Markets in Minutes: September 5, 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 June 1 – August 31, 2018
Investor Learning: “Those who have knowledge don’t predict. Those who predict don’t have knowledge.” – Lao Tzu (Philosopher & author of The Art of War)
“People have always had this craving to have someone tell them the future. Long ago, kings would hire people to read sheep guts. There’s always been a market for people who pretend to know the future. Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts. It happens over and over and over.” — Charlie Munger (Warren Buffett’s business partner)
S&P 500 (SPY): +7.6%, +9.7% for 2018. The upside move started in May caught a tailwind from rising earnings over the summer months. Muted inflation and still-low-by-historical-standards interest rates lent a hand. Both the primary and intermediate uptrends remain intact.
Bonds (TNX): Yields managed to gain +1.1% vs. the prior period but put bond investors on an interesting ride in between with yields following a roller coaster between May’s low and two attempts to break above 3%. Yields on the 10 year are still up 18.6% year-to-date. My concerns about the intermediate term prospects of bonds remain. I think it’s a bad spot to be unless you carry to maturity for income only and could care less what the bond principal is priced at. Long duration bonds (more than 5 years) should be examined very carefully to make sure they are in your portfolio for a specific reason. I expect (but don’t predict) more volatility moving into fall, and any major media “crisis” (Italian debt, tariffs, etc.) might be an opportunity to reduce longer term bond holdings.
Gold (IAU): -7.7% for the period, -8.1% for the year. Gold fell below previous lower support at $11.65 in early August and looks to be in the middle of a failing rally to re-take that level. US dollar strength is not helping the questionable case for gold, although gold bulls may see a spikes if volatility returns to markets in the fall. Any spike that does not break through $12.15 on rising volume seems likely to fail and should be treated as a sell opportunity.
World Ex-US (SPDW): -2.6% in June/July/August, -3.7% YTD 2018. World markets had a bit of a rough summer, although developed markets are still holding up better than expected vs. American markets. Emerging markets are currently skating along the edge of bear market territory, down -8.4% over the summer and -17.1% since the January high. Interest rates are low in most developed nations and economies are still growing globally, which is supportive of positive market outcomes.
As usual, I view risk in markets outside the US as higher than perceived. It may be some investors are beginning to find themselves with similar thoughts as capital flows into US stocks and bonds have been big over the last couple months and have come at the expense of markets elsewhere.
US Dollar: +1% for period, +3.3% for 2018. The dollar moved up since May in the face of geopolitical news & rising interest rates. News of the potential contagion in Italian bonds and the impact on the Euro drove investors into the safety trade of the US dollar in the spring, while rising US interest rates helped maintain that strength as investors left emerging markets. This may continue, adding to dollar strength and potentially negatively impacting the earnings of US multi-nationals if the dollar manages a sustained move above $95 on the index. That may also have a negative impact on the trade balance.
Commodities: Oil +4.1% for period, +16.3% for the year. Global growth expectations continue to support oil in the face of growing American supply aided by reinstated sanctions against Iranian oil and the difficulty socialist Venezuela has in bringing their oil to market. However, US producers are aggressively increasing rig count in an effort to wring every dollar from current prices they can, and August was a record for US oil exports. As before, I will be surprised if American production levels don’t push oil back into the 50’s as the summer driving season ends and we move into the 2nd half of the year.
Copper futures were in free fall for the summer, losing just over -13%, and down -19.1% for the year. Copper rallied and was briefly positive in June following Chinese comments that a deal had been reached with the US on tariffs, but when President Trump said tariffs would be increased instead, copper fell aggressively. With tariffs center stage and the President’s infrastructure plan on the back burner (at least as of today), copper seems to have few catalysts to rally.
But, I do not expect copper to remain here long partly due to technical factors but also because the global economy is growing and global manufacturing along with it. Demand for copper is somewhat inelastic in growing economies. If tariffs do not reduce economic growth in China, it needs copper (as does the US) and this move is more about a fear of what MIGHT happen rather than a realistic look at what IS happening. As such, I expect to see copper to strengthen before the end of the year as long as the tariff talk doesn’t morph into an actual trade war (I’m still in the camp that think this will be negotiated within months).
Economy: Consumer prices rose in May, June and July to 2.9% change in the last 12 months, with the August reading due in mid-September. Ex-energy and food, inflation is now running just over Fed targets. The Fed chair has indicated he is willing to let the economy run a little hot, but with these numbers it’s virtually certain interest rates will see a hike this month. Chairman Powell has maintained that rate hikes will be gradual, possibly because Inflation is still running lower than it should be at this stage of an expansion. Gradual rate increases are supportive of a growing economy (and the stock market).
Industrial production gained 1.5% in June to 60.2, fell in July, then surged in August to a 61.3 reading. New orders were also very strong, clocking the highest level since January 2018 and the 16th month above 60 percent. Manufacturing is clearly in expansion mode.
The Non-Manufacturing Index rose 0.5% in June before falling -3.4% in July to 55.70. Any reading above 50 indicates expansion, so services are still growing, but are growing slower than at any time so far this year. 70% of the US economy is services, so this bears watching. My expectation is for services to rise again when the August reading is released in mid-September.
Official Unemployment is listed at 3.9%, just up from May’s multi-decade low. In the near-to-intermediate term, this is good for the economy.
The US continues to be a sort of Goldilocks situation: moderate inflation, solid employment, low interest rates, rising GDP and corporate earnings.
Earnings: Earnings have been very strong. According to FactSet, with 99% of Q2 reporting done, earnings look to be near 25% growth vs. same quarter last year, the strongest we’ve seen since Q3 2010. With expectations of 3rd quarter GDP of 4%+, solid earnings should continue, which is supportive of the market.
Market Valuation: In the May Markets-in-Minutes I reported that the market was fully valued. The strong run over the summer months put it in a position where it closed August about 11% above fair value. This leaves room for the market to run either up or down from here, but with the strong earnings implied for Q3 it seems likely pullbacks will be temporary and it’s probably smartest to see them as buying opportunities.
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 moving into the fall. The Italian story is not over and that is likely to rile markets, as are the Brexit terms if they can’t make a little traction, as are any changes in the tariff tantrum going on between the US, the EU, China and Canada. Whatever your politics, mid-terms are a concern if Republicans lose the House due to the higher than typical uncertainty that will bring to the markets. There are other potential headline risks out there, most of them occurring internationally which seems likely to drive investable assets to American stocks and American bonds, while holding back the bear market in bonds I still expect.
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 about WHAT IS, not WHAT IF.
S&P Technical Picture: The S&P continues to find support where expected and the expectation that the market would break out in late spring to move to new highs turned out to be correct.
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. Any of these points can present reasonable entry points for index investing from a technical, if not a purely fundamental, standpoint.
For additional color on the current technical situation, please visit: http://www.aciwealth.com/market-risk-snapshot-april-2018/
The SPY Chart (S&P 500 Proxy) You may need to zoom your computer screen in a bit
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