Stock Market Celebrates

The Stock Market Celebrates, While Washington Squabbles

by Louis Navellier

January 23, 2019

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The stock market continued to recover last week despite ongoing uncertainty about the partial federal government shutdown and British debates over Brexit. Other than the IRS recalling 46,000 furloughed employees to process tax returns, it looks like the federal government shutdown will continue to escalate. I am betting that the shutdown persists through the State of the Union address on January 29, since President Trump is digging in on his border security demands and will likely relish lambasting Congress.

So far, the S&P 500’s 14% recovery since December 24 has coincided almost exactly with the shutdown dates. Last Thursday, the market rallied on news that President Trump had abruptly cancelled the use of a military plane for House Speaker Nancy Pelosi’s overseas trip to Afghanistan, Egypt, and Belgium, along with other Congressional representatives, but he allowed them to fly “commercial.”  As President Trump cracks down on Congressional junkets, as well as mocking them for running off with lobbyists to warm-weather resorts, he is basically trying to force representatives to stay in Washington to work on a solution.

In This Issue

Bryan Perry examines why he thinks we’re on more solid ground, but he still favors high-yield blue-chip “ballast” stocks that have withstood the recent storm. Gary Alexander honors the memory of Jack Bogle, while taking a skeptical look at the Frankenstein monster that cap-weighted index funds have become. Ivan Martchev covers the likelihood of an imminent China trade deal and the related cause behind lower oil prices – lower Chinese demand. Jason Bodner is still bullish, and he explains why the data told him to hold on (or buy more, if possible) during the recent Christmas crash. Then I’ll explain why the same old global crises now “don’t seem to matter” to the market, and why the Fed may stop raising rates in 2019.

Income Mail:
Bulls Are Hoping We’re Back on Solid Ground
by Bryan Perry
Ballast Stocks That Withstand Storm Conditions

Growth Mail:
All Hail Jack Bogle, But…
by Gary Alexander
Real Investors Don’t Cap-Weight Their Portfolios

Global Mail:
Here Comes the Chinese Trade Deal
by Ivan Martchev
Crude Oil is the Big Driver of the Improving U.S. Trade Balance

Sector Spotlight:
What a Long, Strange Trip This has Been
by Jason Bodner
What the Past is Telling us about Today, and Tomorrow

A Look Ahead:
A “State of Perpetual Crisis” is No Longer Killing U.S. Stocks
by Louis Navellier
Most Economic Indicators Argue Against Fed Rate Increases

Income Mail:

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

Bulls Are Hoping We’re Back on Solid Ground

by Bryan Perry

In light of the spectacular stock market rebound off the Christmas Eve lows, I wanted to take a quick look through the rear-view mirror to examine some facets regarding the impact that correction had on investor sentiment, and what we can learn from the recent washout. The sell-off officially started on October 4th and ended December 26th after the S&P had lost roughly 20% of its value. In the span of only 17 trading days, the S&P has now rallied from 2,346 to close last Friday at 2,670 – a stunning 13.8% rebound off the lows and easily the most impressive short-term rally I’ve experienced in my 34 years in the business.

We can pretty much define the sell-off unfolding in three phases: investor concern in October, investor fear in November, and investor panic in December. The CBOE Volatility Index (VIX) spiked from 15.96 to 36.41 and has subsequently fallen back to 17.42 as of Friday’s closing bell. It’s as if Shakespeare’s play “The Tempest” were being played out in modern times – that’s the play where the sorcerer Prospero conjures up a great storm to cause his victims to believe they are shipwrecked on a remote island.

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For investors who were long the market on Christmas Eve, it sure felt as if stock portfolios had run into a jagged reef with the hull taking on water. But in the few days after Christmas, news of the Fed changing its hawkish tune, the U.S. Trade Team announcing a trip to China in early January, and solid holiday retail sales data put a fire under a deeply oversold market and the bulls haven’t looked back since.

Most investors are not aware that there is a highly influential “crowd effect” that exists on the floor of the NYSE. This elite group of floor traders has powerful influence on short-term market sentiment. Within the “crowd,” seeds of optimism and pessimism are sown which are watered by the biggest global trading desks they work with, which then morphs into public sentiment. These “specialists” are those whom CNBC’s Bob Pisani speaks with on the floor of the NYSE and reports to viewers daily. I personally like what he has to contribute more than most of the network’s talking heads, who often wear their emotions on their sleeves. Instead, Bob Pisani often gets the best insights into what institutional money is thinking.

It stands to reason that the current “crowd” sentiment has resolved that a trade deal is taking the form of a huge bribe by China to buy $1 trillion of goods over the next six years with the intention of reducing the trade deficit to zero. The offer states little if anything about the structural issues that investors are by now acutely aware of. China’s economy is being evermore impacted by tariffs, which President Xi is feeling pressure from, and President Trump’s needs to shore up his sagging poll numbers and calm the market.

This is the kind of deal that can get done in the next four to six weeks, before the next round of tariffs kicks in, and this is why we’re not hearing from trade hawks like Peter Navarro and Robert Lighthizer, since China floated the offer. This comes only 10 days after Mr. Lighthzer said he didn’t see any progress made on structural issues during the Jan 7-9 U.S./China talks. And sadly, China’s latest deal doesn’t offer any new concessions on structural factors. But again, desperate men (Trump and Xi) do desperate things.

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Wall Street wants to believe that there is a deal in the making, so the Trump team is more than willing to put structural issues off, to be dealt with later. This means the market narrative has found a way to paint a much rosier picture than one month ago. The “crowd” is anticipating a grand purchase deal with China, the Fed is on hold, the government shutdown affecting 800,000 workers is more politics than economic impact, the risk of a hard-Brexit is out in late March, early Q4 earnings reports are encouraging, and the global slowdown will somehow come to an end if a trade deal is struck. At least, this is how I’m seeing it.

Ballast Stocks That Withstand Storm Conditions

After such a spectacular rally off the late December lows, it would seem unimportant to talk about the possibility of another retest of the lows anytime soon, given the remarkable change in crowd sentiment. At the same time, if the stars don’t line up in the next few weeks and market volatility returns, stocks may undergo some back and filling, so it might pay to point out a couple of realities on the “income” frontier.

Being long cash now pays somewhere between 1% and 2% in money markets. Short-term Treasuries pay about 2.5% to 2.7%. Qualified dividends that pay yields north of 3%, where taxes are capped at 20% for those with ordinary income taxed at the max rate of 39.6%, sure beats yields on cash and Treasuries while paying that same 39.6% rate on earned interest from bonds and money markets.

In a market where all rationality sometimes goes out the window – like in mid-December, when the “sell first, ask questions later” mentality drove the tape – it always gets my attention when the market reveals which stocks it trusts the most to manage through the storm. Every market correction uncovers those few names the “crowd” finds to be not just worthy of holding, but worthy of piling into further.

As most stocks caved in during the height of the selling pressure, I noticed five big-cap blue-chip stocks that traded at decade-long highs, or at new all-time highs.

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For 2019, the short-list of ultra-safe stocks that big money wants to own when volatility spikes is a pretty clear-cut portfolio of all-weather, dividend-paying equities that throw off qualified income and pay yields above 3%. The blended yield of these five stocks is 3.67%. Not bad, if one has to ride out another storm.

Thankfully, the market has found its footing and investors are feeling a huge sigh of relief, although the year ahead still holds a high degree of “risk-off” potential. At such times, it’s invaluable to know what to rotate into on short notice. After screening stocks for comparable market cap, defensive sector properties, financial strength, and dividend yield – these five stood out like lighthouses against crashing waves.

Navellier & Associates does not own KO, DUK, PFE, PG, or VZ in managed accounts or sub-advised mutual fund. Bryan Perry does not own KO, DUK, PFE, PG, or VZ in a private account.

Growth Mail:

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

All Hail Jack Bogle, But…

by Gary Alexander

Vanguard Fund founder Jack Bogle died last week. He was the champion of rookie investors everywhere by designing and inventing the first “index fund” back in 1975. No longer did beginning investors have to buy 10 or more individual stock names, at ridiculous brokerage fees, to acquire a balanced portfolio. He launched the fore-runner of his Vanguard Index Fund on December 31, 1975. The timing was fortuitous.

When the stock market peaked in early 1973 and then suffered a long two-year descent, many “Nifty 50” stocks tanked, so the idea of a “broad market index fund” arose, first as a theoretical idea in a popular book by Burton Malkiel, called “A Random Walk Down Wall Street.” In the book, Malkiel fantasized:

“What we need is a no-load, minimum management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch winners….Such a fund is much needed, and if the New York Stock Exchange (which incidentally has considered such a fund) is unwilling to do it, I hope some other institution will.”

That “other institution” became Vanguard Funds, founded in 1975 by Jack Bogle, who had recently been fired by Wellington Management Co. He launched the First Index Investment Trust (later renamed the Vanguard 500 Index Fund) on December 31, 1975. As a result of his untiring efforts since then, plus a long bull market (1982-99) delivering gigantic returns, Vanguard is now the largest mutual fund company in America, by far. At last count, Vanguard controls $3.8 trillion in assets under management (AUM), or about 20% of the $19 trillion placed in mutual funds, far ahead of #2 Fidelity, at $2.1 trillion in AUM.

Then came ETFs. During this week in 1993, the index fund turned into a potential Frankenstein monster when the first index Exchange-Traded Fund (ETF) arrived on January 22, 1993. That’s when State Street Global Investors released its S&P 500 Trust (SPDR, or “spider” for short). With ETFs, investors don’t need to wait for end-of-day settlement price, as with mutual funds. They can trade ETFs during the day.

That’s when Jack Bogle’s egalitarian “index fund” turned into a potential Frankenstein monster. Now, the SPY ETF is not just owned by the “little guy” in trainer wheels. Massive institutions with algorithmic formulas for darting in and out of the market in nano-seconds use SPY, leaving market chaos in its wake.

As Louis Navellier and Jason Bodner have been pointing out here for several months now, ETFs can trade at steep premiums and discounts to NAV, thereby fleecing small traders. ETFs can also fail to accurately track their benchmark in “flash crashes” or deep crashes, or during wicked volatility days such as what we saw last December.

As of the end of 2018, the four biggest funds are index funds led by the S&P ETF, followed by Vanguard:

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This trend has continued through the end of 2018. Last Wednesday, the day Jack Bogle died (January 16), Morningstar reported that actively-managed funds suffered huge net outflows of nearly $143 billion in December – their worst month ever – and -$301 billion in net outflows for the full year 2018.

Morningstar analyst Kevin McDevitt said that actively-managed “large-growth and large-value funds continue to get hit the hardest.”  In December, investors fled to cheaper passive strategies. Index funds reeled in nearly $60 billion in December alone. Investors have seemingly thrown in the towel on stock-picking or managed funds: “I’ll just buy ‘the whole market’ and admit I’m powerless to beat the index!”

Index funds are still ideal for beginners with only a few thousand dollars to invest. For the last six years, for instance, I have been Board President of a local historical society and an index fund is the only kind of stock investment where I can get board approval. Nobody wants to “speculate,” and index funds feel safe.

But in my personal life, I have never invested in index funds. I have been a stock investor, following the lead of analysts I trust, like Louis Navellier. I would never aspire to be “average.” It seems un-American. What kind of American dreams of being a “C” student, sitting on the junior varsity bench in high school and then majoring in finance, settling into suburbia with 2.3 children, and getting into his “driverless car” to commute into a big box building where his job is to add or subtract stocks for some index fund? 

Investing in highly-popular “index” funds is like seeking a guaranteed “C” average. That might work in egalitarian Europe but not in entrepreneurial America. More to the point, investing in these somewhat-manipulated big-cap averages can – at times (like 2000 or 2008) – be dangerous to your financial health.

Real Investors Don’t Cap-Weight Their Portfolios

One big problem with index funds is that they are “cap-weighted,” so that huge mega-stocks (like the FAANG stocks) can dominate the index. This can lead to some serious overweighting near market peaks:

  • In early 2000, about 50% of the S&P 500 index was in high-cap tech stocks.
  • In early 2008, about 40% of the S&P 500 index was in high-flying financial stocks.

In real life stock-picking, investors don’t “cap-weight” their portfolios. If I owned five stocks of various cap sizes, for instance, I wouldn’t put 90% in the biggest stock. I would try to own roughly equal amounts of each, at least in the beginning. Obviously, small stocks have more room to grow, although they might also be more volatile, whereas a $500 billion stock has less room to double. Personally, I prefer “mid-cap” stocks – the “Goldilocks” middle – companies with proven track records but with room to grow.

Imagine you had $555,550 to invest in five stocks in a cap-weighed manner, like the S&P 500. Using cap-weights, you would have to put 90% in one stock, thereby creating a warped portfolio like this:

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If I had five stocks in mind, and they had that wide a variety of market size, I might put 30% of my total available funds into the sturdiest, most conservative pick (maybe large-cap), then 25% in the mid-cap, 20% in mega-cap and 10% to 15% in the more speculative smaller stocks. I would never consider putting 90% into one stock, 9% in another, and 1% in the rest. That doesn’t make sense in your personal portfolio, and it doesn’t make sense in the large (multi-trillion dollar) arena of the aggregated index funds, either.

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By cap-weighting, today’s index funds have more-or-less created a new “Nifty 50” all over again – like the “go-go” early 1970s. In this way, a cap-weighted index is riskier than prudent stock picking. We live in a real world that continues to reward the most prescient investors and analysts – not just the robots.

Global Mail:

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

Here Comes the Chinese Trade Deal

by Ivan Martchev

As the positive headlines on the Chinese trade front multiply, we have seen stock market action in January that is exactly the opposite of what we saw in December: We’re now seeing relentless buying with every dip. I think it would be hilarious if the S&P 500 ends January near 2,800, which is where it started in December. (For those keeping track, the intra-day Christmas low was 2,346.56.) 

The dark comedy here stems from the realization that there were a number of factors that were reinforcing each other in the fourth-quarter market decline, but none of them was economic deterioration in the United States, which in theory should be the driving factor behind any stock market action.

I have often said in this column that there will be a trade deal based on the realization that the domestic economic situation in China is very precarious and the lack of a trade deal will make matters a lot worse for the Chinese economy. Multiple media outlets reported that the Chinese made an offer in mid-January to go on a bigger-than-$1-trillion-dollar buying spree in a bid to eliminate the trade deficit by 2024.

I think this is a very good offer and one that will be the basis of a trade deal – no matter that the U.S. side wanted results much faster than 2024. The reason why the trade deficit has kept growing, despite the trade tensions and some added tariffs, is the strong economy in the U.S. and the fact that many key goods are no longer manufactured domestically.

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I believe that the U.S. trade deficit with China can be eliminated completely, as the Chinese have been employing a very clever trade policy – to the detriment of the United States. Since China is a hybrid economy, Chinese state buyers control where China buys from. The Chinese have been running trade deficits themselves (i.e., trade surplus for the partner country) with many countries they consider key partners, so that they can increase their political influence. If China is the #1 trading partner for South Korea, for example, Chinese influence in South Korea can increase while U.S. influence decreases, despite the sizeable U.S. military presence there. There are numerous other examples where China is the #1 trading partner and the Chinese buy more on purpose – so that they can be more influential politically.

On the other hand, because the Chinese could get away with this clever maneuver, worthy of masterful Sun Tzu disciples, the American side has been enabling this activity by tolerating it, that is until President Trump showed up. Both Republican and Democratic administrations are at fault here as neither President George W. Bush nor his successor President Obama did anything to stop this Chinese trade policy.

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It has to be noted that the trade deficit numbers in 2018 would be horrific in absolute terms (estimated to be $879 billion according to the Paterson Institute of International Economics), yet in relative terms things were a lot worse during the second George W. Bush administration, when the current account deficit as percentage of GDP hit 6%. That same number is 2.4% for President Trump.

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Crude Oil is the Big Driver of the Improving U.S. Trade Balance

If you said shale oil production helped the trade deficit, you would be correct. It is true that in a recession consumption tends to suffer so the flow of trade with China and the rest of the world shrunk in 2008, but the reverse of that is happening right now. Back then, crude oil was a much bigger trade deficit problem.

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Since U.S. shale crude oil production surged and is nearly three times the rate it was in 2008, when it took out its previous all-time high peak from 1970, its relative effect on the trade deficit became much less meaningful. Today, China is the largest importer of crude oil. For decades that spot was reserved for the United States. As the Chinese economy has dramatically slowed, as evidenced by the sharp fall in crude oil prices, confirmed by the sharp fall in industrial metals, the price of crude oil has fallen rather sharply.

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It is interesting to note that the rebound in the London Metals Exchange Index is much smaller than the rebound in the crude oil price since the December 2018 lows, both on a relative and absolute basis. That tells me that sentiment is driving the price of crude oil and not necessarily demand, since we are in the seasonally weak period for crude oil (September-March) and investors are positioning themselves for a trade deal. I do not expect the Chinese economy to turn around on a dime after a trade deal is announced, which I believe will happen within the 90-day period ending March 1, notwithstanding any extensions that would be possible if the parties are close to a deal but the details have not been hammered out yet.

That means that the rally in crude oil is a rally to sell, not a rally to buy.

Sector Spotlight:

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

What A Long, Strange Trip This Has Been

by Jason Bodner

Four weeks ago, on Christmas Eve, it seemed like the world was ending. You couldn’t open a website or read a headline without seeing the words “bear market” in big type. People were goading me back then, saying things like “Are you still bullish?” or “I am guessing you’re just as bullish as ever.”

My usual response was that while it was hard to be bullish when everyone is decidedly turning into a bear, I had to go with my data, and the data said to be bullish. The data told me that “this will pass.”

If I were a doctor making a dire diagnosis, it would not please me to be right. But I was making a prognosis for a swift recovery of the market, not a crash, so I can tell you it pleases me to be right. Since December 24th, 2018, the four major indexes have rocketed higher in massive gains in a short time:

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It doesn’t really surprise me that the sectors enduring the most punishment are remarkably resilient in this new year. Energy rallied more than 18% since 12/24. Consumer Discretionary, littered with growth stocks, shot up 17.1%. In fact, 8 out of 11 sectors were up over 10% in 17 trading days. The laggards were defensive sectors. Real Estate only vaulted +9.3%, Staples +7.5%, and Utilities gained +3.1%. After writing for weeks, and inserting charts that were only red, it’s a welcome change to be seeing all-green.

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So yes, I’m still bullish. That’s not to minimize the damage that was done. The sheer scale of the slide we all witnessed was colossal and fearsome. By now, I am pretty certain that ETFs caused the chaos. We at Navellier just completed a 25-page study on it, which you’ll see soon, but the 30-second version is this:

ETFs rose in popularity from one ETF in 1993 (SPY) to currently over 2,200 with $5 trillion of assets in them. Many of the passive vehicles were directed by model managers – outsourced fee-based strategy managers. They had sell-stops that were triggered by a lack of “dip-buyers” starting in the summer of ‘18. Algorithmic traders took advantage of low liquidity and shorted heavily. Sell triggers were hit, and model managers told their Financial Advisors (FAs) to sell. When you only have a few hundred liquid ETFs to trade out of the 2,200, and one stock can be present in almost 200 ETFs, it gets ugly. A watermelon is quickly shoved through a keyhole, and all stocks get abused because they must absorb the impact of sell-hedging from $10s of billions of outflows in a few days.

The fact that we are seeing a swift recovery doesn’t surprise me. Nor does the rise in growth names. We are seeing previous growth champs rise to the top of our buy list again, and just look at how the Russell 2000 is regaining ground faster than other indexes. This is an encouraging sign. A drop-off of unusual sell signals, replaced by slow and steady buy signals rotating from defense into more growth names, all with a major drop-off in volatility, is a good sign. And our MAP-IT ratio steadily climbing adds a great signal.

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In the past week’s Sector Spotlights, I offered studies about what to expect after sustained periods of a depressed ratio. I also went over what to expect after oversold conditions. Both were very bullish near-term and medium-to-long term. This week, I decided to take a trip into, well, what defines a “trip”?

Out of 5,500 stocks, we find 1,400 on average can absorb institutional trading without major impact to their price. A stock that flags our scans for unusual volume and volatility indicates potential unusual institutional trading. Each day when we run our models, we get an average of roughly 500 stocks that “trip” the model for unusual trading. From those 500, we get 100 unusual buys or sells, stocks breaking out above a high or below an interim low: 61 buys and 46 sells on average each day looking like this:

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Navellier & Associates does not own XOM, MSFT or MCD in managed accounts.  Jason Bodner does not own XOM, MSFT or MCD in a personal account.

What the Past is Telling us about Today, and Tomorrow

Looking at data from the past has provided us with important insights about what to expect. So far, they have been spot-on. So, I wanted to know what happens after monster trip-days. When I look at our model and see 1000+ stocks tripping the model (for unusual institutional activity) on one day – I take notice. That means over 70% of our institutionally tradeable universe is trading above average on volume and volatility. We now know that situations like that occasionally occur with big up days in the market, but they usually coincide with big down days in the market. So, what should we expect after they happen?

This week, I did a study to answer that question. I went through our data from 2011 on and pulled out days when we found 1000 or more stocks (over 70%), showing unusual activity. I then calculated forward returns 1-to-12 months out for the four major U.S. indexes. Let’s look at the data:

From 2011 until today, there were 64 instances in which 70% or more of our 1,400 institutionally tradeable stocks flagged unusual activity on the same day. The average for those 64 times was 1,133 per day, which is closer to 81% of the universe flagging unusual activity. As you can see below, the forward return profile was very positive. For example, the forward 3-month return of the S&P 500 was positive 75% of the time (48 out of 64) to the tune of +2.7% average. To the right you see that on average over all periods, the return was +4.3%, up 68.5% of the time. The Russell 2000 showed slightly stronger results.

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To be fair, I wanted to present the data including 2018. The end of 2018 greatly skewed the returns downward, due to the monstrous sell-off late in the year. Even still, 7 out of 10 up isn’t bad. When we remove 2018 and survey 2011 through the end of 2017, we get a much more bullish picture: The S&P 500 was positive 100% of the time three months later for an average return of +6.5%! The average 12-month return for the S&P was +14.9% while the average 12-month return for the Russell was +16.3%:

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Again, no matter which way you look, the data is bullish for this post-washout period. When things get hairy and uncertainty is as high as a giraffe’s ears, pessimism reigns supreme. That’s the time to dig into the data. The data said: “Be bullish,” even though everyone was prepping their bunkers.

The data now is even more bullish. So, if someone says to me: “I bet you’re just as bullish as ever,” I’ll say: “Yes I am,” until the data says otherwise.

A Look Ahead

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

A “State of Perpetual Crisis” is No Longer Killing U.S. Stocks

by Louis Navellier

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The world seems to be in the midst of a perpetual political crisis, especially in Europe, where Britain and France remain in chaos. On Tuesday, British Prime Minister Theresa May suffered a massive Brexit defeat in the House of Commons by a resounding vote of 432 to 202, which subsequently triggered a “no confidence” debate that Prime Minister May barely survived. Ironically, no one really wants to be the British Prime Minister leading up to the implementation of Brexit on March 29th, so the British pound remains volatile as international capital flight seeks safer shores.

Another Brexit referendum is possible, but it has to be done before March 29th when the European Union (EU) is scheduled to boot Britain out. The reason that there could be another referendum is that there are substantial majorities in Parliament that apparently do not want to exit the EU. In the meantime, the euro also remains weak due to the ongoing Brexit chaos and the uncertainty about exit fees that the EU wants to impose – although Britain is increasingly unwilling to pay the EU any significant exit fees.

If this were not enough chaos, China’s woes are still making some investors nervous, but the U.S. trade talks are no longer the country’s biggest problem. On Friday, China offered to go on a six-year buying spree to ramp up imports from the U.S., which signaled that the trade talks may be going well.

Despite all the international chaos, fourth-quarter announcement season is off to a strong start, led by Netflix, which continued to surge in the wake of raising its monthly fees by 13% to 18%. On Thursday, the company announced that it added 8.8 million new subscribers last quarter, substantially higher than analyst estimates of 7.5 million. In the fourth quarter, Netflix sales rose 27.4% to $4.19 billion, compared with $3.29 billion in the same quarter a year ago. The company’s fourth-quarter earnings were $133.9 million or 30 cents per share, 25% higher than analysts’ consensus estimate of 24 cents. Overall, Netflix trades more on its new subscriber growth, but its price increases should insure steady earnings growth.

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.

Now that the fourth-quarter announcement season is underway, a “retest” of the Christmas lows is less likely. So far, companies in the S&P 500 that have announced fourth-quarter results have posted 7.8% annual sales growth and 21.5% annual earnings growth. Typically, the good sales and earnings announcements come out early, so I expect the S&P 500’s fourth-quarter sales growth will decelerate to a 6% annual pace and fourth-quarter earnings growth will decelerate to about a 16% annual pace in the upcoming weeks.

I should also add that our friends at Bespoke Investment Group issued an excellent report last week that implied that since the S&P 500 has resurged by 13% from its Christmas lows, a retest is becoming less likely. They looked at prior periods in which the S&P 500 fell 15%+ in three months or less and then proceeded to rally by 10% in the span of 10 or fewer trading days. They found that the S&P 500’s average and median forward return over the next one, three, six, and 12 months was better than the historical average for all periods, but it wasn’t typically a smooth ride, so be prepared for volatility.

We saw such wide swings twice in this bull market, first as the bull market began, with a 27.6% drop in early 2009 followed by an 11% rise in 10 days, then in the late summer of 2011 we saw an 18.8% drop in August and September followed by an 11.4% rise in 10 days. In both cases, the market never looked back – there were no “lower lows” to come – and the overall market kept rising throughout the coming year:

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Most Economic Indicators Argue Against Fed Rate Increases

On Tuesday, the Labor Department announced that the Producer Price Index (PPI) declined 0.2% in December, the biggest monthly decline in more than two years and one notch more than economists’ expectations of a 0.1% decline. Wholesale gasoline prices declined 13.1% in December, while food prices rose 2.6. The core PPI, excluding food and energy, was unchanged in December. Wholesale service costs declined by 0.1% in December, which represents the first decline in four months.

In the past 12 months, the PPI and core PPI have risen 2.5% and 2.8%, respectively, but those numbers are coming down. Overall, the PPI provided more evidence that inflationary pressures are “decelerating,” which means that the Fed can be “patient” and not raise key interest rates for the foreseeable future.

December retail sales data from the Commerce Department was not released due to the government shutdown but based on credit card sales, it appears the holiday shopping season was stunning. However, retail sales may stall in the upcoming months due to approximately 800,000 furloughed government employees. The situation for government contractors is dire, since their back pay will not be restored.

Speaking of dire, the University of Michigan on Friday stated that its consumer sentiment index dropped sharply to 90.7 in January, down from 98.3 in December to the lowest level since October 2016, before President Trump was elected. This is a clear sign that the ongoing government shutdown is impacting consumer sentiment. This is a bad omen. Slower consumer spending may slow overall GDP growth.

The Fed announced on Friday that Industrial Production rose 0.3% in December, slightly better than the economists’ consensus estimate of a 0.2% rise. For all of 2018, Industrial Production rose an impressive 4% and was led by the domestic energy boom. In December alone, mining (includes energy production) rose a robust 1.5%, while utility output declined 6.3% due largely to abnormally warm weather. The best earnings for the next couple of quarters are expected to be predominately energy-related stocks, as the domestic energy boom is expected to continue, boosting Industrial Production in the upcoming months.

Speaking of energy, I should add that, thanks to the boom in shale oil production, the U.S. is now producing more crude oil at 11.8 million barrels per day than Russia and Saudi Arabia. Furthermore, U.S. crude oil production is expected to expand by another 1.1 million barrels per day in 2019, so by the end of the year, domestic crude oil production will be near 13 billion barrels per day and significantly higher than Saudi Arabia ever produced (its maximum was 12 billion barrels per day), so the U.S. will displace Saudi Arabia as the #1 producer of crude oil and dictate crude oil prices worldwide.

Overall, we are essentially in the midst of an interesting “libertarian experiment” to see how much the U.S. economy and stock market might rally without the federal government fully functioning. Amidst the shutdown, multiple Federal Reserve regional Presidents, both doves and hawks, have clarified that there is no reason for further interest rate increases in the foreseeable future, which is good news for stocks.

Frankly, I am happy that the stock market has reverted to following fundamentals versus being “spooked” by external events. There will always be crises in the world, but stocks mostly move based on earnings. I think we could make a lot of money this quarter as stocks celebrate outstanding fourth-quarter results!


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