Deal? What Deal???

I am sure I am not the only one who is really skeptical about this “trade deal” with China being real. While I am sure the two parties agreed on some items, we are so far from a real deal, signed, sealed and delivered. This doesn’t even sound like an agreement in principle since the Chinese have a different recollection and their state run news service tells their own story. This saga is far from over.

The stock market was very strong on Friday in anticipation of a deal being struck. Almost too strong. I tweeted that I wished a deal would not have been announced until after the close so there could be a possible selling opportunity on a higher Monday opening. The Trump administration had other ideas. The Dow Industrials dropped 200+ points on the announcement to close near the lows for the day. That’s not exactly comforting and my gut says we could see some short-term weakness to give back all of those gains.

I still really, really like the action in semis, something I have discussed here over and over and over for most of 2019. There are a lot of things people can say about my opinion, analysis and forecasts, but being unclear on semis isn’t one of them. Nor is my call for Dow 28,000 this quarter. I may not get them all right, but I never, ever run or hide from any flops.

Finally, I am keeping a close eye on REITs as they seem to be the most constructive of the defensive sectors. As you know, I have been talking about a “barbell” approach for the past few quarters with semis, utilities, staples and REITs. Own the aggressive and conservative sectors. Leave the rest alone.

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Bears Wrong, Again?

On Monday, I wrote about the bulls thwarting the bears with another low forming in the stock market. I also showed some of the fuel that was building up for higher prices in the form of very negative options traders who are usually wrong. Couple that with my Twitter feed turning negative and the bears ostracizing my bullish view, I felt pretty good that stocks would rally. And rally they have in short order, catching the masses off guard.

I tell ya; these perma bears. I can’t believe they have any money left from continuing to hate and disavow the bull market. They continually whine about the markets being manipulated by the Fed and everything being fake. They warn that it’s a house of cards about to crumble. It would be one thing if they just started playing Chicken Little now, but this has been going on for the better part of a decade. Eventually, they will be right and crow about it, but what a joke they have been.

Stocks are back into the middle of the Q3 trading range, but trying to close at their highest levels in October. Whether or not there is one more shot to the downside on a failed trade deal or some tweets from 1600 Pennsylvania Ave, I remain confident that Dow 28,000 is up next with a chance at 30,000 in Q1 2020. The bears just continue to have it wrong. And now, they’re getting nasty about it.

Sector leadership is very slowly and quietly improving. Semis, banks and discretionary are looking better and better. While transports are neutral, they look constructive and could certainly turn more positive later this quarter. High yield bonds are behaving fine and the NYSE Advance/Decline Line is poised for yet another fresh, all-time high sooner than later.

I may sound like a broken record, but use weakness as a buying opportunity until proven otherwise. It’s been an absolute loser’s game to sell weakness.

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Bulls Thwart Bears With Another Low

Last Wednesday as stocks had pulled back to the lower end of the recent trading range, I thought we were about to see a showdown between the bulls and the bears. That battle was fought one day later as an early morning mini-collapse triggered by a poor manufacturing number flushed out the sellers and allowed the bulls to come roaring back the rest of the day with a beautiful intra-day reversal. On Friday, the bulls added to those gains and put the major indices right back into the old range as you can see below on the far right of the chart. This is textbook behavior for ridding the market of short-term, weak handed traders.

At this point, in the strongest of strong markets, stocks should pause and then continue higher towards the old highs without any downside. I am not so sure that’s where we are today, but I wouldn’t sell the bulls short. Another scenario has stocks seeing some modest weakness this week and then beginning a more meaningful assault higher next week. I don’t see an immediate collapse right here.

With only a 6% decline, it’s a bit odd to see traders behave so bearishly in the options market. Below, you can see the S&P 500 on top with a 10 day average of volume in options looking for lower prices versus higher ones. Option traders are just as negative now as they were at market lows in August and June. While this is only one single indicator and doesn’t guarantee anything, it is certainly fuel for the bulls to move prices higher this month.

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The Truth About October

With Rosh Hashanah taking me out of the office for two days, I forgot to offer some stats as the sometimes nasty month of October begins. I cannot recall who first alerted me to the breakdown I am about to show so I will just say thanks to my usual cadre of characters whose work I value and respect. Rob Hanna, Ari Wald, Jason Goepfert and Tom McClellan.

Overall, October has been better known for stock market bottoms than any other month of the year. However, that usually occurs after a poor September. A month ago at this time, I debunked the myth and refuted the media and pundits’ claim that September was a universally poor month for stocks. The facts don’t support the claim.

Today, we will look at various stats from Octobers past. Unlike most months of the year, October actually performs better when it begins the month in a downtrend. In other words, when the S&P 500 starts the month below its average price of the last 200 days. When stocks are in an uptrend, they struggle to finish October in the black. When the market begins the month on its heels, October becomes the best month of the year, returning more than 2%.

With October beginning in an uptrend, let’s look at how the weeks shake out historically.

  • First 5 days +0.66%
  • Second 5 days -0.26%
  • Third 5 days -0.30%
  • Fourth 5 days -0.25%
  • First 10 days +0.35%
  • Last 10 days -0.91%

So far, October is conforming to a weak month, but it’s not following the strength first script. At this point, I expect an initial low to be formed by the end of the second week.

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Lower End of Range Hit – Can Bulls Make a Stand?

Last week was the single worst week of the year based on seasonal patterns and it certainly lived up to the billing I gave it several times here. Weak seasonality didn’t end last Friday. It extends to the first part of October. For the past few weeks I have been in the trading range / mild pullback camp with an eye on the upper and lower ends of recent range. After stocks failed to exceed the top of the range last month, I offered that a visit to the lower end of the range would probably be in line.

After a feeble bounce to close the month and quarter on Monday, the bears made a lot of noise on Tuesday after the ISM economic report came in much weaker than expected with a chorus of recession calls following. While I continue to expect a mild recession beginning in the next year, I don’t think it’s right here and now. And certainly, the markets are not forecasting recession just yet.

Tuesday was an ugly day for the bulls. Looking at an updated chart of the trading range below, you can see that the lower horizontal blue line is where stocks closed. Wednesday will be a key day for the very short-term in determining if the bulls have enough ammunition to make a meaningful stand here or will they need to stand back and wait for lower prices to circle the wagons. If the uptrend is still strong, I would expect early morning weakness to be bought with the bulls coming in stronger after lunch. If not, then early morning weakness should lead to a mid-morning rally that is sold with lower prices after lunch and into the close.

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Stock Market Reaction to Impeachment

Here we go.
I remember writing about impeachment in 1998 and hoped and prayed the country wouldn’t have to experience this kind of political circus again. It took 21 years, but the circus is back in D.C.
Thankfully, since we only have two prior, modern day instances of impeachment, stock market results are certainly not statistically significant. Given that, however, let’s take a look at the environments surrounding each of the prior two along with where we are today.
First, let’s look at Richard Nixon in 1973. You can see on the chart below where the “official impeachment inquiry” began. At first glance, it certainly looks like the stock market unraveled immediately following the inquiry. However, correlation is not causation. In other words, just because it looks like one thing is tied to another doesn’t make it so. It’s like saying that at the stock market peaks in 2007, 2000, 1990 and 1987 sharks migrated west to east instead of north to south. Or that the path of the stock market is moving tick for tick with the migration pattern of wildebeests. It’s just coincidence.
The macro picture in 1973 was very poor. The U.S. was heavily dependent on foreign oil and OPEC began production cuts in October 1973 against all nations they perceived to be supportive of Israel. The embargo continued in late 1974 and oil skyrocketed 400% leading to a global recession.
While the stock market looked like it was strong right into the peak in early 1973, that was the time of the Nifty Fifty, 50 stocks that were soaring while the rest of the market had already rolled over into a bear market. At the peak in January 1973, more than 50% of stocks were already down 20%. In short, the stock market’s foundation had crumbled, but the house was still standing.
I would strongly argue that the stock market would have seen the exact same results had the Watergate scandal happened or not. If you want to push back a little, maybe I would cede that a single digit decline could have occurred, but certainly nothing like the carnage from the oil shock and serious recession.
Let’s turn to 1998 when Bill Clinton was impeached. Below, you can see the official inquiry began in October 1998 at the end of the stock market’s 20% decline. Some would very wrongly argue that the threat of impeachment weighed on stocks. In 1998, stocks collapsed in August as Russia defaulted on her debt. After a brief bounce, they fell once again when hedge fund, Long Term Capital Management threatened to take down the entire financial system with their staff of Nobel prize winners and 100x leverage on bets that a 1 in a 1000 year storm wouldn’t happen.
Unlike 1973, the economic backdrop was much more constructive in 1998 as the Fed slashed interest rates and created a Wall Street consortium to bail out the imploding hedge fund. GDP growth never missed a beat, continuing to click at 4%+ until the end of the century. The stock market was already at the end of the bottoming process when the impeachment inquiry became official in October 1998. Stocks literally soared like a rocket ship from that point as the Dotcom Bubble was just beginning to inflate.
I feel very strongly that Clinton’s impeachment had almost zero stock market impact because the market had a strong base and there was almost no chance of him being thrown out of office.
Where are we today?
Today’s economic landscape falls somewhere between 1973 and 1998, however the geopolitical backdrop is much more stable than 1973 and more closely resembles 1998. Economic growth is “fine” and I don’t see an imminent serious threat. Yes, I still believe a mild recession is coming next year, but nothing like we saw in the 1970s. The tariff tantrum may seem like the biggest concern on the surface, but with an election just around the corner, Trump will almost certainly capitulate before jeopardizing the economy.
Looking at the stock market, it is also somewhere in between 1973 and 1998. While price is near an all-time high, the foundation remains very solid and stable which is more like 1998. We see high yield bonds near all-time highs and the New York Stock Exchange Advance/Decline Line is also close to all-time highs. This tells us that any and all declines are buying opportunities.
So far, the threat of impeachment has had no effect on stock prices. And unless a “smoking gun” appears and Senate Republicans begin to jump ship, I continue to believe that the stock market will proceed higher to Dow 28,000 and perhaps 30,000 in Q1 2020. Impeachment makes for sensational headlines, drives people to the media and creates an even bigger country divide, but I believe this will be the third time without market impact.

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Void of Relevant Data Makes Market Vulnerable to Headlines

With the Fed meeting behind us and earning season still a few weeks away, the markets are now acutely focused on geopolitical news. In other words, the markets are very susceptible to the latest headline or tweet. From my seat, stocks remain in a little range which I mentioned on Monday and you can see below on the right side of the chart bound by the purple line and blue line. While stocks could pop a little in very short-term, I do think that they will touch the blue line before long.

All four key sectors are pulling back constructively right now with only the transports causing me any concern. High yield bonds are hanging in really well, suggesting that another run to all-time highs isn’t far off. The NYSE A/D Line is only a day from all-time highs. This week continues to be the weakest week of the year historically and so far, the bears have been in charge.

With gold’s glitter of late, few have noticed that price action is no longer supportive of the bulls. Best case, it’s neutral. A closing price below $1490 will likely set up additional weakness of roughly $50.

Before someone emails me about the impeachment inquiry, I am writing an article for the next full Street$marts on the subject. I am hoping to have that out by the end of the week.

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Weak Week Clouds Short-Term Picture

Welcome to the single weakest week of the year, at least that’s what history suggests over the past 30 years or so. The five days after September options expiration have not been kind to the stock market overall. I should have done a little more digging to see how stocks behaved when they were already in uptrends heading into this week. Usually, September is much weaker when it begins with weakness, as I wrote about in The Myth of September’s Gloom.

When I look at price action in the Dow, S&P 500 and NASDAQ 100, the bulls have had a hard time on two separate occasions this month. You can see this on the chart below where I drew the arrow in the upper right corner. Closing above that area should push the indices to all-time highs right away which is not saying much. Conversely, that medium blue line is a downside target for any pullback.

Regardless of how the short-term shakes out, I think stocks are still moving substantially higher next quarter. Dow 28,000 should be a layup.

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THE Weakest Seasonality of the Year is Here

Stocks are looking a little tired. That’s my take today. The bulls have tried twice to score new highs, but the bears have put up a little resistance over the past two weeks. While I do not believe the market is on the verge of a bear market or even a 10% decline, risk/reward is no longer tilted strongly towards the bulls. And that’s okay. FYI, next week is the weakest week of the year on an historical basis for the stock market.

Stocks have run fairly hard since the August lows without much in the way of leadership deterioration. In fact, leadership has only gotten stronger with semis and discretionary pulling up transports and banks. Junk bonds are only slightly off all-time highs. There is lots of upside room left in this bull market.

I heard an interview with the head of a midwest state pension fund yesterday. I am not 100% sure, but I thought it was Wisconsin. Maybe not. But that’s what my 53 year old brain remembers. Anyway, I was absolutely floored with what I heard. First, this guy said he expects to earn 6% a year over the next 5 years which led me to think they had a very high allocation to anything but bonds. Then he said the fund is 45% allocated to bonds. And then he proclaims that his peers will only earn 5% a year over the next 5. His confidence lies in the fact they own a lot of private investments in private equity, private real estate and private debt and they know how to find only the best managers.

I was shocked at his arrogance and flat out ignorance. Someone should have told him that pension money is usually viewed as “dumb money” by analysts. To think he could outearn what he forecast for his peers by 20% is laughable. If that was a way to short his fund and buy someone else’s, I would love to do it.

When asked about why active investing was about to have its renaissance over passive, something I do believe will begin in the early 2020s, this joker boldly states that it’s because a few huge stocks are dominating the indices while the rest of the market is not doing well. HELLO! ANYBODY HOME?

This is where a seasoned, market informed interviewer would strongly push back on a thesis not supported by facts. Look at one of my favorite canaries below, the New York Stock Exchange Advance/Decline Line which measures participation in the stock market.

Where is it and has it been sitting?

ALL-TIME HIGHS

That means that the rally is broad -based with lots of of stocks participating and going up. I can’t believe a manager charged with tens of billions in assets can seriously be this clueless. I mean, if you don’t know, why make statements that can so easily be refuted with facts? I will be shocked if this fund will outperform its peers over the next 5 years with a leader not in touch with reality.

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Here Comes Another Cut, But Will the Markets Celebrate?!?!

What to Expect Today

The Federal Open Market Committee (FOMC) is going to cut interest rates by another 1/4% at 2:00pm on Wednesday. The market is expecting it and the cut has already been priced in. Any other action would be a shocker. With stocks so close to all-time highs, this is again reminiscent of 1995 when the Fed came from an overly restrictive monetary policy in 1994 to realizing they screwed up and quickly played catch up. Stocks had long understood and priced this in with 1995 being one of the all-time great investing years in modern history.

Right after the Fed announces their decision, all eyes will be on the statement for clues of future interest rate cuts or signs that the Fed may be close to being done. The stock market will definitely not like a rate cut with a hawkish statement, meaning comments from the Fed that they are not looking for more cuts ahead. I find it hard to believe that Jay Powell & Company will cut rates and then prepare the markets for more rate cuts this year.

Model for the Day

As with every Fed statement day, 90% of the time stocks stay in a plus or minus .50% range until 2pm before the fireworks take place. I fully expect that to be the case today. Besides that, there is also a strong long-term trend for stocks to close the day higher, although that is not as strong as it used to be. Additionally, with stocks near all-time highs and significant upside progress over the past month, the bulls have even less dry powder than normal, not to mention how poorly stocks have done under Jay Powell on Fed day. 6 weeks ago, I offered that “any short-term rally may be sold”. From 2:00pm on July 31 until August 5, stocks fell in a straight line after Powell et al indicated that the rate decrease was a “mid-cycle cut” and not the beginning of a new accommodative cycle.

Jay Powell’s Arrogance & Ignorance

As I already mentioned, everyone knows what the Fed is going to do at 2:00 pm today. That’s not in debate. And right now, the market is pricing in at least another rate cut. Long time readers know that I have been very critical of the Fed, more with Yellen and Powell than Bernanke although Big Ben did make perhaps the single greatest imbecilic comment in 2007 when he said the sub prime mortgage crisis was “contained” and there would be “no contagion”. It would be impossible to have been any more wrong than that and on an epic scale.

Anyway, I think the Jay Powell led Fed is among the worst groups since 1988 when I entered the business. Greenspan may have been the worst Fed chair since Arthur Burns in the 1970s but Powell is certainly working on his legacy and it’s not an enviable one.

For 6 years I have pounded the table that raising interest rates AND selling assets which is now being referred to as quantitative tightening is the mistake of all mistakes. Selling assets is akin to also hiking rates as it reduces liquidity and tightens financial conditions. Janet Yellen should have chosen one or the other. Pick your poison. Instead, she forged ahead with both.

Jay Powell continued on that path except he, in a grand stroke of additional arrogance, decided that rates should go up at a quicker pace. Arrogance and ignorance are among the two worst character traits and I think Powell has them both. We all saw what happened last December when the Fed added that one additional rate hike and did not temper the asset sales. The global financial markets collapsed like hadn’t been seen since the Great Depression.

The Fed – Savior of the Financial Markets

Now, you can argue that it’s not the Fed’s job to appease the financial markets and you would technically be correct. The Fed has a dual mandate from Congress. Price stability (inflation) and maximum employment. However, the Fed, for the most part, usually follows what the markets want and have priced in. I say “usually” because there have been a few times when the Fed has gone off book.

Remember, the Fed doesn’t want to upset the financial markets. These markets are absolutely vital the U.S. and global economies. And despite what you may hear from Lizzie Warren and Bernie Sanders, a healthy and vibrant Wall Street community is an absolute necessity to a growing economy, even though that same group is prone to bouts of greed and bad behavior which can have a periodic and significant detrimental impact on the economy (see chapter on how the financial crisis began in 2007 and 1929).

When politicians from both sides talk about how Wall Street “wrecked” the economy, they always forget how many direct and indirect jobs were created from Wall Street’s work. The problem is that we (the U.S.) always seems to reward bad behavior and don’t punish it. And so many politicians continue to pat themselves on the back for the Dodd-Frank piece of legislation which did good by increasing capital standards but failed miserably by declaring victory that the days of Wall Street bailouts were over. Not a chance.

When push comes to shove, the political will is never there to let a Morgan Stanley or a Goldman potentially take down the economy. In real time in 2008, my thesis was that AIG should not have been saved which would have sent Goldman down with it. I thought letting more institutions be punished would have caused more short-term pain, but the free market would picked up the slack and the economy would have seen a much, much better recovery than it did. A topic for a different day.

Dual Mandate

As I already mentioned above, the fed has a dual mandate from Congress. Regardless of what President Trump believes or wants, the Fed’s instructions are from Congress. When we look at the Fed’s dual mandate, Congress essentially directs the Fed to keep inflation manageable and seek to have the country fully employed.

Right now, unemployment is at or near record lows with minority unemployment also at or near the lowest levels since records began. That is maximum employment, a point where the Fed would normally worry about a labor shortage and a spike in wages. While wages are finally rising, we are not seeing a squeeze and nothing like McDonalds paying signing bonuses like we saw years ago. With half of the Fed’s mandate pointing towards a rate hike, it’s makes me wonder.

Looking at price stability (inflation), we see the same trend that has been in place for more than a decade; inflation cannot seem to get going. While many people are familiar with the Consumer Price Index, the chart below is a much better gauge and you can Google if you want more info about it. The blue line excludes food and energy and this CENTURY you can’t find a single year of 3%. The very random Fed target of 2% has barely been met since the financial crisis.

So, the second half of the dual mandate is certainly amenable to a rate cut although the most recent data was just a tad “hotter” than the market was expecting. You have the dual mandate at odds. In my world, that would mean a neutral stance by the Fed. Leave rates unchanged and stop selling assets, which they did announce at the July meeting.

Jay Powell & Company at Odds

Jay Powell and the majority of the voting members of the Fed want to cut interest rates by 1/4%. There is a minority faction that wants to leave rates alone. Powell has spoken about an “insurance” rate cut which in my mind means a single cut. Today, we are look at cut number two. He discussed weakening economies in Europe and Asia that eventually could impact the U.S. I just want to know where in the dual mandate it says that the Fed should worry about China and Europe. The rest of the world is now loosening financial conditions so now Powell wants to follow them.

ECB chief Mario Draghi is on his way out of Dodge, leaving Europe in worse shape than when he began 8 years ago. With more than $15 trillion in negatively yielding bonds and a whole new round of bond buying starting, Europe is that fly in search of the windshield. That story ain’t gonna end well. However, the powers that be refuse to accept their fate. The Euro experiment is a failure, plain and simple. It should be dismantled, but I digress.

The markets are expecting 1/4% cut. One of the many great charts and work that Tom McClellan does has to do with forecasting a rate move based on the two-year Treasury Note. Below is a chart of that instrument overlayed with the Federal Funds Rate which is the actual interest rate the Fed controls. Tom argues that all the Fed needs to do is follow the two-year Note instead of meeting and debating all the time. His analysis certainly has merit.

When the solid black line is below the colored line, the Fed is allowing easy financial conditions. The reverse is true when it’s above the colored line. Right now, the two-year Note (the market) is telling the Fed to cut rates although a little less than it did 6 weeks before the Fed’s last meeting. While I believe it’s premature, the market does not.

What I Would Do

While I could go on and on and on as I sometimes tend to do, I am going to wrap this up by saying that Powell is going to hide behind tariffs and China as the reason to cut rates today. Although I absolutely do not think he will intend to poke the President, I do think that labeling tariffs as the potential economic weakness culprit will certainly tweak Donald Trump.

My own economic forecast remains unchanged since I first offered it in late 2017. I think the U.S. will experience a very mild recession beginning before the 2020 election. Although there are so many doom and gloomers who forecast something much more ominous, it’s almost impossible with the banks in such great shape, literally sitting on more than two trillion dollars in cash. And if you want to know what I would do instead of cutting rates, I would stop paying the banks to keep their excess reserves at the Fed. This would force them put some money to work in the economy.

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