market staged a big rebound.

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

In the vast majority of cases, the junk bond market tends to lead the stock market before big sell-offs and most certainly before major tops, but not this time. I looked at how junk bond spreads were performing 3-4 weeks into the 4Q sell-off in the stock market and I saw that the “junkier” the junk bonds were, the tighter the credit spreads. That told me that it was not an economic problem that was driving the selling.

I have said many times that sharp sell-offs in a good economy tend to reverse themselves. Some reverse themselves very fast, like in 1998, while others take some time, like in 1987. The stock market went down better than 20% in those cases but those weren't real bear markets. The fact that junk bonds are now rebounding quite a bit more vigorously than stocks is a positive sign for the stock market.

A real bear market would be characterized by a grinding decline that takes its time due to shrinking EPS for a major index like the S&P 500. Last time I checked, for all of 2018, companies are expected to report EPS growth of over 20% and revenue growth of 8.8%. For all of 2019, analysts are projecting earnings growth of 6.9% and revenue growth of 5.5%. Those projections have been aggressively cut in the last three months, but they are still positive and the economy is still expanding.

It’s the Market (before the Economy), Stupid!

As earnings season approaches, is it possible that a lot of companies are getting too pessimistic in their earnings guidance because of the downdraft in the stock market? Could they be thinking that falling stocks – as well as December’s experience with impossible-to-issue leveraged loans and junk bonds – mean a weaker economy? It sure is. In the brave new world of quantitative easing, it was the stock and bond markets that pulled the economy out of a recession, as QE inflated assets prices. Now, quantitative tightening (QT) is deflating asset prices. The question is: Can QT push the stock market and the junk bond market sharply lower, and can such declines cause a recession themselves?

In other words, in the brave new world of quantitative tightening, is the tail wagging the dog?

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

 In theory, draconian QT policies by the Fed can create a crash in the stock market, as well as the junk bond market, contributing to a recession. The Fed has the power to crash the economy by increasing the suction rate of excess reserves and thus removing large amounts of electronic cash from the financial system. I don't believe they want to do that, but in theory, they can, if they want to.

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Over 20 years ago, one of my favorite graduate school finance professors told the class on multiple occasions that he thought the Fed Chairman (then Alan Greenspan) had more power than the President of the United States (Bill Clinton at the time). I was still a rookie and found it easy to dismiss his rather bombastic statement, but after more than 20 years in the trenches of the fascinating world of finance, I have come around 180 degrees on the issue. The trouble is: Being Fed Chair is an unelected position.

Sector Spotlight:

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

What Happens When Stocks Fall 15%+ Then Rapidly Rise 10%

by Jason Bodner

We are capping off another strong week. Weakness on Thursday morning was met with strong buying. On Wednesday, Bespoke Investment Group put out a report saying the S&P 500 has staged a very rare comeback. To summarize their findings:

  • After declining over 19% in less than three months, the S&P 500 came roaring back for a 10% gain in just 10 trading days.
  • Since WWII, there have only been 12 other declines of 15%+ within the span of three months that were followed immediately by a 10%+ gain in 10 trading days or less.
  • After those previous 12 instances, equity returns were generally positive. In half of these prior sharp bounces off of 15%+ declines, the S&P 500 never made a lower low within the next year.

This fits very nicely with what we have been saying here. The MAP ratio went oversold in October and I said, “Expect a bounce.” A +7% rally succumbed to wicked selling, pushing us oversold again. “Expect a rally,” we said. Now, after 12 trading days since the Christmas low, the S&P 500 closed Friday up 10.4%.

Info Tech, Energy, Consumer Discretionary, and Real Estate were last week’s big winners. This makes sense as they were heavily punished for so long. It also fits with the theme of small- and mid-caps seeing notable buying. The Russell 2000 outperformed significantly this week, as did the S&P Mid Cap 400 and Small Cap 600. Either way, it’s both refreshing and eerie to see this much green. I would expect a give-back and Friday set up for a modest correction, but Friday recovered ground through the day.

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

When we run our models, we scan 5,500 stocks a day. We find that only about 1,400 of those can absorb institutional-sized orders without a major impact on price. Out of these, the model gets “tripped” by stocks that trade on above-average volume and volatility. At Mapsignals, we look at those “trips.” The last 5+ years show us an average of 500 stocks per day (that means that roughly 35% of institutionally tradable stocks trade on larger-than-average volume as the norm). Don’t confuse “trips” with actual buy and sell signals. Trips just mean that a stock is trading unusually. In order to get a buy or sell signal, the stock also has to break above or below a recent technical high or low. So, what are the “trips” telling us?

Below is a 29-year chart of the S&P 500 with days of trips (unusually-traded stocks and ETFs) which were twice the daily average or more noted in red. You will typically notice that extreme selling days yield a lot of trips. This is logical, but as noted in the past several weeks, extreme lows tend to also coincide with big ETF signal days.

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

ETFs are the “Tail that Wags the Dog”

We have been postulating that ETFs are the tail that wags the dog, that is, ETFs became the directors of market direction – through massive asset gathering and allocation – especially under periods of uncertainty and heavy pressure. This lends even more credence to the thought that the fourth-quarter sell-off began with uncertainty over rates, trade, and the global growth slowdown. This took buying pressure out, which paved the way for high-frequency traders (HFTs) to profit off of thin liquidity and high volatility. The pressure of that condition led to ETF model management reaching sell-triggers. Then, liquidations of ETFs caused a massive dislocation in the market.

One stock can be present in many ETFs. For example, according to ETFdb.com, Facebook (FB) is present in 138 ETFs, totaling about 200 million shares. A redemption of hundreds of ETFs on the same day, as seen by the orange spikes above, representing heavy selling, amplifies volatility in a big way. And when markets are down, ETF spreads tend to blow-out, which also affects stock bid/offer spreads.

It’s clear to us that ETF passive management gobbling up retail assets for decades has reached a tipping point. The ETFs move stocks, not vice-versa. A larger study is almost concluded which will go into much greater detail, but I’ll state the clear conclusion here: We believe 2018’s horrendous finish was caused by fear vaporizing buying. Then, as soon as the decline got too uncomfortable for retail managers, ETFs caused a monstrous cascade of selling.

Navellier & Associates does not own FB in managed accounts and or our sub-advised mutual fund.  Louis Navellier and his family do not own FB personally.

So, when Financial Advisors (FAs) who spent a decade-and-a-half gathering assets and plopping them into passive management vehicles (namely, ETFs) have their model managers say to “hit the sell button,” the FAs all rush for the exits on the same day. This is what happened this past fall.

As of now, our Mapsignals ratio is increasing and currently sits at 31.8%. For the last few days, we are seeing more buys than sells in stocks. In fact, the last five days has averaged 85.4% buying (that means that our data says that 85% of our buy and sell signals in stocks are likely buy tickets). Homebuilders, Health Care, and Info Tech are starting to get bought. (The ratio has a low value because it’s a 5-week moving average and the prior four weeks favored selling.)

As noted in last week’s study, when the ratio pops back above 50% after being below 50% (meaning, sellers in control) for 40 days or more, forward returns should be strong from 1-12 months out. We have 2 weeks so far of positive action for the market. Small- and mid-caps lead the rebound and the market is being re-liquified. Pension funds, mutual funds, and assorted other institutional managers are deploying capital and bringing liquidity back into the market- something we noted should happen (in prior weeks).

We continue to be bullish on U.S. equities. We believe the trade stand-off will be resolved. The Fed is now being apologetic and walking back their language. Fourth-quarter earnings are upon us and we believe we are in for another strong earnings season. We look for a more selective phase of the bull market for 2019.

A Look Ahead

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

ETF Spreads and Treasury Yields Have “Normalized” in 2019

by Louis Navellier

Last year was marred by two major selling panics – in late January and December – which particularly punished investors who blindly sold ETFs during those panics. During 2018, SPY – the largest and most liquid ETF, one which supposedly tracks the S&P 500 – declined 20.4 during market hours, but rose 13.3% after market hours, according to researchers at Bespoke Investment Group (BIG). How can that be? This would not be possible with a highly-liquid stock, but this 33.7% performance differential for the largest and most liquid ETF exposes how individual investors that panic during market hours got fleeced.

The good news is that these excessive ETF premiums or discounts have finally “normalized.” This should help to restore investor confidence in the upcoming months. (For more on how this works, see Ivan Martchev in MarketWatch, “This is how some ETFs are run like a shell game scam,” June 27, 2018.)

Treasury yields have also “normalized” a bit in the wake of December’s strong payroll report. I am carefully watching the Treasury auctions as the bid-to-cover ratio has tightened up a bit to 2.5 vs. 2.8 when yields were falling, so Treasury yields have meandered a bit higher. However, the big news on the Treasury front is that the Fed is “data dependent” once again, so the fear of an imminent interest rate hike has diminished. Specifically, the Federal Open Market Committee (FOMC) minutes, released on Wednesday, revealed that “many participants expressed the view that, especially in the environment of muted inflation pressures, the FOMC could afford to be patient about further policy firming.”  The FOMC minutes went on to state that they have “some latitude to wait and see” how the data develops.

I should add that Boston Fed President Eric Rosengren on Wednesday said that the recent decline in asset values (the recent drop in stock prices and the housing market) could cause economic growth to slow, which would reduce any need for future interest rate hikes. Rosengren also added that financial market sentiment has been “unduly pessimistic.”  I should also add that Rosengren is one of three new voting members that have been added to the FOMC this year. The other new voting members are Chicago Fed President Charles Evans and St. Louis Fed President James Bullard, both of whom are outspoken doves.

The Market Recovery Has Coincided with the Partial Government Shutdown

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Another wild card is the partial government shutdown. After Tuesday night’s Presidential Address, it is apparent that the partial shutdown will continue until President Trump and House Majority Leader Nancy Pelosi resolve their differences. Right now, this rift has become a big game of “chicken” to see who will “blink” first. Majority Leader Pelosi is now arguing that the federal government should be reopened before negotiations continue. Despite the fact that many federal workers and contractors are not getting their paychecks, which may soon adversely impact retail sales, the stock market does not seem concerned.

The federal government showdown is expected to spread to the federal court system next week, so it will be interesting to see how all this ends. In the meantime, the stock market remains oblivious to the federal government shutdown and has not yet been adversely impacted. By the way, despite a delay in federal income tax refunds due to the shutdown, we still have to pay estimated quarterly taxes by January 15.

Thanks to the partial government shutdown, there was not a lot of economic news released last week, but a private company, the Institute of Supply Management (ISM), reported that its non-manufacturing (service) index slipped to 57.6 in December, down from a robust 60.7 in November, to the slowest pace in the past five months. This deceleration in the ISM service index was not a surprise, since economists were expecting a reading of 58.4. Any reading over 50 is still considered an expansion, so the service sector continues to expand at an impressive pace, just a bit slower. The new orders component actually rose slightly to 62.7 in December, which is a good sign that the service economy remains healthy.

The Labor Department was kind enough to announce last Friday that its Consumer Price Index (CPI) declined 0.1% in December, the first decline in nine months. The core CPI, excluding food and energy, rose 0.2% in December, since it factored out the 3.5% decline in energy prices. In the past 12 months, the CPI and core CPI have risen 1.9% and 2.2%, respectively. The fact that the CPI is right around the Fed’s 2% inflation target should allow the Fed to be “patient and flexible,” which Fed Chairman Jerome Powell assured the Fed would be during an interview on Thursday at the Economic Club of Washington DC.

Finally, the trade talks with China are apparently progressing well, based on preliminary reports. The U.S. has tremendous leverage over China, which is in the midst of an abrupt economic slowdown. The latest casualty of the economic China slowdown are European automakers like Jaguar Land Rover, which announced layoffs for 4,500 workers, representing about 10% of their overall global workforce. Ford (F) also announced that it would lay off European workers and shut down at least one manufacturing plant in France. In the midst of this global economic slowdown, I expect that China will be eager to resolve its trade dispute with the U.S. in the upcoming months, and that would be a big boost to the stock market.

Navellier & Associates does not own Ford in managed accounts and or our sub-advised mutual fund.  Louis Navellier and his family do not own Ford personally.


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