Markets in Minutes: October 6, 2018
S&P 500 * 10 Year Treasury * Gold * World Ex-US * US Dollar * Commodities * US Economy * Stock Market Valuation
Markets in Minutes is intended to give our client partners and subscribers a quick and easy understanding of current market conditions. This update covers September 1 – September 30, 2018
Investor Learning: “It’s an oversimplification – but not a grievous one – to say the inevitable hallmark of bubbles is a dearth of risk aversion” —Howard Marks
“The beauty of stocks is that they do sell at silly prices from time to time. That’s how Charlie and I have gotten rich.“ —Warren Buffett
Manager’ Note: The above is not meant to be a warning per se – earnings are strong, interest rates low on a historical basis, inflation is mild, and the economy is moving in a good direction. Right now, it seems to me we are likely set up for another year (possibly more) of the bull cycle (subject to change).
What is concerning is the rising lack of investor discretion. Investors are chasing growth at nearly any price. A recent Wall Street Journal article revealed that 83% of 2018’s IPOs are companies that can’t make a profit. For reference, the DotCom Bubble peaked at 81% of IPOs made up of money losing companies. https://www.wsj.com/articles/red-ink-floods-ipo-market-1538388000?mod=djem10point
For those that clearly remember the Dot Com Bubble (and subsequent crash) this is not a happy comparison.
So, a brief comment about Risk Management for ACI partners: the vast majority of market crashes were preceded by the US moving into recession, including Dot Com. ACI uses pre-planned risk protocols to risk down partner portfolios when the US moves into recession, designed to reduce portfolio downside and position our partners to take advantage of the silly prices when they come. And they will.
In the meantime, investment decisions need to stay data driven, and the data is still good. While increased risk taking in money losing companies that have little more than an idea and venture capital backing may be a warning that we are in a late cycle bull market, we already knew that. (see minutes 8 – 10 in the Market Risk Update from March 2018 CLICK HERE ).
The investment climate is still stable, and investors are still likely to be rewarded for continuing investment.
S&P 500 (SPY): +0.0% for September, +8.9% YTD. The market looks to be consolidating after a strong summer move and it seems likely that we will see further consolidation or even correction ahead of mid-terms. Both the primary and intermediate uptrends remain intact.
Bonds (TNX): The 10 year yield surged 7.1% in September on the back of the Fed rate raise, hitting the highest yield since 2013, and is +27.1% YTD. My concerns about the intermediate term prospects of bonds remain. I expect (but don’t predict) more volatility in the next couple months, and any major media “crisis” (Italian debt, tariffs, etc.) might be an opportunity to reduce longer term bond holdings if you haven’t done so already.
Gold (IAU): -0.6% for the period, -8.6% for the year. Gold tried to rally past previous support at $11.65 twice without success. As over the summer, dollar strength is not helping. Gold appears to be consolidating over the last several weeks and seems like it may make at least one more attempt to retake $11.65.
World Ex-US (SPDW): +1.1% for September, -2.9% YTD 2018. Analysts have been crowing about value opportunities outside the US for months, and the summer selloff appears to have caused some buying in developed & emerging markets outside the US starting in mid-September, but it hasn’t been overwhelming.
Keep this in mind. When the US economy catches a serious cold, the developed world catches the flu, and emerging markets sometimes catch Ebola.
US Dollar: +0.0% for period, +3.3% for 2018. The dollar showed some weakness early in September but recovered to finish even for the month as the Fed made the rate raise official. Continued dollar strength at this level has the potential to negatively impact the earnings of US multi-nationals and the balance of trade.
Commodities: Oil +5.3% for period, +22.4% for the year. Global growth expectations coupled with increased recent attention to the Iranian sanctions helped oil spike to it’s highest level in years. Supply constraint in Venezuela isn’t helping. That being said, American producers continue to ramp rig counts and have begun converting natural gas pipelines to get more oil to port. American production levels seems likely to push oil back into the high 50s/low 60s at some point in the next few months. If oil can sustain itself above $75 for any length of time, it will begin to act as a headwind on the consumer.
Copper futures rallied +5.2% in September after a difficult summer (-14.9% YTD) and seem likely to benefit from news of continuing US economic strength and a continuation of the global growth story. Copper seems to be shrugging off tariffs for now and appears to want to move higher, but this recovery could be threatened by a failure to resolve the US/China trade spat in a timely manner.
Economy: Consumer prices continued to rise in August, with a gain of 0.2%. Ex-energy and food, inflation was stable for the period, running just over Fed targets. Chairman Powell continues to maintain that planned rate hikes will be gradual. Gradual rate increases are supportive of a growing economy (and the stock market).
Industrial production fell slightly (-2.5%) in September but still strongly in expansion with a reading of 59.8%.
The Non-Manufacturing Index has strengthened considerably since the last July reading, rising to 61.6 from July’s 55.7 number, a gain of 10.6% and the highest level seen since June 2005. 70% of the US economy is services, so this is a pretty significant positive.
Official Unemployment fell further to 3.7%, the lowest rate since 1969. Employment across all demographics has increased significantly over the last couple years. The U6, which better reflects the situation, is at 7.5%, the lowest level since 2001, indicating there is still a little slack in employment, but probably not enough to prevent wages from rising in the intermediate term. This is a net positive for the economy, provided wage inflation doesn’t increase rapidly.
The US is still in the Goldilocks zone: moderate inflation, solid employment, historically low real interest rates, rising GDP and corporate earnings.
Earnings: FactSet recently reported the expectation that S&P earnings would increase by 20% for the 3rd quarter in a row. Earnings season is beginning again, but if this thesis is born out in reality, such earnings are supportive of market prices.
Market Valuation: As in the last report, current market valuation is above Fair Value, but if FactSet’s earnings estimates are accurate, that implies the S&P 500 is only about 8% above Fair Value at the end of September on an equal weighted basis. As before, this leaves room for the market to run in either direction, but also implies that pullbacks are more opportunity than risk.
Recession Probability Indicator: The most recent reading on the RPI is 12. The RPI is still indicating we are not currently in recession and the investment environment is stable. CLICK HERE to learn more about the RPI. Update coming soon.
A brief note on headline risks as we move into the fall. Italy continues to be a risk, as does Brexit, but the real movers will be bond rates, mid-terms and the China/US trade spat. If the 5 year Treasury manages to get above 3.5% – 4%, there may be some movement out of equities (particularly dividend payers) into a guaranteed return. Democratic control of the House implies bad things for the Administration’s efforts on many fronts, including regulation, taxes and trade. The trade deficit is widening despite tariff threats, which suggests the Administration might take an even harder line if a deal isn’t reached by 2019.
These are all WHAT IF, rather than WHAT IS.
WHAT IS: The Fed still appears committed to gradual rate raises, and the real Fed rate is still strongly stimulative of economic growth. The Administration secured a deal in principal with Mexico and Canada, against media expectations. China is running out of bullets and their markets are in trouble. They are quickly approaching a point where they will have few choices that do not involve more economic pain than making a deal.
Ultimately the market only cares about 4 things: interest rates, earnings, inflation, and the economy. They are all in a reasonable place for American investors as of today. Investing is WHAT IS, not WHAT IF.
S&P Technical Picture: The S&P powered to an incremental new high in September, but a pullback after the strong run from July may be starting. If so, it’s most likely an opportunity.
Both the intermediate and primary uptrends are intact.
The intermediate term and primary trends are identified by the red arrows below, Fair Value by the thick blue line. If the FactSet earnings estimates are accurate, Fair Value will rise to approximately $270, vs. the $260 or so currently identified. Any of these points can present reasonable entry points for index investing from a technical, if not a purely fundamental, standpoint.
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