Stocks behaved like sinners in church last week. Anxious. Sweaty. And panic prone. Continuing their downward skid as investors responded negatively to disappointing economic data from China and the Eurozone, a slight increase in interest rates and rising global trade tensions. All being viewed against a backdrop of concerns over the White House. Which may or may not be in discord amid multiple political and legal fronts.
The S&P 500 fell -1.22 percent last week. An unfortunate follow-up to the prior week’s -4.6 percent debacle. With only two weeks left in 2018, the index lounges nervously in negative territory for the year, down -2.8 percent.
Disconcertingly, the market appears to be breaking down on technical fronts. Technical analysis represents the means by which one analyzes pricing trends and momentum patterns. And has nothing to do with its analysis counterpart, which considers the fundamentals. Readers of this missive know we have mentioned many times the decline of the S&P 500 under its 12-month average at the end of a calendar month (as it did in October). And how that represents a red flag. So, let’s look at the Value Line Composite Index, which is a widely watched index comprised of 1,800 companies across the market-cap spectrum.
The chart below shows how the index has formed a broad distributive top, resulting in a break of the nine-year uptrend that began with the 2009 low and was last touched in 2016. This is serious. Should the market close below 5,550, and hold that low for a calendar week (or worse, month)? That opens the door to a move to around 5150-5200. 10 percent beneath current levels. If the S&P 500 fell that much? A higher-risk index like the Nasdaq might fall a multiple of that amount, e.g. 15 percent.
Were that kind of decline occur, it might not happen gradually. Which is to say that the rug could be pulled out from under this very fragile condition without much notice. Creating a rising volatility trendline. One that could create a vicious cycle. A self-perpetuating cascade of volatility. Because bad things occur during the weakest conditions. And even though we sit within a time frame that is seasonally the most positive of the year, the current environment has been anything but. While stocks should have a tailwind, they’ve trended lower. And when seasonally strong stretches are weak, seasonally weaker stretches tend to be worse.
October? Ugly. November? Rough. December hasn’t deviated. The benchmark index being 4.5 percent lower, thus far.
Though history offers a ray of hope…
Jason Goepfert of SentimenTrader.com analyzed all the times that the S&P 500 has suffered a 4 percent or larger December drawdown. Of which there have been 10 instances since 1950. Turns out the next month was consistently positive. Higher 90 percent of the time. The index rose 2.3 percent over the next two weeks, and 4.1 percent over the next month. 90 of those periods were positive.
Continuing, the next year was up 19.1 percent, and positive 80 percent of the time. The most recent being December 2016, and all forward measures were higher. December 2008 is also in the data, with the following week and month being positive. And while the three-month measure was down (-12 percent), the six-month and twelve-month periods were up big, +14 percent and +36 percent.
All of which is to say, be careful before you use the recent swoon as rational to simply throw in the towel. As that may be the exact moment Mr. Market relents, and steers everything higher yet again. It’s obvious that stocks are behaving oddly. Especially in December, a typically ebullient period for equities. Pointing to an extreme level of discomfort with stocks. Which could be a good near-term sign of a tradeable panic. But may not promise much beyond the next month. And will demand close, continuing scrutiny. As the S&P 500 is now nearly 13 percent below September’s all-time high. And we begin to enter a phase in which, should stocks go lower, many of our pre-set trailing stops will begin to trigger. Raising cash. As well as more questions about the market’s direction.
This week, the Fed could goose stocks and lift spirits for a few days by announcing a pause in its rate-hiking campaign. Yet, it would have to do so in a way that doesn’t spook investors who might fear that the central bank has changed its tune on the positive economic growth forecast. This represents a tricky balancing act.
These last weeks, two standalone events served as market drivers.
The first being the previous Wednesday’s comments from Fed Chair Jerome Powell, who indicated that the Fed funds rate might be closer to neutral territory than previously thought. Leading investors to conclude that Powell and Co. might slow, if not even pause, the Fed’s rate hike program next year.
Later that week, investors fixated on President Trump’s Saturday pre-G20 dinner with China’s President Xi. Hoping it might yield good news on trade relations.
Well, the dinner in Buenos Aires appears to have gone well. As U.S. and Chinese leaders declared a temporary cease fire. Providing both sides with a temporary reprieve from the razor’s edge. And allotting an opportunity to find a mutually amicable solution. More on that below…
On Wall Street, Bloomberg notes that the perennial penchant for bullishness among Wall Street strategists has looked shaky of late. Which hasn’t kept them from their annual ritual of predicting another positive year for stocks in 2019.
Bloomberg gathered 14 forecasts for 2019 from the firms it tracks. And the average prediction shows the S&P 500 rising 11 percent, reaching 3,056 by the end of next year. That trajectory partly reflects the damage recently done to stocks. Yet it remains the most optimistic annual forecast since the bull market began in 2009.
Such resilience contrasts with the mood of ordinary investors. With individuals raising cash at the fastest pace in three years. Even hedge funds have gone defensive. As nerve-racking as the recent equity rout has been — the S&P 500 entered a correction and is still down by almost 13 percent from its record high — there remains scant evidence of a looming market crash, forecasters say.
Growth may be decelerating. But corporate profits are still expanding. The threats from trade wars and higher interest rates are real. But the fear has probably gone too far. Reflected in the steep decline in equity valuations.
Still, analysts have been relentlessly reducing Q4 expectations. In October, Wall Street was looking for 17.1 percent year-over-year earnings growth for the quarter. At the end of October, that number was 16.1 percent. Now, it’s 13.6 percent. A far cry from the +24 percent growth during the year’s first three quarters.
Remember, bull markets must climb a wall of worry. Despite all the concern, stocks have become reasonably valued.
At 15.8x forward earnings, the S&P 500’s multiple has contracted 15 percent from a year ago. Resting near its cheapest level since early 2016. Assisted in that by two things: stocks just haven’t moved much this year, while profits have jumped almost 25 percent.
The only thing this market is missing? A catalyst. Till one arrives, this consolidation period (up, down, and mostly sideways) will likely continue.
Economic data was plentiful this past week. Though two offsetting data points caught our eye…
1) Strong post-Thanksgiving retail data continues to portend a strong holiday shopping season.
2) Economic confidence remains optimistic, but continues to drift lower. Falling short of the November forecast. Of course, given the abundance of dreary headlines, what would you expect?
In geopolitics, there’s more happening than there is in a Salvador Dali painting. And every bit as surreal.
Prime Minister Theresa May’s effort at handbag diplomacy appears to not be playing well at home. As her conservative party forced a confidence vote. She survived. But came out wounded. Which can only embolden the EU negotiators sitting across from her. If the goal was to force a second referendum on Brexit? Mission accomplished.
Rumors have gone so far as to say that the Monarch may have to become involved. Which she can. Though it would be an extraordinary intervention. Yet, it may end up as the nation’s best solution.
Returning to our side of the pond, the Oval Office scrum which occurred last Tuesday provided excellent political theater. As President Trump sparred with incoming Speaker of the House Nancy Pelosi. Threatening to shut down the U.S. government if the border wall is not funded by next week. We will likely see a shutdown. The last couple shutdowns have seen stocks edge higher.
In France, Macron’s government is under siege from the “Yellow Vests.” Under duress, Macron is throwing out the budget rule book and will begin spending on a much larger scale. The Italians must be thrilled. As this will serve to camouflage their own financial profligacy. Once the Belgians, Dutch and other disaffected populations join in? That fiscal party will get interesting.
Crime may not pay. But rioting might.
Two weeks ago, we honored the life of George Herbert Walker Bush, the nation’s 41st president. President Bush also served as Reagan’s VP, was a congressman, ambassador, and the director of the CIA. He was a patriot, an honest arbiter, a loyal friend, and a committed family man. Bush presided over the Cold War’s end. And will be remembered as, among many other attributes, a man of courage, dignity and honor.
Last week rang in the 219th anniversary of the passing of another great American, President George Washington. He was, and remains, one of the finest leaders in American history.
On December 12, 1799, George Washington contracted a bacterial infection of the epiglottis, the cartilage at the base of the larynx. The infection was virulent, and everything his doctor did while employing the best medical knowledge at the time made things worse — and the patient’s suffering more painful. It would be another 129 years before Alexander Fleming would discover penicillin. So they were helpless as their fully conscious patient was slowly strangling while his throat closed on him.
Eventually, the great man rasped, “Doctor, I die hard, but I am not afraid to go.” He died at Mt. Vernon sometime before 11 p.m. on December 14, 1799. His last words were, “‘Tis well.” His final act, fitting for this man of action, was to feel his own fading pulse.
Upwards and onwards, friends…
Major indices finished down last week. The DJIA lost 1.18%. The S&P 500 fell 1.25%. The Nasdaq fell 0.84%. While small cap stocks lost 2.57%. 10-year Treasury bond yield rose 5 basis points to 2.89%. Gold closed at $1,238.33, down $10.02 per ounce, or 0.80%.