Andrea | Wellington Shields & Co. LLC

Forget the Bad Down Days … Worry About the Bad Up Days

Posted on 08/19/202208/22/2022 by Andrea

DJIA: 34,000

Forget the bad down days … worry about the bad up days. Wednesday was certainly the former. The Dow muddled around all day before closing slightly lower. Advance-Decline numbers, however, were 4-to-1down, our idea of a bad day. The market can live with that, it’s those days when the averages rise and the A/Ds are flat that cause problems. This measure of the average stock has probably been this market’s best feature. The A/D Index for the 500 stocks in the S&P just reached an all-time high, impressive in its own right, but more impressive is it has done so while the S&P Index itself remains some 10% below its own high. This divergence, new high in the A/Ds versus the Index, has led to higher prices one year later every time, according to SentimenTrader.com. Similarly, stocks above their 50-day average have moved above 90%, a level which also has led to higher prices every time. Over the years betting “this time is different” has cost a lot of people a lot of money. Then, too, you never know. Heraclitus, the famed technical analyst of 550 BC once observed, you never step in the same river twice.

So bad down days aren’t the problem, they are to be expected. The market averages don’t go up every day and when they go down it’s more than likely more stocks will decline than advance. A little less than 4-to-1 down would have been nice on Wednesday, but it’s more about the next up day and how the numbers recover. Rallies quit when they start to lose participation. Monday was a bit of an interesting day in that the Dow reversed to rally some 150 points while the A/Ds were barely positive. The overnight China news sent oil and other commodities stocks lower, and financials seemed weak as well. Simply put, there are a lot of commodity stocks and a lot of financial stocks to the point we were a little surprised the A/Ds were positive at all. That said, you don’t want to start making excuses for the numbers. And that said, typically it takes a pattern of bad up days to cause problems.

Last time, courtesy of the Leuthold Group, we pointed out that the S&P outperforms when Tech outperforms. While that may seem obvious, less obvious is Tech performs best when it performs slowly. The Nasdaq Composite and other Tech indexes have rallied more than 20% off their 52-week lows. The rally took 40 days, relatively long by historical standards. These rallies that took longer, however, had more staying power, according to SentimenTrader.com. When we think of good rallies this seems somewhat counterintuitive – good rallies don’t give you a good chance to get in, and all that. Especially when it comes to Tech, however, the quick rallies, even if 20%, often can be about short covering. The more drawn out rallies are where, dare we say it, the fundamentals have a chance to evolve. If you’re keeping score, this seems another plus on the rally’s side.

There once was a time we used to talk as much about volume as we do now about A/Ds. That was when volume was NYSE volume, and that was pretty much it. The importance of volume cannot be overstated. The problem for us became, whose volume? These days volume seemingly comes from everywhere. For sake of consistency, and because it is in many ways THE market, we’ve been tracking SPY (428) volume, that’s volume in the SPX ETF. The market and stocks should go up on rising volume and fall on declining volume, it’s that simple. We recently resurrected an indicator combining volume with A/Ds. By now you know we consider A/Ds more important than the averages, so we have an A/D index using only days when volume is higher than the previous day’s volume. The indicator bottomed on 7/14, but it’s the direction that’s important. Since then it has been in a consistent uptrend.

As the A/Ds would suggest, there’s more to this market than just Tech. Indeed, at what might be thought of as the other end of the spectrum, Staples have performed quite well. And utilities these days are not your father’s Oldsmobile. In any event, on the back of green names like Nextera (90) and Constellation Energy (82), XLU (78) is probably outperforming XLK (151). The area we really think deserves attention is energy, and probably commodities generally. Energy led the market into early June before declining sharply into mid-July. Since then most of the stocks, and ETFs like XLE (79) have moved back above their 50-day averages, which now should act as support on any pullback. With the commodity itself having been under pressure lately, the hype seems to have corrected as well.

Frank D. Gretz

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US Strategy: Expectations

Posted on 08/17/202208/23/2022 by Andrea

The current rebound has carried the broad indices between 14% (Dow Jones Industrial Average) and 23% (Nasdaq Composite Index) above their June lows and the rally has created a number of positive technical changes in our indicators. These technical changes are encouraging for the intermediate-to-longer term. Still, we would not be chasing the rally at this juncture. Walmart’s (WMT – $139.37) better-than-feared earnings report for the second quarter, was a sign that some companies are beginning to adjust to the hurdles facing them in this difficult economic environment. But while WMT jumped more than 5% for the day, its earnings report did not suggest the economy and the consumer are about to return to normal. In fact, Walmart’s results suggest that higher income families have shifted to Walmart to buy groceries. This is not a sign of consumer strength, in fact, it appears to be the opposite.

Plus, there are numerous signs that speculation is returning to the equity market. In particular, the performance of meme stocks during the August 16^th trading session suggests that “risk” is back in vogue. Bed Bath and Beyond (BBBY – $20.65), halted at least twice for volatility during the day, rose 29%. GameStop (GME – $42.19), also halted for volatility, ended the day with a gain of 6.3%. Meme favorite AMC Entertainment Holdings (AMC – $24.81) rose 2.5%, fuboTV (FUBO – $6.35) jumped 45% and Vinco Ventures (BBIG – $1.13) soared 58.8%. Meme favorites tend to be beaten down stocks with high short interest levels that attract speculators looking for high risk and quick gains. In short, this activity does not represent true equity investors and it is a short-term negative.

We continue to have an overweight rating in stocks and sectors that have the most predictable earnings streams, and these areas also tend to be equities that are both inflation and recession resistant. Sectors such as energy, utilities, staples, and defense-related stocks in the industrial sector have these characteristics. Healthcare, where we have a neutral weighting, is also a “necessity” for most households and also tends to be inflation and recession resistant.

Expectations

The return of the speculators suggests that some investors feel the worst is behind us and the economy is about to rebound after a weak and recessionary first half of the year. The University of Michigan consumer sentiment indicator for August suggests there is some truth to that thought. The August reading of 55.1, was up from July’s 51.5 reading and was a nice rebound from the record low of 50 recorded in June. Expectations also rose from a very weak reading of 47.3 in July to 54.9 in August. But strangely, the current conditions index fell from 58.1 in July to 55.5 in August. See page 7. In other words, consumers are not feeling great at the moment, but are hopeful that the future will get better. This may have a lot to do with the decline in gasoline prices in the last four weeks.

This optimism may be supported or upturned by the retails sales report coming out this week. We will be watching to see if real retail and food services sales can turn positive and show gains even after being adjusted for inflation. The last four consecutive months of negative growth in real retail sales is a classic sign of margin pressure on retailers, and a sign that consumers are actually consuming less in real terms. Moreover, it tends to be a sign of a recession. See page 7.

In our view, it is too early to celebrate, or to believe that the Federal Reserve has managed to steer the economy into a soft landing. Monetary policy is as tricky to predict this year as we have seen in many years. Inflation remains a hurdle. July’s CPI was up 8.5% YOY, down from June’s 9.0% YOY, but still extremely high. Core CPI was unchanged at 5.9% YOY last month. PPI for finished goods was 15.5% YOY in July versus 18.5% in June. Core PPI was 8.7% YOY in July versus 8.9% in June. In sum, by all price measures inflation remains well above the long-term average of 3.4% or the Fed’s target of 2%. And though inflation may have decelerated a bit, it remains dangerously high. See page 3. This poses a problem for the Fed. Although the high end of the fed funds target rate has increased from 25 basis points in February to 250 basis points in August, it is likely to go much higher. The reason for this is that the real fed funds rate is still negative 5.2% relative to the CPI and negative 4% relative to the PCE index. This is the equivalent of 520 or 400 basis points, which means it would not be surprising if the fed funds rate increases at least 200 basis points, or more, before it truly impacts inflation. See page 4. Unfortunately, these interest rate hikes will do damage to the economy and to corporate earnings.

Housing is very interest-rate sensitive, and the housing sector’s combined contribution to GDP generally averages a sizeable 15% to 18%. We believe housing is either already in a recession or about to slip into one. And though interest rates may be only halfway through their rise, housing affordability is already at its lowest level since late 1985. The NAHB confidence indices are also plummeting and looking quite bleak. See page 5. Housing prices continue to rise, due in large part to low inventories, but as a result, the median existing home price relative to income per capita at its highest point on record. This, coupled with rising mortgage rates account for the big decline in affordability. Not surprisingly, both building permits and housing starts are rolling over in July, with housing starts falling nearly 10% in the month and down 8% YOY. See page 6. With this as a backdrop, it will be difficult for the Fed to navigate the economy to a soft landing.

Lower crude oil prices will lower inflation in coming months, but this was not a result of monetary policy. Oil prices are down due to signs of progress on the Iran nuclear talks and the possibility that Iran could add a million barrels a day to global production. Also dampening oil prices were the surprisingly weak economic data coming from China (the world’s largest crude oil importer). This was coupled with worries of a global slowdown and signs of massive demand destruction after peak gasoline prices. However, all this could be temporary since the European Union’s embargo on Russian oil is set to take effect in December and could shift the supply/demand balance. In sum, investors may be too optimistic about inflation and a Fed pivot in rates.

We also feel investors are too optimistic about current and future earnings growth. The S&P Dow Jones consensus EPS estimates for 2022 and 2023 fell $6.38 and $1.01, respectively, this week. Refinitiv IBES consensus EPS forecasts rose $0.16 and fell $0.55, respectively, however, IBES does not adjust for actual earnings or adjust for GAAP accounting, which is why we prefer S&P data. Which means with the S&P estimate for 2022 now down to $210.50, a 1.1% YOY gain, we may have to lower our $218 estimate once again. In short, expectations for earnings may be too optimistic.

Technical Indicators Show Promise

The 25-day up/down volume oscillator rose to 4.93 this week, the highest since December 8, 2020, and has been in overbought territory for four of the last five consecutive trading sessions. This is an interesting juncture for this indicator because bear markets rarely record overbought readings and if they do the readings are brief. If this oscillator can remain overbought for five consecutive days this week, it would be a sign that most stocks have already seen their lows and the worst of the bear market is likely behind us. Nonetheless, the current reading of four overbought trading days already implies that the broad market may have seen its worst, and is likely to remain in a wide trading range for the rest of the year. The S&P 500 and Russell 2000 index are currently trading above their 200-day moving averages (MA) and the longer they trade above this key level, the more likely the rally will push higher. However, in all the indices, the 200-day moving average continues to fall, which remains a sign of a bear market trend. At a minimum, we would like to see the 50-day MA better the 100-day MA in each index, to suggest a bottoming trend is in place. In short, things have improved but expectations may be too high. We would not chase stocks here and continue to focus on earnings growth for stock selection.

Gail Dudack

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New Bull Market or Bear Market Rally… Does it Really Matter

Posted on 08/12/202208/12/2022 by Andrea

DJIA: 33,336

New bull market or bear market rally… does it really matter. This remains a technically sound rally. Sure Wednesday saw the market rip higher, but with the Dow up only 29 points on Monday advancing issues outnumbered decliners by better than two to one. That’s not how markets get into trouble. Bear market rallies end but so too do bull markets. Those numbers will flip – up averages and flat A/Ds – before important weakness. The bear market rally thesis also seems to be flipping, in keeping with our long-held belief that opinions follow price. And prices themselves are on the edge of being convincing. As of last Friday the S&P had retraced 43% of its decline and was 13% off its low. With maybe one exception, that doesn’t happen in bear markets. Similarly, stocks above their 50-day average have cycled from 5% to 75%, a move that typically produces sustained rallies. Call this what you like, it’s better than not bad.

When it comes to stocks above the 50-day average, the Holy Grail is 90%. That has happened 30 times in 70 years, and since 1942 the market was higher one year later every time, according to SentimenTrader.com. It’s the idea that strength begets strength, and strength begets opinion change. There almost seems a little FOMO in the air. It’s one thing to see stocks in general go up, it’s another to see stocks you wanted to buy go up without you. Opinions certainly have changed in the world of option traders. Not that long ago they were loaded for bear but lately have seen the light. If this is a new bull market that’s not a problem, you have to expect traders to be bullish in uptrends. If a bear market rally, that’s another matter. But if the latter, we would have expected momentum to be changing around now as well.

Semiconductors remind us of that guy with a can of tuna. The can keeps being bid higher and higher until finally he opens it to find – it’s just a can of tuna. It’s explained to him it wasn’t for opening, it was for trading. Semis never seem just right – there’s always too many or not enough. Years ago we remember shorting Micron (62) because even we had figured out the so-called shortage then wasn’t real. Even we had figured out everyone had double ordered. Finally with the stock around 90 we gave up because the stock just wouldn’t go down. We shorted it again around 30 when it was growing about 40% per year and selling for about four times earnings. Yet that was a much easier trade. It’s hardly an insight to say semiconductors are important in many ways. It’s just that they sometimes trade like tuna.

In a database we use there are over 500 stocks in the category of Biotechnology. After going through them recently we have two thoughts. First, we really need to get out more. The second, there are roughly 400 must buys. Granted many of these you could buy by the handful – they are two dollar stocks. And for most it’s just about sold out bounces. But it seems more than just that, and in a way reminiscent of Energy at the start of the year. To that point, how much Biotech do you own? We are still positive on Energy particularly those that have moved above their 50-day averages. We feel the same about Biotech, which really had become underloved and likely underowned.

A thought the other day was why not just buy Microsoft (287). If we’re not going to overthink this bull market/bear market rally thing, why overthink what stocks to buy. It may be hard to find a semi in a long-term uptrend, it’s not hard to find other Techs in long-term uptrends, and Microsoft is one of them. And the fact is, market uptrends don’t get far without Tech. Data from The Leuthold Group shows over the last hundred years, but who’s counting, the S&P 500 only outperforms when the Tech sector does so as well. Of Tech’s leadership cycles, only the period between December 1964 to November 1967 saw the S&P make only modest gains. The rest saw gains of up to 36%. Meanwhile, the Fed seems to be going out of his way to lean against the rally. Perhaps they’re human after all – they were late to tighten, they don’t want to be wrong again by being early to ease. May be time to fight the Fed.

Frank D. Gretz

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US Strategy Weekly: TMI (Too Much Information)

Posted on 08/10/202208/17/2022 by Andrea

This week the BLS will release price data for August, and although we believe it is too little too late, inflation data is getting a lot of attention from market watchers. Investors are hoping that price data will begin to decelerate, and if so, it will ease the pressure on the Federal Reserve to be aggressive in terms of raising interest rates. However, they may be disappointed. A deceleration from the CPI’s 9% YOY pace in June would be nice; yet many are pinning their hopes on the fact that WTI oil futures are down more than 20% from their May close. But this ignores the fact that oil prices are up 33% YOY, a percentage that will continue to add to inflation pressures. Moreover, the geopolitics around energy is complex, volatile, and unpredictable, particularly since the leaders in many oil-producing countries like Brazil, Iraq, Iran, and Russia are facing a multitude of domestic issues, making any long-term forecast for oil prices nearly impossible.

Still, it is clear that inflation data for July and August will be important, and they will set the tone for the next FOMC meeting set for September 20-21. So too will employment data and that is one of our two main topics this week.

Employment Data

The July employment report showed a surprisingly strong monthly increase of 528,000 jobs and an equally surprising dip in the unemployment rate from 3.6% to 3.5%. Given the gloomy backdrop from other surveys such as the ISM manufacturing and nonmanufacturing surveys, this big jump in employment was clearly unexpected.

However, with July’s increase, the total number of people employed in the US rose to 152.54 million, beating the previous record of 152.50 million workers in February 2020 by 32,000. This was important in our view, since the fact that the total level of employment had not exceeded its February 2020 peak was one indication that the post-pandemic recovery was weak. It also helped explain the declines in GDP.

Also in July, the participation rate inched lower to 62.1% while the employment-population ratio rose 0.1 to 60% in July. However, both remained below their respective February 2020 peaks of 63.4% and 61.2%. These ratios show the relationship between the labor force and/or employment to the overall population. What July’s data indicated was that both remain below the 2020 peak levels. See page 3.

One reason for this weakness is that the labor force has been shrinking. In July, those no longer or “not in the labor force” rose to 100.15 million, the highest level seen since October 2021. There can be a variety of reasons for people to leave the labor force, but the percentage of those no longer in the labor force yet indicating they want a job increased to 6.3%, up from the February 2022 level of 5.3%. Separately, discouraged workers jumped from 386,000 to 471,000 in July. Keep in mind that the decline in the labor force is what contributed to the unemployment rate falling in July. See page 4.

Since employment data can have a major impact on monetary policy in coming months, we dug into the data in greater detail and we noticed several interesting things about July’s job report. The establishment survey showed seasonally adjusted employment rising 528,000 to a record 152.54 million, but not-seasonally-adjusted data showed a decrease of 385,000 jobs to 152.25 million. In short, unadjusted employment remained well below its peak of 153.1 million in November 2019. See page 5.

In addition to the establishment survey, the BLS conducts a broader household survey each month. This survey showed July employment at 158.29 million, a bit less than the 158.87 million recorded in February 2020. However, the not-seasonally-adjusted household series showed 159.1 million workers in July, matching the previous October 2019 record. All in all, a deep dive into job data left us questioning whether employment actually reached a record level in July.

And the BLS will add another complication to employment data. On August 24, 2022, the Bureau of Labor Statistics will release a preliminary estimate of the upcoming annual benchmark revision to the establishment survey. These benchmarks are derived from state unemployment insurance tax records that nearly all employers are required to file. A final benchmark revision will be issued with the publication of the January 2023 job report released in February 2023. Since benchmarks adjust data retroactively, it is nearly impossible at this moment to know if employment has really exceeded its February 2020 peak. We are skeptical particularly since seasonal adjustments are done on an active basis and pandemic layoffs have undoubtedly impacted normal seasonal patterns in employment. This may be too much information for some; but since the Fed is required to maintain full employment with moderate inflation, it is important to understand where US employment stands today. We think it could be weaker than the headlines imply.

Employment data is also a tale of the have’s and have not’s. The unemployment rate for workers with a bachelor’s degree or higher was 2% in July, well below the average, whereas the unemployment rate for workers without a high school degree rose to 5.9% in July, well above the headline 3.5%. The US workforce with a college degree has grown from 26% of all workers to 44% in July. It eclipsed all other groups in 2000. However, since the pandemic it is the only group that recovered to peak levels of employment. This means the other 56% of the workforce is yet to recover to pre-pandemic employment levels. See page 7.

Reducing Earnings Forecasts

Our other deep-dive topic is earnings. As we noted last week, financial headlines are full of reports of better-than-expected earnings results for the second quarter, but this too is misleading. Last week we discussed the difference between consensus estimates and whisper numbers. The whisper numbers, primarily among hedge fund managers, were far worse than the actual consensus earnings expectations and from this perspective, earnings were a positive surprise. Nevertheless, the S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $1.40 and $1.59, respectively, this week. Refinitiv IBES consensus earnings forecasts fell $1.52 and $1.97, respectively. Over the last seven weeks the S&P Dow Jones estimate for 2022 has dropped $7.36 and for 2023 has declined $6.26. IBES forecasts in the same seven weeks fell $4.07 for 2022 and $7.63 for 2023. As a result, the nominal earnings range for 2022 declined and is now $216.88 (S&P) to $225.50 (IBES). EPS growth rates for this year fell to 4.2% and 8.4%, respectively. To adjust for the weakness seen in second quarter earnings, we are lowering our DRG 2022 estimate from $220 to $218 and our 2023 estimate from $240 to $237, and fear that there may be more downside risk to these estimates. See page 10.

Technicals Of all the indices the Russell 2000 has had one of the best performances from its June low. This is encouraging. We used the RUT as a leading indicator at the top and it may prove to be a good predictor of the low as well. Our 25-day volume oscillator is approaching an overbought reading. Bear markets rarely have overbought readings, and if they do, they are brief. Therefore, the current rally may be at a turning point. Without follow through in coming sessions and a solid overbought reading in this indicator, we would label the current advance as a bear market rally. We continue to focus on recession-resistant stocks and sectors. See page 15.

Gail Dudack

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US Strategy Weekly: Perception versus Reality

Posted on 08/03/202208/09/2022 by Andrea

Earnings, and earnings growth, are the bedrock of the equity market. And they can be especially important in an environment like the present where recession fears are plentiful. Therefore, we continue to focus on second quarter earnings results, yet we are having trouble reconciling perception versus reality in this department.

According to Reuters, “US companies are reporting mostly upbeat news this earnings season, surprising investors who had been bracing for a gloomier outlook on both businesses and the economy. More than halfway into the second-quarter reporting period, S&P 500 company earnings are estimated to have increased 8.1% over the year-ago quarter, compared with a 5.6% estimate at the start of July.” However, data from IBES Refinitiv shows that their S&P 500 earnings estimates for 2022 and 2023 fell $1.25 and $2.02, respectively last week, after rising only a penny for 2022 and falling $0.78 for 2023 a week earlier. Similarly, forecasts from S&P Dow Jones indicate earnings estimates fell $2.42 and $2.91, respectively, last week and fell $2.48 and $0.36, respectively, a week earlier. These sharp drops in estimates during peak earnings season hardly support the statement of “better than expected” earnings in the second quarter.

However, Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices, may have said it best in the U.S. Equities Market Attributes July 2022 (August 2, 2022) report. He noted that: “while earnings for Q2 2022 were expected to increase 13% over Q1, the whisper numbers were much lower, as was the concern over the second-half guidance. However, actual earnings (72.1% reported) did not make the expected 13% gain and now indicate a 7% gain, which is a headline disappointment for some, but not if you were one of those money managers (or traders) who traded into the whisper numbers (and sold). For them, it was an unexpected beat and a time to reallocate…”

In other words, hedge funds were positioned for sharp earnings declines and were relieved at the actual numbers, even though they did not beat the consensus estimates. This is quite different in our opinion from an actual increase in earnings growth — which did not materialize. In fact, the nominal dollar earnings range for 2022 fell to $218 (S&P Dow Jones) and $227 (IBES). S&P Dow Jones and IBES earnings growth rates for this year sank to 4.8% and 9.1%, respectively. And while second quarter earnings season is less than 75% complete, we find that our DRG 2022 estimate of $220, a 5.7% YOY increase from $208.19 in 2021, is at risk and is currently under review. See pages 11 and 18.

Moreover, what the Reuters article failed to mention is that even though the IBES report shows an overall blended earnings growth estimate of 8.1% for the second quarter, if the energy sector is excluded the earnings growth rate falls to negative 2.5%. This was an important omission. And we would advise monitoring the much-discussed Senate’s Inflation Reduction Act since it would currently reinstate the Superfund tax on crude oil and imported petroleum at 16.4 cents per gallon (indexed to inflation) and increase other taxes and fees on the fossil fuel sector. Obviously, this would hurt S&P earnings since so much of the earnings growth in the last 18 months has come from the energy sector. More broadly, the bill would instate a minimum 15% tax rate on all corporations. This again, would negatively impact earnings. In sum, we are not finding comfort in second quarter earnings results or current fiscal policy.

Monitoring Economic Data

With first quarter GDP growth already inked at negative 1.6% and second quarter falling 0.9%, the US economy is technically in a recession. Many will be debating this issue in coming months, but the calculation for GDP makes it rather difficult to record a negative number after a negative quarter. In short, 2Q22 GDP implies economic activity continued to slide in the April through June period. The GDP price deflator also jumped to 7.5% YOY in the quarter, the highest pace seen in this indicator since the December 1981 report of 8.4%. Note that the December 1981 reading took place in between the 1980 and 1981-1982 recessions. These two recessions were also triggered by Fed rate hikes as monetary policy struggled with an inflationary cycle. See page 3.

The ISM manufacturing index fell to 52.8 in July, the third consecutive monthly decline, the fourth decline in the past six months, and remaining below a six-month average of 55.5. New orders declined from 49.2 in June to 48 which is the second consecutive month that new orders were below the neutral threshold of 50. All in all, this is a display of declining momentum in manufacturing. See page 4.

Homebuilder confidence fell from 67 in June to 55 in July and is at its lowest level since early 2020. The June pending home sales index fell from 99.6 in May to 91.0 in June, which was the lowest reading since the March/April 2020 recession readings and the third lowest since data began in 2018. Still, the homeownership rate edged up to 65.8% from the first quarter reading of 65.4%, with the strongest gains seen in the South and West sections of the country. The housing sector began to slow well before the Fed increased rates this year and we expect it will continue its slump throughout the second half as interest rates continue to rise. See page 5.

The personal savings rate fell from 5.5% to 5.1% in June and sits at its lowest level since the 2008 recession. Real personal disposable income, which was $15.10 trillion in June, remains below its pre-pandemic February 2020 level of $15.16 trillion and is one sign of potential weakness in consumption. And despite recent monthly job reports, this does not tell the whole story. Total employment remains more than half a million jobs below its February 2020 peak level. See page 6. Inflation has also changed household spending patterns. See page 7. In the 18 months ending in June, household spending for gasoline and other energy goods increased 106%, transportation services increased nearly 50% and food services and accommodations rose nearly 45%. These increases have reduced household consumption of things other than energy and food. See page 7.

With the yield curve nearly inverted, the debate about whether or not more rate hikes will be implemented this year will intensify. Nevertheless, June’s personal consumption expenditures index, the favorite inflation measure of the FOMC, indicated price trends were accelerating and the index rose 6.7% YOY, the highest rate since January 1982. Excluding food and energy, the PCE index is rising at a 5% YOY pace, the highest since records began in 1987. This report implies more rate hikes are required to tame inflation. See page 9.

Multiple Signs of Recession

The WTI crude oil future is at $94.42 and below its 200-day moving average now at $94.70. The longer the future trades below the 200-day MA, the more likely oil prices will fall further to the $80-$85 range. This decline in oil would bring relief to future inflation, but it is not a result of Fed rate hikes. More exactly, energy is falling due to fears of weakness in China’s economy, as a result of shutdowns, weakness in manufacturing and troubles in the real estate sector. Meanwhile, the 10-year Treasury note yield at 2.74%, having recently reached an intra-day low of 2.52%, has become very volatile and is signaling economic weakness. With the fed funds future at 2.5%, a falling 10-year Treasury yield increases the likelihood that the entire Treasury yield curve will invert resulting in a classic sign of a recession.

And lastly, Technicals The recent equity rebound carried all the indices up to their 100-day moving averages which are now at roughly DJIA: 32,719; SPX: 4,119; NAZ: 12,335; and RUT 1,873. However, only the Nasdaq Composite is currently trading above its moving average. These moving averages are only first-level resistance points, yet they could prove to be pivotal for the intermediate term. At present, the market appears to be wobbling at this resistance level. In sum, we continue to maintain a relatively cautious stance focusing on stocks where earnings are most predictable, even in a recession. In general, this equates to energy, staples, utilities, and defense stocks.

Gail Dudack

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The Low Was More Than a Month Ago … But it Had Been Hard to Tell

Posted on 07/29/202208/01/2022 by Andrea

DJIA: 32,530

The low was more than a month ago … but it had been hard to tell. The averages are up some 10%, and the S&P is above its 50-day for the first time since April. Moreover, more than 50% of S&P stocks are above their 50-day. At the low that number was 2% – clearly the charts are improved. However, what seemed to be leadership, pharma and the biotechs have stalled rather than lead. When the leaders aren’t leading, it’s not much of a rally. Being over the 50-day is like clearing an obstacle but no guarantee of success. You’re over that prison wall, but still not in the clear. For now there are many stocks still dancing around their 50-day averages. Moving above that level may be no guarantee of success, but it does put the odds in your favor.

To the point “they have stopped going down,” the oil stocks provide an interesting example. If you look at the Energy ETF (XLE-75), it peaked some 12 points above its 50-day, and for now seems to have bottomed 12 points below the 50-day. We realize this is hardly in-depth analysis, and if were not above our pay grade percentages would be more appropriate. Still, if only aesthetically you have to appreciate the symmetry. Commodity types have suggested oil’s demise is more in the financial world, the futures market, then it is in the world of cash. Most of us assumed it was about getting out ahead of the recession. Cash suggests that may not be right. Natural gas meanwhile is back to its highs.

When you get most people on the same side of the boat, it’s prime time for a little mean reversion. And that’s pretty much what we have seen in investor sentiment, especially the all in Put buying by small options traders. And now US consumers generally share that gloom. The latest survey of households by the Conference Board showed that only 25% of consumers expect stock prices to rise over the next 12 months. This reading is in the bottom 5% of all months since 1987. Meanwhile, 46% of consumers expect stocks to drop, ranking it in the top 3% of all months, according to SentimenTrader.com. The difference between Bulls and Bears is -21%, one of the worst readings in the survey’s history. Even during some of the worst bear markets, the current level of pessimism has almost always preceded at least a multi-month relief rally

They say the only thing that goes up in a crisis is correlation. It turns out that Bitcoin and other cryptos made that point. Their correlations to the stock market over the first months of the year have been striking. Despite the ambitious claims of crypto as a diversifying asset, Bloomberg’s John Authers points out it has been increasingly procyclical. We have wondered in the stock market’s dark days of June, if there might not be a little causality to go with the correlation. Consensus is the Cryptoverse is too small to have much impact, Bitcoin being only the market cap of a large US company and it would be ranked 10th in the S&P, between Nvidia (180) and Procter & Gamble (148). According to Citi, most main stream financial firms are waiting for regulatory clarity and are only at early stages of exploring crypto investing, leaving it somewhat isolated from other financial markets. If crypto’s troubles haven’t spilled over into other markets, it’s clear it’s not immune to those other markets and the factors driving them.

Good rallies don’t give you a good chance to get in, they get overbought and stay overbought, and all the other technical clichés. This hasn’t been that kind of rally, at least so far. On top of that, the best momentum typically comes early, not six weeks after a low. Yet the Naz just had its best day in years and that on the “good news” of a 75 basis point Fed hike. Or should we give credit where credit is due. Phooey on FANG, it was Microsoft (276) to the rescue. And looking at the stock’s action going into those numbers, the news was quite a surprise. Of course one day is just that, which makes Thursday’s follow-through impressive, that and the positive A/Ds. Meanwhile, though not the oils or biotechs in terms of numbers, the solar stocks have taken on a whole new and dynamic character.

Frank D. Gretz

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US Strategy Weekly: A Fed Primer

Posted on 07/27/202212/19/2022 by Andrea

This is a week filled with potential market-moving events that include the July FOMC meeting, the first look at second quarter economic activity and 172 earnings results for companies in the S&P 500 index. Each of these events will have important implications for equity investors, but in our view, second quarter earnings results will be the most significant since these will help define where value is found in the equity market.

75-basis points and the Treasury Curve

In terms of monetary policy, the consensus is expecting a 75-basis point increase in the fed funds rate this week and we think this should prove accurate. In recent months the Fed has had a pattern of either matching consensus expectations for monetary policy changes or signaling its intentions well in advance of changes. In short, the Fed displays no desire to surprise, or stress, the financial markets and as a result, the expectation of a 75-basis point hike is probably discounted in current stock prices. However, we are less certain that the longer-term ramifications of a 75-basis point increase has been fully priced into equities, particularly if the economy slips into a recession.

The Treasury yield curve is currently flat, although it is technically inverted between the 6-month and 10-year Treasury note benchmarks. This makes a 75-basis point increase on the short end of the curve important since it is possible that the entire yield curve could invert shortly after the July Fed meeting. Keep in mind that a 75-basis point increase this week and the 75- or 50-basis point increase expected in September could raise the short end of the curve as much as 150 basis points. See page 3.

What makes the Treasury yield curve important at this juncture is that it has been better than most economists in terms of predicting a recession. A long history of the Treasury yield curve, focusing on the 1-year to 10-year curve, shows that in nine of the eleven inversions since 1956, an inverted yield curve has been followed by an economic recession, typically within eight months. (The range has been zero months (1957) to fourteen months (1978).) The only exceptions to this were in September 1966 — when a five-month inversion was not followed by a recession — and in September 1998 — when a four-month inversion did not result in a recession. Yet more recently, as in 2000, 2006 and 2019, inverted yield curves were followed by a recession within six to eight months. See page 4.

Quantitative Tightening and Money Supply

Yet as we focus on the fed funds rate and the yield curve, it is important to point out that rates are not the only tool in the Fed’s arsenal. While the Fed is expected to raise rates at each meeting this year, it also has indicated its intention to shrink its balance sheet. The $1.6 trillion increase in the Fed’s balance sheet between January 2021 and March 2022 was implemented during an expanding economy and it was a contributing factor to the stock market’s advance and current inflation. However, as of June 1, 2022, the Fed began reducing the reinvestment of principal payments in Treasury securities by $30 billion per month and will increase this amount to $60 billion per month beginning September 1^st. For agency debt and agency mortgage-backed securities, the reinvestment reductions are $17.5 billion and $35 billion per month. In short, the liquidity balloon that has been propelling stock prices higher since early 2020 is slowly deflating. But this is important in terms of reducing money in circulation, or money supply.

Another part of the Fed’s stimulus program was the elimination of required reserves for banks. The removal of this requirement in March 2020 resulted in a huge jump in excess reserves in the banking system and a massive increase in money supply. See page 5. This was an unusual tool for the Fed since there are laws that require banks and other depository institutions to hold a certain fraction of their deposits in reserve, in very safe, secure assets. This has been a part of our nation’s banking history for many years and “required” reserves are designed to ensure the liquidity of bank notes and deposits, particularly during times of financial strains.*

Nevertheless, in March 2020 the banking system was suddenly awash in liquidity. The 6-month rate-of-change in M2 (i.e., M2 money stock – a measure of the amount of currency in circulation) jumped to 19.5% in July 2020, an all-time record. The linkage between money supply and inflation is well-known by economists and was surely known by Fed officials. Yet this was the quandary of 2020 and 2021 for economists, strategists, and investors. Money supply fuels inflation but it also fuels stock prices. It was a double-edged sword. However, as liquidity is now being withdrawn to temper inflation, the underlying booster for equities is gone. Unfortunately, the longer-term problem of inflation remains.

GDP and Housing

Second quarter GDP will be released this week and it may answer the question of whether the US is currently in a recession, or on the brink of one. We continue to focus on the housing sector since it represents 17% to 19% of GDP in any given quarter. Unfortunately, recent news releases have not been encouraging. New home sales were 590,000 in June, down 17.4% YOY and down from 642,000 units in May. The average price of a single-family home fell to $456,800 in June, the lowest price in 12 months, but still up 5.8% YOY. The NAR affordability index dropped to 105.2 in May, which was its worst level since August 2006. However, the June, July and August readings are apt to move lower as the impact of rising mortgage rates negatively impacts potential buyers. See page 7.

Earnings and Valuations

To date, second quarter earnings season has been mixed, but a clearer picture may be available by the end of the week, or once we pass the midpoint of earnings season. We are noticing that many companies are making or exceeding revenue forecasts but are missing estimates on the bottom line. This was to be expected due to the rising cost of labor, transportation, and raw materials, but it is not good for earnings overall. Last week, the S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $2.48 and $0.36, respectively. Refinitiv IBES consensus earnings forecasts rose $0.01 and fell $0.76, respectively. This disparity between S&P Dow Jones and IBES is typical in the second half of the year since S&P adjusts earnings for GAAP accounting while IBES simply aggregates estimates. We measure “value” in the equity market by the S&P Dow Jones data.

Following S&P’s cut in its 2022 forecast to $220.21 this estimate is now in line with our forecast of $220, a 5.7% YOY increase from $208.19 in 2021. This earnings quarter will be important, and we will be looking closely at margins and the impact margin pressure may have on our $220 forecast.

All in all, none of this changes our view that the equity market is bottoming but may not have found its ultimate low. We continue to emphasize that recession/inflation proof segments of the market like energy, staples, defense-related stocks, and utilities where earnings are most predictable in this difficult environment. *https://www.federalreserve.gov/monetarypolicy/0693lead.pdf

Gail Dudack

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We Beseeched the Lord, We Summoned the Witches … and We Finally Got a 90% up Volume Day

Posted on 07/22/202207/25/2022 by Andrea

DJIA: 32,036

We beseeched the Lord, we summoned the witches … and we finally got a 90% up volume day. Let’s hope it’s not much ado about nothing. To rain just a little bit on our own parade, some lows have involved a few of these 90% up days, interspersed with a couple of 90% down days. Market bottoms can be a process. Make no mistake, however, Tuesday’s 90% up day is a positive. Two of the last three days actually have seen better than 87% up volume, and since 1962 that has resulted in double digit gains virtually every time. Speaking of 1962, this year has its similarities. Stocks were down almost 20% in the first half of that year, culminating in a similar pattern of 2% intraday declines. Prices in 1962 went on to rally 15% in that year’s second half. Even if this year does prove similar, you have to realize volatility is a given.

To go with Tuesday’s 90% day, the market indices were able to push through their respective 50-day averages where, as it often happens, they had stalled. For the S&P it was its first time back above the 50-days since April. A move through the 50-day by no means guarantees follow through, and several stocks including Microsoft (265) have danced around their own 50-day for a while now. For the averages the move is another incremental sign of improvement. Now it’s important to stay there – the 200-day is around 4350 which, speaking of no guarantees, the March rally briefly surpassed. As we suggested above, expect plenty of dancing around, hopefully all of it above the 50-day. Price objectives have never been one of our favorite endeavors. We would rather go with the idea rallies end when they do something wrong, the obvious here would be lagging Advance/Decline figures against strength in the averages.

Tuesday’s 90% up day was made possible by those former leaders, the commodity stocks. As measured by the Energy ETF (XLE-72) the peak here was early June, and relative to its 50-day it had become even more stretched to the downside than it had been to the upside. Again, no guarantee, but something. As measured by the Metals and Mining ETF (XME-45), commodities in general peaked in late April, found a temporary low in mid-May, and seem to have at least done so again. What makes this important is that these commodity stocks are many. It’s difficult to get a 90% up day while they’re going down. There should be more to this commodity stock rally, if only because of what hopefully will be a rising tide. Meanwhile, we don’t see commodities back to their leadership position which for now seems a role being played by Pharma and Biotechs.

This week’s positive price action comes against the backdrop of some extreme negativity on the part of traders and investors. We pointed to the Citi Panic Euphoria Index and its reading of “panic,” and the panic of sorts in analysts’ downgrades. And small option traders, among the worst market timers, are pretty much all in on a big leg down. Anyone will tell you these measures of investor sentiment are not for market timing. Still, if you’re buying put options chances are you have already sold a lot of stock, and it’s the selling that makes market lows. To that point, the latest edition of Bank of America’s monthly survey of global fund managers finds they are now more underweight in stocks than at any time since March 2009, the month the stock market hit bottom after the financial crisis.

This Monday the market wiped out a 1% gain in the S&P, obviously annoying if not disconcerting. Two weeks ago the S&P erased a 2% loss, meaningless like most intraday reversals. It’s easy to be thrown off by the recent volatility, and it has been volatile. The S&P has closed 1% or more above or below intraday levels the second most times in 40 years, according to SentimenTrader.com. Sometimes it’s a wicked game the market plays, so when the real deal comes along it’s hard to trust. This seems the case now. When it comes to volatility certainly Amazon (125) and Tesla (815) come to mind, yet while positive they have been anything but volatile. They act more like safe havens. Meanwhile, many of those long-term uptrend stocks we often allude to have moved above their own 50-day averages, taking them out of the category of falling knives. Long-term trends here are compelling, examples plentiful – Estee Lauder (263), Intuit (435), Dominos (406), Accenture (288), Zoetis (181), and Edward’s Life (104). Get our list and check for the 50-day.

Frank D. Gretz

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US Strategy Weekly: 92% Up Day on Low Volume

Posted on 07/20/202207/25/2022 by Andrea

The July 19, 2022 trading session was notable, not just for the 754-point gain in the Dow Jones Industrial Average, but because preliminary NYSE data shows that 92% of the day’s total volume was in advancing stocks. We have been waiting for a 90% up day to appear in breadth data which would show that downside risk is minimized. Yet while we are pleased for the near term, we are not impressed for the longer term.

This was the first “90% up-volume day” since the 92% up-volume day recorded on May 13. The May 13 session materialized right after the S&P 500 dropped below the 4000 level, which in our view, was a sign that value was returning once prices fell below the SPX 4000 mark. However, on both May 13 and July 19, total NYSE volume was average, or in the case of July 19, below the 10-day average. This is unfortunate since below-average volume weakens the signal in terms of defining a major bear market low. Nevertheless, the July 19 trading session is important since it denotes a return of buying pressure and it represents another step in the market’s bottoming process. We expect more follow-through to this rebound in prices.

In concert with the 90% up day, all the broad equity indices moved above their 50-day moving averages for the first time since April. It is quite normal for a bear market rebound to retest the 100-day or 200-day moving average. However, the 50-day moving averages have been a ceiling for prices in all the indices since early April. At this juncture, it would be normal for momentum to carry stock prices to at least the 100-day moving average lines. These averages equate to Dow Jones Industrial Average 32,840; S&P 500 4,148; Nasdaq Composite 12,470 and Russell 2000 1,890. See page 9.

Another technical indicator we will focus on in coming weeks is our 25-day up/down volume oscillator. It has amazed us that despite the substantial declines in prices this year, there have been few oversold readings in this indicator. But in the last two weeks the oscillator was oversold in six of eight consecutive trading sessions. The deepest oversold reading was on July 14 at negative 5.17, the most extreme oversold reading since March 27, 2020. At a classic bear market trough pattern, stock prices may fall to a new low in price, but this oscillator will have a less extreme oversold condition. This would be a sign of waning selling pressure and be favorable. So, in coming weeks, a new low, but a less severe oversold reading would be a positive sign.

The Week Ahead

The equity market is way overdue for a rebound; however, there are several land mines in the immediate future. Next week is the July FOMC meeting and there is a vigorous debate about whether the Fed will raise the fed funds rate 75 basis points or 100 basis points. Fed Chair Powell will be announcing the decision on July 27. A rate hike is widely expected; yet history has shown that when the Fed raises interest rates substantially, it increases the value of the dollar. Rising interest rates coupled with a strong dollar can have repercussions on global finances, particularly in subprime credit markets, in ways that are unexpected.

On July 28, the Bureau of Economic Analysis will release its preliminary estimate for second quarter GDP. As we have previously stated, we would not be surprised if it is a weak number, or a negative reading. A negative GDP number could ironically be a major plus for investors since it would confirm a recession — and stock markets tend to bottom in the second half of a recession. In short, the next few days should be interesting.

Inflation, the Fed, and the Consumer

Barring signs of an immediate recession, recent economic releases show the Fed is way behind the curve and has a lot of work ahead of it.

Inflation accelerated in June. Headline CPI rose 9.1% YOY, up from 8.5% in May and core CPI increased 5.9% YOY, in line with the 6% recorded a month earlier. Although the administration and many economists are highlighting the small decline seen in gasoline prices recently, the outlook for inflation is not good for the rest of the year. For example, homeowners’ equivalent rent increased 5.5% in June, up from 5.1% in May. Rent prices are apt to rise further since rents tend to lag the trend in home prices, and home prices are still rising at a double-digit rate. The median price of an existing single-family home rose 15% in June. See page 3.

Plus, there is plenty of inflation in the pipeline. The PPI for finished goods rose 18.6% YOY in June. Core PPI increased 8.8%. The PPI for final demand rose 11.2% in June, up from 10.8% in May. These price gains in the PPI indicate consumers face more price increases ahead or businesses face more margin pressure. One or both of these trends are likely in coming months. See page 4.

The persuasive argument for a recession is directly linked to inflation because inflation has increased more than wages. See page 4. As a result, real wages are declining and so is purchasing power. The way to stall or reverse inflation is to raise interest rates, but that too, will hurt consumers through higher mortgage and loan rates. It will impact small businesses by weakening profit margins, making credit more expensive and in some cases unavailable. Unfortunately, the Fed allowed inflation to get too high before responding. The gap between inflation, now at 9.1% YOY, and fed funds, now at 1.75%, means the fed funds rate is 863 basis points below inflation, or the “neutral” level. The Fed’s forecasts show that they expect inflation to slowly decline in 2022 which would make this gap a bit smaller. But that may be wishful thinking.

While a weaker economy and therefore lower inflation is a possibility, it also means a recession is already here. We think there are signs of an imminent recession in recent retail sales data. Total retail and food service sales increased 8.4% YOY in June, which may sound like the consumer is strong and vibrant. However, once sales are adjusted for inflation, year-over-year real retail sales (measured in $1982-1984) have been negative for four consecutive months. See page 5. Negative year-over-year real retail sales have been highly correlated with recessions in the past.

Auto sales are a major part of retail sales, and though there was a pickup in June; the longer-term trend remains negative. Moreover, as interest rates and prices rise, we expect auto sales to remain sluggish in the second half of the year. Gas station sales have been a boost to retail sales, but these gains are due only to the high price of fuel and it is shutting out other areas of consumption. Housing is also weak. The National Association of Home Builders survey for July dropped from 67 to 55. Traffic of potential buyers fell from a weak reading of 48 in June to an even weaker reading of 37 in July. In sum, many areas of the economy are showing weakness and it may not all be factored into equities as yet.

Gail Dudack

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BOTTOMING PROCESS

Posted on 07/19/202207/19/2022 by Andrea

The S&P 500 declined 21% in the first half of 2022, the worst showing since 1970. More persistent inflation than the Federal Reserve had forecast is forcing it to tighten monetary policy into a slowing economy. Russia’s invasion of Ukraine has been an additive to inflationary pressures, especially in energy and agricultural commodities. COVID lockdowns and fiscal responses in the past two years distorted supply chains and consumption patterns throughout the global economy. The repercussions are profound. Workers left the energy and many services sectors. Durable goods consumption was pulled forward at a time factories remained supply constrained. These distortions lead to a lagged inventory build now present at precisely the wrong time as consumers are tightening belts in response to food, rent and energy inflation. With the Fed fighting to catch up to inflation, these stresses make it likely the US will experience a recession in the coming months, and indeed may already be in one. The actual timing and severity will only be known with hindsight.

Inflation is pressuring corporate margins and forcing consumers to curtail discretionary spending, reducing aggregate demand. This, in turn, will flow through to negatively impact corporate earnings. So far analysts’ estimates of forward earnings have remained resilient, and the market’s decline to date has been largely a compression of the multiple investors are willing to pay for those earnings. The final market lows will likely be accompanied by a reduction in earnings estimates.

Regardless of whether a recession occurs or not, the stock market is unwinding a liquidity-driven run-up from the extraordinary monetary policies enacted during the COVID crisis. Market bottoms are emotional and take time. While the tell-tale characteristics of a final market capitulation are not evident yet, we are well into the process of forming a bottom.

Investors should not lose hope, as there are some silver linings. Strong earnings and shareholder returns—in the form of dividends and buy-backs—have propelled the market in the past two and a half years. The S&P 500 finished the first half of 2022 17% higher than the end of 2019, before COVID, however second quarter trailing twelve-month S&P earnings are estimated to be 43% above pre-COVID levels. While the pace of growth should decelerate from current expectations—and may pause—growth will resume again. A variety of secular growth areas from batteries and electric vehicles, to hydrogen and solar, to genetics and big data (to name just a few) will continue to provide ample growth opportunities for companies in many industries.

Historically, markets bottom in the midst of recession, not at the end. The market is a discounting mechanism and the decline in the market to date has discounted a lot of the dour news cited above. This year marked the sixth time in history that the S&P 500 declined over 15% in the first half. On each of those occasions the market rallied in the second half. It is too early to say the low is altogether in, but we are significantly on the way.

July 2022

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