Andrea | Wellington Shields & Co. LLC

US Strategy Weekly: A Potential Global Risk

Posted on 11/10/202111/13/2021 by Andrea

China’s Property Sector

China’s property woes first rattled global markets in September and October, however, fears of systemic risk are resurfacing again. China Evergrande Group, the world’s most indebted developer, has been stumbling from deadline to deadline as it struggles with more than $300 billion in liabilities — $19 billion of which are in international bonds. A $148 million bond payment must be made on Wednesday, and this will be followed by coupon payments totaling more than $255 million on December 28. However new concerns appeared last week when Kaisa Group made a desperate plea to Beijing and creditors for help. Trading in shares of Kaisa and three of its units was suspended after an affiliate missed a payment to onshore investors. In response to Kaisa’s woes, China’s property sector has taken a pounding.

In terms of sales Kaisa Group is China’s 25th largest real estate developer but it ranks second to Evergrande Group in terms of bond repayment bills due next year. This makes Kaisa’s crisis meaningful. Also interesting is the fact that the US Federal Reserve just sent its first direct warning to China and investors about potential global damage from China’s property crisis. In its twice-yearly financial stability report released this week, the Fed wrote: “Financial stresses in China could strain global financial markets through a deterioration of risk sentiment, (and) pose risks to global economic growth.”

It is worth mentioning that economists estimate China’s property sector to be the largest contributor to China’s economy and if related industries are included, property accounts for more than 25% of GDP. Real estate has been a large and steady creator of jobs in the country and land sales account for a third of local governments revenues according to Nomura. Property also accounts for 40% of assets owned by Chinese households according to Macquarie Group Ltd. This suggests that if real estate continues to fall Chinese consumers could lose confidence and curtail consumption. And according to Reuters, the value of nationwide land sales fell 17.5% YOY in August. In short, there is a major risk to the Chinese economy as a result of the current property crisis.

Reuters also notes that due to a long, massive building boom and speculation, China has about 65 million empty homes, or the equivalent of all the households in France and the United Kingdom combined. As of June, Chinese developers owed 33.5 trillion yuan ($5 trillion), or a third of the country’s GDP, up more than two-fold from 2015, according to Nomura. This outstanding debt is roughly equivalent to the GDP of Japan, the world’s third-largest economy. The overriding question is whether or not China will be able to handle the risk that is growing in its property sector. All in all, these developments underscore why investors should not be myopic as the US equity indices make a series of record highs and instead be alert to global issues. Clearly factors outside the US could impact the global banking system, global liquidity and reverberate through the global financial markets. To sum up, China could easily become a major risk for the financial markets in the months ahead.

Assessing the Technical Backdrop

There are many good things happening in the technical backdrop of the market at present. This week the cumulative NYSE advance decline line reached an all-time high confirming the new highs seen in the indices. The Russell 2000 index made a bullish breakout from an 8-month trading/consolidation range which generates a positive outlook for the intermediate term. The daily new high list is averaging 350 new highs per day, and finally, sentiment indicators are oscillating in neutral ranges which means they are not indicating any excess optimism on the part of investors. See pages 9, 11 and 12. These are all positive. The only weakness is seen in volume.

Our first concern is that total volume on the NYSE has been decelerating and has been running below the 10-day average in many November sessions. Volume should increase during advances since rising volume reflects increasing demand. Second, the 25-day up/down volume oscillator has ticked higher but remains stuck in neutral. Currently, the oscillator is at 2.07 and neutral after spending only two days in overbought territory October 25 and 26. To confirm new highs in the popular indices, this indicator should remain in overbought range for a minimum of 5 consecutive trading sessions. The last time this indicator did this and confirmed new highs in the equity market was between February 4 and February 10 of this year. From a technical perspective, this is a sign of underlying weakness, and it is a warning that the bull market is aging.

Still, this is a seasonally strong time for equities. November ranks as the best performing month for the S&P 500 and ranks number two for the DJ Industrial Average. December ranks third in terms of performance for both indices. The other contender is April which currently ranks second for the S&P 500 and first for the DJ Industrial Average. Note that the seasonally strong months tend to coincide with pension funding cycles or tax strategies and IRA funding for individuals. Liquidity is an important ingredient in terms of stock performance; and this good seasonality coupled with a decent technical backdrop makes us optimistic about the next few months. But we see the potential of storm clouds ahead. Not only is China a threat to the global economy and to global liquidity, but earnings growth in the US will fall into single-digit territory in 2022. The great support found in earnings growth this year will not be repeated in the next twelve months. Therefore, a balanced portfolio with companies that are inflation resistant, have strong balance sheets and below average PE multiples remain our preferences.

Economic Roundup

Economic data is mixed. October’s employment report was encouraging not only because it showed a gain of 531,000 jobs in the month, but because the increase in private industry jobs was significantly higher at 604,000 new jobs. Revisions to two prior months were also positive. In the household survey, the number of people employed grew in excess of the increase in the labor force, which resulted in the unemployment rate falling from 4.8% to 4.6%. Nonetheless, there are 4.2 million fewer people employed currently than in February 2020. See page 3.

October’s ISM manufacturing survey showed that global supply-chain issues are not abating. Most areas were slightly lower but there was an uptick in hiring plans. Conversely, the ISM nonmanufacturing survey was strong, setting a record for the fourth time in 2021. The only blemish in the services report was the decline in the employment index. See page 5.

Vehicles sales increased to 13 million units (SAAR) in October and was below 14 million for the fourth straight month. October’s sales were 21% below a year ago and the lowest October in 11 years. However, sales did rebound from September’s low, and this should help next week’s October retail sales report. See page 6. The NFIB small business survey slipped 0.9 points in October to 98.2, but the real story is that the outlook for business fell 4 more points to negative 37. This was just above the record low of negative 38 set in November 2012. The survey shows both sales and earnings have been sliding since mid-2020. Plans to raise prices jumped from 46 to 51 in October. See page 7.

Gail Dudack

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From Facebook to META … Too Bad Philip Morris Was Taken

Posted on 11/05/202112/19/2022 by Andrea

DJIA: 36,124

From Facebook to META … too bad Philip Morris was taken. As is typical of most renamings, this one has its critics. Professionals find “META” (336) already a fairly common name, and it’s one that ties the company to a very specific future in the augmented/virtual reality space – about which most were unaware. What may capture the spirit of the many cynics, it’s like a restaurant that fails its health inspection and changes its name in a rush, said Ryan Goldstein of A. P. Keaton. As the saying goes, a rose by any other name is still a rose. It’s one thing to have the government on your case, something else when even your employees turn on you. For all its troubles, recent weakness is a mere flesh wound to that long-term chart. A move down to 300, a break of the uptrend, would be a different story.

For the market overall the backdrop has lined up pretty well for a good fourth quarter. From last Thursday, the 208th trading day of the year, the odds of a 5% or greater decline through year-end are only about 15%. The odds of a 20% correction are more like 2%, according toSentimenTrader.com. Speaking of seasonality, Staples have a win rate of close to 85% this time of year. We mentioned before when 80% of the S&P components were up on the year at the end of the third-quarter, as was the case this year, the market was higher in the fourth quarter each of the five other times. And the S&P component stocks have cycled from fewer than 10% of stocks above their ten-day average to more than 80%. When this close to new highs in the averages, returns were positive several months later.

If that’s the backdrop, the market action itself has lived up to it. On Monday with the Dow up only about 90 points, there were 3000 stocks up on the NYSE. That’s almost remarkable. It’s the sort of number you expect to see at the start of a bull market rather than one this far along. The Advance-Decline Index is at a new all-time high, leaving less than a 5% probability of a 10% or greater decline in the next few months. The reason for Monday’s unusual number was the strength in so many secondary or mid-cap stocks. The Russell 2000 (238), a measure of secondary stocks, finally has broken out of what pretty much has been a year-long trading range. Inasmuch as secondary stocks typically peak before the large-cap averages, leaving divergences in the A/D Index, this seems another positive sign in terms of the uptrend’s longevity.

They say in a bull market you don’t need a technical analyst, and in a bear market you don’t want one. A day with 3000 advancing issues does not a bull market make, but it is a day when you don’t need anyone to tell you what’s going up. That said, the various commodity groups – oil, lithium, uranium and probably gold, still appeal to us. And if those underinvested pros are about to get run-in, you have to think Tech, including FANG, and Google (2965) especially. Meanwhile, Tesla (1230) can’t go up forever, or can it? At almost double its 50 day, history says time for a rest. We find interesting an ETF with one of our favorite symbols, MOO (97). This AG Business ETF in its top holdings covers a couple of excellent charts in diverse areas – Zoetis (218), a drug company, and the retailer, Tractor Supply (218). The ETF is consolidating just above its base pattern.

Taper without the tantrum? It’s not so much the market got what it wanted, it got what it expected. It was a “nothing to see here” sort of fed event. If good enough for the market, it’s good enough, but still. The market’s fixation on rates and when they will rise seems a little misplaced when historically markets rise well after the first right hike. Meanwhile taper means money is coming out of the demand equation and that would seem to matter. But, sufficient unto the day is the evil thereof. Here again, pay attention to those Advance-Decline numbers. If there’s less money to push stocks higher there will be fewer and fewer advancing issues. Instead of Monday’s 3000 advancing stocks, there will be a rally in the averages with just as many declines as advances. That’s when trouble starts. Taper is our idea of bad news, the market ignored it. That’s what good markets do.

Frank D. Gretz

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US Strategy Weekly: An Earnings Focus

Posted on 11/03/202111/13/2021 by Andrea

Quantitative Easing

Last week we wrote that the economic, political, and technical backdrop for the equity market was the best it had been in many months and that this combination would set the stage for a year-end rally. In our opinion, the inability of Congress to pass a large stimulus package – which could have included hefty business and personal tax rate increases — combined with the positive seasonality of November, December and January should not be ignored. Moreover, the monetary policy changes expected this week have been well telegraphed and discounted by investors and should make the slow elimination of quantitative easing a non-event. In sum, barring some unexpected negative mishap, we believe the stage is set for higher stock prices and a decent Santa Claus rally. Nonetheless, earnings growth is forecasted to slow in 2022, and though this may not have an impact until next quarter, we would still emphasize quality stocks. Companies with inflation resistant earnings growth are apt to be the best performers in the months ahead.

Earnings Backdrop

Third-quarter earnings are center stage again this week and as the economy bounces back from the coronavirus pandemic, most companies continue to report better-than-expected results. One should keep in mind that estimates were downsized in September when analysts were concerned about supply chain issues hurting third quarter estimates. Nonetheless, with 320 companies having reported, Refinitiv IBES indicates that S&P 500 earnings are anticipated to have climbed 40.2% in the third quarter from a year ago. This hefty earnings jump produces a nice cushion for the broad market as we move into the final months of the year.

Technical Challenges

But there are a few challenges in the technical backdrop this week. The 25-day up/down volume oscillator is at 1.96 and neutral after spending only two days in overbought territory last week. To confirm the string of new highs seen in the popular indices this week, this indicator should move to and remain in overbought range for a minimum of 5 consecutive trading days. However, the last time this indicator did this and confirmed new highs in the equity market was nine months ago, between February 4 and February 10 of this year.

In February, when the Russell 2000 previously recorded a record high, overbought readings in this indicator confirmed the equity market’s advance. Since then, there have been no validations of a succession of record highs. We should also point out that while the many indices made marginal new highs on November 2, breadth data was not convincing on the NYSE and data showed more declining issues than advancing issues for the session. Volume was also disappointing since it slipped below its 10- day average. In sum, November 2 was a great day for equities globally. The S&P 500, the DJIA, the Nasdaq Composite, the Russell 2000, the Wilshire 5000, France’s CAC 401, and the MSCI all-country world index all made record highs. However, it was not a convincing day from a breadth perspective. This could change over the course of the next week, but for example, the bullish breakout in the Russell 2000 index from a 9-month trading range needs to see confirming follow-through. In the interim we believe this is another reason to emphasize quality stocks.

Economic Data and the Fed

It has been a busy week in terms of economic releases and overall, we believe most results relieve the Fed of any pressure to raise interest rates. In general, we found economic data discouraging. The advance estimate for third quarter GDP indicated economic activity grew at a seasonally adjusted annualized rate of 2.0%. This was a big disappointment since 2.0% is well below the long-term average for GDP growth of 3.2%. In addition, third quarter activity was concentrated in a buildup of private inventories. This is a negative since the need to increase inventories is diminished and this could reduce economic activity in the fourth quarter. The main weaknesses in the third quarter estimate were found in personal consumption of goods, the negative drag from trade and a decline in residential investment. See pages 3 and 4.

The decline in the household’s consumption of goods can be explained by the recent data on personal income, consumption, and savings. Personal savings were $1.3 trillion in September down from $1.67 trillion in August and well below the April 2020 peak of $6.4 trillion. This is a sign that the “pent-up demand” economists expect from the pandemic’s buildup of household savings is quickly evaporating. September’s savings rate was 7.5% down from 9.2% in August and closing in on the 20-year average rate of 6.8%.

Personal income was $20.5 trillion in September, down from $20.7 trillion in August and well below the $24.1 trillion seen in March 2020. Personal disposable income was $17.9 trillion in September, down from $18.1 trillion in August, and also well below the $21.7 trillion seen in March. See page 5. However, wages rose to a record $10.38 trillion in September as people began to move back into the workforce. Keep in mind that wages represented a peak of 65% of personal income in July 1966 but have been steadily declining as a percentage of income and hit a low of 41% in March 2021. Wages rose to 51% of total personal income in September but much of this gain is statistical.

September’s headline personal income number declined as government social benefits fell from $4.2 trillion in August to $3.8 trillion in September. Total unemployment benefits fell from $352.3 billion in August to $97.7 billion in September. Note that unemployment benefits peaked at $1.4 trillion in June 2020. See page 6.

The decline in disposable personal income from $1.81 trillion in August to $1.79 trillion in September could reverse and improve dramatically if people return to work as unemployment insurance benefits are exhausted. But if employment does not increase and income stagnates, the outlook for the economy will dim. Historically, there has been a close, but lagging, relationship between the year-over-year growth in disposable personal income and the year-over-year growth retail sales. To date, retail sales have been the beneficiary of the massive 32% YOY growth in disposable income in March of this year. Retail sales grew nearly 12% YOY in September (14.2% on a 3-month average) and were easily beating inflation. See page 7. However, this may not continue. Disposable income growth slipped to 2.3% YOY in September, which is less than half September’s rate of inflation of 5.4%. This implies that retail sales will weaken in the months ahead. Companies have indicated that they have been able to pass on higher raw material and transportation costs to consumers. However, if household incomes do not grow faster than inflation in coming months, this cannot continue. Either corporate margins will contract, or top line growth will decline. This is not good news for 2022 profits. Therefore, we are not surprised that consumer and business confidence indices were weak in October. The University of Michigan consumer sentiment index fell from 72.8 in September to 71.4 in October and while the Conference Board Consumer Confidence index rose from September’s dreary 109.8 to 113.8 in October, it remains below previous highs. The NFIB confidence index continues to languish below 100. See page 7. In short, economic data suggests there is no reason for the Fed to raise rates in the foreseeable future. This is positive for equity investors.

Gail Dudack

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Waiting for Washington

Posted on 11/01/202111/01/2021 by Andrea

Our July letter noted that it was time for some caution—a recommendation that proved premature until the last week of the quarter. Stocks produced slightly positive returns in the third quarter, primarily driven by upward earnings revisions and easy money. In some respects, money has never been easier. A quick calculation comparing the yield on the U.S. Treasury 10 year inflation-protected security and the expected inflation rate would indicate that money is free. Many corporations are taking advantage of this by raising capital, and it would appear that investors have come to grips with the fact that our Federal Reserve will most likely start slowing its massive securities purchases as soon as year-end.

Most, if not all, of the fears we mentioned in our July letter have not been resolved. A Democratic-controlled Congress has not been able to coalesce around a spending bill designed to support both physical and human infrastructure. The nature of the tax increases necessary to fund this spending remains unknown. Leverage and imbalances in the Chinese property market were laid bare by the Evergrande implosion, which in turn heightened focus on the slowing growth profile of that economy. COVID-induced global labor shortages colliding with increased demand for goods have stressed the global transportation industry, slowing the delivery of goods. Witness the fleets of vessels waiting to unload into west coast ports, and UK gas stations waiting for truck drivers to deliver fuel. Production slowdowns during the COVID pandemic across a variety of material producers from fossil fuels to metals have not reversed quickly enough to meet resurgent demand. Companies across many industries have raised prices to offset increased labor, material, and transportation costs, stoking fears of a persistent inflationary environment. These fears are soon to be inflamed by increases in rent in the U.S. as eviction moratoriums end. The U.S. labor market is in the paradoxical situation of having five million fewer people working than prior to the pandemic despite businesses clamoring for employees. While extraordinary unemployment benefits have largely expired, consumer balance sheets remain unusually strong, and the many reverberations of COVID continue to keep workers on the sidelines.

There is reason to think many of these negatives will recede in the coming year. The surge in the COVID Delta Variant was responsible for transportation and supply disruptions as workers were unable to report to factories and ports. The ebbing of that spike, coupled with positive news on the efficacy of booster shots, suggests that COVID-related disruptions should end sooner rather than later. As history has shown, the cure for high prices in oil and base metals is high prices, which catalyze increased production. The U.S. oil industry has the capacity to ramp up production. While the Federal Reserve may begin tapering its quantitative easing program in November, this monetary support will still be coming into the markets until June of next year. Lastly, with the turnover of the Fed governors there is the potential for a Fed with even more dovish tendencies next year.

In spite of more persistent inflationary data, credit markets are well-behaved, and demand for goods and services remains strong, all suggesting a still growing economy. Though productivity gains many companies have been able to protect margins and maintain a growth outlook into next year. With a yield under 1.7% on the 10-year Treasury, the bond market still does not offer a compelling alternative for capital preservation or accumulation. Instead, select areas of the equity market continue to provide the most viable solution for protecting wealth and purchasing power against inflation.

October 2021

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Still Looking for a 20% Correction… That Could be Your Career Flashing in Front of You

Posted on 10/29/202111/01/2021 by Andrea

DJIA: 35,730
Still looking for a 20% correction… that could be your career flashing in front of you. That’s true for the
professionals, many of whom already are lagging. And it could give new meaning to, “buy don’t bid” as the year
comes to a close. Imagine, Tesla (1077) up every day? More modestly, we wouldn’t expect too much trouble going
into year-end. It’s a seasonally positive period, but almost more importantly the harrowing month of October is
ending. We have mentioned the Advance-Decline Index once or twice, in this case to point out its new high. This
measure of the average stock tends to lead the stock averages prior to important corrections. Since 1928, the S&P was
five times more likely to see a 10% decline within three months if the A/D Index was not at a multi-year high. When
it did break out, as it has now, there was only a 4.6% probability of a 10% or greater decline in the next few months,
according to SentimenTrader.com.
Whether it’s a drift or a sprint higher, where you’re in likely will remain as important as whether you’re in. The
market has favored commodities and financials over most, but don’t tell that to stocks like Advanced Micro (121),
Nvidia (249) and Microsoft (324). And just when you think there’s nothing new under the sun, so to speak, Solar
comes along with a blowout move on Wednesday. Solar is a good example of how hard it has been this year to
settle on leadership. Until February it looked like the real deal, and by May it looked like the great meteor was on
its way. Overall, at least to look at TAN (98), the Solar ETF, it seems to be coming out of a lengthy base pattern.
Yes, more rotation, but probably not to the detriment of Oil. Lithium and Uranium also are two areas we favor, LIT
(91) and URA (27), respectively, are the ETF’s there. And, there’s Gold.
Bitcoin has garnered renewed enthusiasm in part on the back of the new ETF, Bitcoin Strategy (39). We’re
exaggerating just a bit, pun intended – talk is Bitcoin to the moon. Here at a modest new high, you have to admit it
has fulfilled previous expectations, defying naysayers. Meanwhile, Bitcoin has its skeptics, but so did Amazon
(3468) and Tesla. Then, too, there’s a graveyard of stocks, especially in Tech, where the skeptics had their day. We
have no strong overall opinion except to notice while never lacking for enthusiasm, Bitcoin does seem to have its
bouts of over-enthusiasm. One of those was when Coinbase (319) came along last April. From its high back then
COIN dropped some 50%. More to the point, if you use Marathon Digital (50) or Grayscale (49) as a proxy, the
enthusiasm COIN engendered at the time finished the rally in Bitcoin. Just as COIN was thought somehow to
legitimize Bitcoin, the same is now being said of the ETF. We wonder if it may not play out the same, at least
temporarily.
To dampen your enthusiasm just a bit, you might consider “the economy” section of last week’s Barron’s. The
article recounts a paper earlier this month by David Blanchflower and Alex Bryson in which they show that
consumer expectation indexes from both the University of Michigan and the Conference Board predict downturns
up to 18 months in advance in the U. S. They found that all recessions since the 1980s have been predicted by at
least a 10 point drop in these indexes. The Michigan gauge peaked in June and fell 18 points by August, while the
Conference Board measure peaked in March and then fell 21 points through September. While they call the
economic situation in 2021 “exceptional,” downturns in consumer expectations in the past six months suggest the
economy is entering a recession now, they say. Why the consumer gloom? Surveys show inflation is the
consumer’s top concern, something even Powell last week suggested may not be transitory.
The market has ignored /survived a lot of bad news, including last week’s word from Powell that inflation may not
be transitory. The surprise isn’t that he seems wrong – he admits to it! It’s possible the market may run in the
underinvested, but if it’s only a muddle higher, so be it. To whatever degree, higher seems likely. Aside from the
stocks we’ve mentioned, in a get-me-in market, if it goes that way, Google (2917), Tesla and Microsoft seem
indicative of where money might easily go. And so it did Thursday with Google. Curiously, the market’s initial
response to numbers from both Google and Tesla were tepid at best, and then the stocks blew higher – part of the
get-me-in? It will be interesting to see what comes of the likely Amazon (3447) and Apple (153) dips. Amazon
doesn’t seem immune to the world’s problems, but will the buy the dip stock do the same? Meanwhile, it’s a
Gambit, if you catch our drift.
Frank D. Gretz

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US Strategy Weekly: Setting the Stage

Posted on 10/27/202110/28/2021 by Andrea

Third Quarter Earnings

This is going to be a busy earnings week since 165, or one-third of the components of the S&P 500 companies will report third quarter earnings results in the five-day period. Thus far, results have generated an abundance of positive surprises. However, it is important to remember that the bar had been lowered by analysts in September when they dramatically cut estimates in response to supply chain hiccups and weaker than expected employment increases. To date, according to IBES Refinitiv, third quarter S&P earnings should show a gain of nearly 35% YOY, which is a healthy improvement in view of the disruptions from rising costs, supply issues, and hiring problems. In general, the quarter shows that corporate America is adept at maintaining margins despite rising costs and has been able to pass these costs on to consumers. Nonetheless, the S&P sectors that are accounting for the majority of the earnings gains in the third quarter are the areas that benefit from inflation.

Driven by Inflation

For example, in the third quarter, earnings are expected to rise 1538% YOY for energy, 96% YOY for materials, and 78% YOY for industrials. Technology ranks as the fourth best sector with IBES Refinitiv showing a gain of 33% YOY in the quarter. And the same trend holds true in the fourth quarter. IBES Refinitiv is forecasting S&P earnings growth of 22.8% YOY for the fourth quarter which includes an 8067% YOY gain for energy, a 66% YOY gain for materials, and a 57% YOY gain for industrials. The only minor difference in the fourth quarter is that the fourth best earnings growth rate of nearly 23% YOY is expected to be seen in the healthcare sector. See page 7. However, we would be amiss if we did not point out that, to date, the sector with the biggest surprise factor in the third quarter has been financials. Analysts were looking for earnings growth of 17% YOY at the start of the month and estimates are now showing a gain of 33% YOY. It is worth noting here that financials are fairly well insulated from the negative aspects of significant inflation and also benefit from a steepening in the yield curve.

Overriding Economic Worries

Positive earnings results contributed to the record highs in the popular indices this week, but we think investors were also encouraged by the fact that the proposed $3.4 trillion stimulus package was unraveling in Congress. This change also meant that the proposal to raise the corporate and individual tax rates was unlikely to materialize. This shift removed a dark cloud overhanging corporate earnings expectations for 2022 and it cannot be underrated. In our view, this “improvement” in earnings prospects for 2022 overcame signs of economic weakness in China and Germany.

Technical Changes

This news from earnings and the political environment not only drove several indices to record highs, but it was accompanied by significant changes in the technical status of the market. The 25-day up/down volume oscillator is at 3.09 this week and in overbought territory for the second consecutive trading day. Readers of our strategy weeklies know that to confirm any new high in the popular indices, this indicator needs to remain in overbought for a minimum of 5 consecutive trading days. Very simply, overbought readings demonstrate that the rally is accompanied by strong and consistent buying pressure.

The last time this indicator was in overbought territory for five consecutive days was February 4 through February 10 of this year, when the Russell 2000 also recorded its all-time high. Since then, there have been no validations of new highs by this indicator despite a succession of record highs in the SPX. The absence of overbought readings in this indicator, coupled with a one-day oversold reading on July 19 revealed that equity advances have not been accompanied by solid or consistent buying pressure. This has been true since February and it has been a sign of weakness. However, this week’s overbought reading could be a turning point. Two days is not yet sufficient for a confirmation which means the next week will be an important time for this indicator. See page 9.

The 10-day average of daily new highs had a significant jump to 275 this week and daily new lows fell to 65. This is also important since in recent weeks, the 10-day averages of daily new highs and lows had been converging and leaning toward a negative signal. Daily new lows actually exceeded 100 per day which is a sign of a bear market. However, this week’s data tilts positive. In addition, the A/D line made a confirming record high on October 25, 2021, beating its last record made on September 2. Volume has been slightly below average on this rally, which is a concern, but only a minor one. See page 10.

The Dow Jones Industrial Average, the S&P 500, and the Wilshire 5000 all reached record highs this week, while the Nasdaq Composite is trading fractionally below its September high. The Russell 2000 continues to be a major focus for us, and it is less than 3% from its February high. A breakout in the Russell 2000 index from what is now an 8-month trading range, would create a bullish chart pattern for the intermediate term. This would be true for both the index and the overall market. See page 8.

Setting the Stage

All in all, the economic, political, and technical backdrop for the equity market is the best it has been in many months. Given that we are moving into a seasonally strong time for the equity market, this shift in the political scene is timely. Monetary policy changes have been well telegraphed in recent months and have been discounted by investors, in our view. In short, barring some unexpected negative event in the next few weeks, we believe the stage is being set for a solid Santa Claus rally. Still, we continue to focus on quality stocks given that earnings are apt to be the major driver of stocks in the months ahead.

A Housing Bounce

The housing market experienced a nice rebound in September. Recent data shows new home sales rose 14% YOY to an annualized rate of 800,000 units and existing home sales increased 7% YOY to 6.29 million annualized units. Both of these rates were below the peaks seen at the end of 2020 however both reports were better than anticipated. See page 3. Housing permits and starts cooled a bit in September, but since the gap between new permits and housing starts was small, it suggests an improvement in starts is apt to appear in the fourth quarter. As of August, total residential construction reached a record annualized pace of $75.2 billion, a 25% YOY increase. See page 4. There was concern that this may have been a cyclical peak in residential construction. However, in August, the NAR housing affordability index ticked up as a result of a small decline in mortgage rates and a similarly small dip in home prices. These declines helped to offset the small drop in median household income. October’s National Association of Home Builders survey showed an encouraging rebound. The survey indicated an increase in pending sales, an uptick in home buyer traffic and an expectation that sales will increase in the next six months. See page 5. Since housing is a significant segment of the economy, this improvement in sentiment is a good sign for the fourth quarter.

Gail Dudack

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Woulda, Coulda, Shoulda … but Didn’t

Posted on 10/22/202110/22/2021 by Andrea

DJIA: 35,603

Woulda, coulda, shoulda … but didn’t. It’s more than a little pretentious to talk about what the market should or should not do. Then, too, if you’re reading this it’s not your first day at the rodeo, and we all have a pretty good idea of how the market tends to react to news. The market as measured by the S&P has had a 5% correction, but we would argue there has been news which could have sent prices quite a bit lower. The Fed has said it will taper, yet there was no tantrum. There are 100 ships waiting outside the port of LA compared to a pre-Covid average of 17. Congress can’t get out of its own way, and the growth driver they call China has become a bit unglued. We realize it’s a bit perverse to argue the market is going up because it didn’t go down, but sometimes that’s the way it works.

The correction saw its share of selling, including a fair number of negative days in the Advance-Declines. When the averages are down, that’s just what happens. Drops of 200-300 points in the Dow, for example, will see 2-to-1 down days but that’s not a worry. We don’t worry so much about the down days, we worry about the up days, that is, the weak rallies. Those were absent during the selloff —the up days saw respectable participation. That’s always important, but especially in the midst of a selloff it’s good to see demand not completely disappear. Finally, there’s the idea that strength begets strength. At the end of September 80% of the S&P component stocks were higher on the year, something that has happened only five other times in 40 years, according to SentimenTrader.com. The others all saw stocks higher into year-end.

The S&P is up about 20% this year. The real story this year, of course, is the S&P has been hard to beat. After all, how much of the five stocks that dominate the index can you own? As for the rest, they’ve come and gone and come and gone, something they’ve called rotation. This isn’t the first time this year we’ve thought of just buying the SPY‘S (454) or the Q’s (377). You might also look at something like the Momentum ETF (MTUM-187) with its 5% position in Tesla (894), and positions in financials, part of the leadership. The ETF has made a new high, usually a good sign coming out of a correction. Meanwhile, it has been more of a commodities market than stock market — Oil, of course, Uranium, Lithium, Copper and everyone’s holiday favorite, Coal. Tech is mixed, even within the semis where we favor AMD (119) and Nvidia (227). The FANGS, ex. Facebook (342), also have shaped up and would seem go-to stocks into year-end.

The much awaited Bitcoin ETF (41) launched on Tuesday. If, as Jamie Dimon has suggested, it’s just the proverbial can of tuna, made for trading and not for opening, trade it did – some 27 million shares on the day. We have nothing against bitcoin, and to look at the Grayscale (49) chart, though back to the resistance area of the old highs, it has acted quite well. The problem with ETFs like BITO is they are futures based. Futures contracts have to keep being rolled over, and that costs money. The United States Oil Fund (57), for example, is similarly based. From a peak back in 2012, the fund is down some 83%. Crude is not down 83%. The SPDR Gold Trust (167) was devised by the gold mining companies to promote interest in gold. It did not, but instead investors just bought the ETF. Suppose the same sort of thing were to happen with bitcoin?

For the first time since early September the Advance-Decline index has made a new high. It is almost without precedent to see the market averages peak before the A/D Index, and typically by several months, so it’s another good sign for the uptrend’s longevity. Another good sign is the market’s momentum in just the last month. From less than 10%, the number of S&P component stocks above their 10-day average has cycled to above 80%. This is very unusual, typically only seen after significant declines. It, too, suggests a durability to the rally. While all seems well, of course there will be setbacks and the problem of the ever changing reflate or not reflate trade. Then, too, we are nearing that wonderful time of year when October comes to an end. The time of the year, too, when professional money managers don’t want to be left behind.

Frank D. Gretz

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US Strategy Weekly: History in the Making

Posted on 10/20/202110/22/2021 by Andrea

Stock prices moved higher this week on the back of good earnings results for the third quarter. However, the 10-year bond yield (TNX – 16.35) and the WTI crude oil future (CLc1 – $83.00) also moved up which implies that higher interest rates and higher inflation are in our future. Most companies reporting third quarter earnings indicated that rising raw material and transportation costs are becoming a margin problem, but in nearly all cases, corporate leaders state they plan to pass these costs on to consumers via higher prices. As we have been suggesting, inflation is not a temporary phenomenon, but is becoming engrained in the system. In the months ahead the risk of margin pressure and/or higher consumer prices increases. The former will hurt earnings, but the latter could negatively impact consumption and top line growth. In sum, earnings risks are compounding.

We believe the fourth quarter of 2021 will be a time of shifting trends, but right now little has changed. Monetary policy remains extremely accommodative, and the Fed continues to buy $120 billion of securities per month flooding the banking system with liquidity. But this week Federal Reserve Governor Christopher Waller, in a speech to Stanford Institute for Economic Policy Research, stated that tapering of asset purchases should commence following the next Federal Open Market Committee meeting set for November 2-3. This implies a change is on the horizon, but remember, monetary policy will remain stimulative, just slightly less so. Putting recent Fed actions into perspective, the central bank has purchased $4.3 trillion assets since the end of 2019, a number that represents 19% of nominal GDP. Fiscal stimulus has added $6 trillion of liquidity to the economy and together this stimulus is the equivalent of more than 45% of GDP, a historic level! However, this is unlikely to continue. Easy monetary policy will slowly shift and could end by mid-2022. Fiscal stimulus is unknown. To a substantial extent, the stimulus package working its way through Congress is not apt to have a major impact on the economy. Most of the proposed spending in the bill will go to federal agencies and programs — not directly to households. Government bureaucracy tends to mute the impact of money spent by Congress. Again, stimulus support will be waning in 2022.

But this is not likely to be true for inflation. Even if supply chain issues get resolved quickly, the rising price of energy will keep inflation elevated in 2022. With WTI futures at $83 a barrel, crude oil prices are up 130% year-over-year. These prices will be trickling down into producer and consumer price indices over the next three to six months. Auto sales have been weak recently due to a shortage of semiconductors; however, auto makers indicate that once production resumes, auto prices will move significantly higher. Raw material costs are also raising the price of new homes, remodeling, and home furnishings. The two segments of the economy that have not experienced big price increases have been homeowners’ equivalent rent and healthcare. But last month’s CPI data showed that housing costs are now on the rise and although rent increases tend to lag house prices, they are now beginning to trend higher. Healthcare costs tend to be seasonal and health insurance prices tend to rise in the fourth quarter. For all these reasons, we see inflation remaining higher than expected for the near future.

Keep in mind that inflation is similar to raising taxes on households. Inflation changes and lowers consumption patterns. Historically, inflation tends to lower PE multiples and for this reason higher inflation has made high-growth high-PE sectors like technology more volatile. We expect this will continue. Nonetheless, inflation will benefit the energy sector. Higher interest rates are a positive for the financial sector, particularly banks. To the extent that corporations are able to pass on higher costs to consumers without hurting demand, these stocks should do well. But we favor companies with strong balance sheets, moderate PE multiples and dividend yields in excess of 1.5% in order to insulate portfolios in the fourth quarter.

Not All Records are Good

Recent data on market capitalization, GDP, margin debt and the household’s balance sheet revealed interesting patterns. Market capitalization hit a record 2.23 times nominal GDP in December 2020 and has been hovering around 2.2 times in the first half of 2021. Margin debt reached an all-time high of 3.9% of GDP in June 2021. Both of these ratios imply that the stock market may be running ahead of the economy and that leverage has been an integral part of the market’s advance. See page 4.

The sum of NYSE and NASD margin debt was $903 billion in September, just slightly below the record $911.5 billion seen in August. Margin debt as a percentage of market capitalization was 2.03% in September, slightly below the record 2.07% of March 2013. More importantly, on a year-over-year basis, margin debt has grown 38%, far more than the 20% YOY gain in market capitalization. This disparity in growth can be a long-term risk factor. However, a major warning appears whenever the 2-month rate-of-change in margin debt is 15% or greater and widely exceeds the margin debt in total market capitalization (or the Wilshire 5000). Luckily, this comparison is currently neutral, but we will be monitoring margin debt for signs of excessive speculation. See page 5.

Household net worth increased 7.8% in the first half of 2021 to a record $159.3 trillion. The greatest driver of net worth came from equities (directly and indirectly owned), up 77% in the six-month period. Nonfinancial assets rose 6.5% and financial assets gained 8.3%. For the first time since March 2000, the household’s ownership of equities exceeds its holdings in real estate. Typically, a home is the household’s largest asset, not stocks. Therefore, this significant increase in equity ownership may be a sign of excessive exuberance. See page 6.

Equity ownership as a percentage of total assets was 29.5% in June and as a percentage of financial assets equities was 41.5%. Both of these percentages now exceed the previous records made in March 2000 at that major market peak. The counterbalance to equities was the record low in debt securities, now at 3% of financial assets. This is a result of historically low interest rates, the Fed’s dovish monetary policy, and it helps to explain how monetary policy can inflate asset prices and runs the risk of generating a stock market bubble.

We do not believe the equity market is a bubble, but valuations are high and equity ownership is at record levels; therefore, it is wise to be on the alert for signs of extreme optimism or excessive leverage. To date, these are not apparent. However, as Mark Twain famously wrote “history does not repeat itself, but it often rhymes.” The current cycle includes the introduction of meme stocks, bitcoin, and other digital currencies. Therefore, we should be aware that the signs of speculation used to identify equity tops in previous cycles may not work as well this time.

Technical Update Market gains have lifted all the popular indices above their key moving averages this week, including the Russell 2000 index, which continues to lag but is now above the critical 200-day moving average. However, volume on rally days has been well below average and this makes the advance suspicious. The 10-day average of daily new lows increased to more than 100 per day this week, erasing the looming negative seen a week ago. The 25-day up/down volume oscillator is at 1.82, its highest and best level since June, but it still remains in neutral territory and has not confirmed any new high since February. Keep in mind that the Russell 2000 index made its all-time high back on March 15, 2021. Overall, broad-based upward momentum may have peaked in the first quarter of 2021.

Gail Dudack

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Start Being Naughty … You Just Might Get Coal For Christmas

Posted on 10/15/202110/22/2021 by Andrea

DJIA: 34,912

Start being naughty … you just might get coal for Christmas. These days coal is a good thing! Coal has been on a tear, as have most energy sources. And like most, it had been completely out of favor. When we checked on what used to be a coal ETF, we found it no longer exists – that’s what we call out of favor. Obviously the world has changed for these energy stocks, but the change is exaggerated by the fact that no one owns them. As we pointed out last time, the same seems true of Staples, down to a market cap of only 6% of the S&P. The charts here are not as far along as the energy stocks, but names like Hershey (182) and PepsiCo (159) are more than good. Meanwhile, most of Tech has struggled. They like to blame rising rates, to which we say hooey – a technical term. In the case of Tech, just five stocks are 25% of the S&P, not exactly the energy sector profile. Rather than under owned, for Tech you might ask who is left to buy.

The overall market seems stuck in what reasonably might be called October. It’s a tough month, often weak, usually volatile. We don’t usually place too much emphasis on seasonal patterns, but October is different. So far it hasn’t been all that bad, which itself is a reason for optimism. The market has had its chances to go down, but it has not. We know this sounds a bit perverse, but we’ve found what the market doesn’t do often can be important. Similarly, weakness happens, but weakness is not how markets get into trouble. Trouble comes with weak rallies, as we call them. So far rallies have come with respectable Advance-Decline numbers. You don’t want to see the Dow up a 100 or 200 points with even flat A/Ds, and so far we haven’t. Things could yet change but, as we’ve suggested, the market has had its chances. And, October typically closes well.

Rather than stock exchange, of late the market has seemed more commodities exchange. Oil, of course, has been the poster child here, perhaps the best example of what under owned/ under loved can do. We’ve heard it said oil is peaking, to which we say we don’t see it, but who knows. Being bullish, we do know we would rather have them call for a peak then call for $90-$100 oil. We don’t remember anyone getting the peak in oil reasonably right over the years, but we do remember plenty of raised targets before any peak. Meanwhile, there’s also Lithium and Uranium with their respective ETFs, LIT (85) and URA (28), and stocks like Lithium Americas (25) and Cameco (25). Copper, while better of late, is still basically neutral, but gold finally is lifting.

If all of this sounds like inflation, it should. The oil market clearly has garnered the most attention, but higher prices show up in other commodities, the labor market and complaints from businesses as they struggle with higher prices. It shows up in other areas of the commodities market as well, more subtle in that they are not covered in futures markets. The Commodities Research RIND Index covers a group of industrial materials which includes obscure commodities such as burlap, tallow and, our personal favorite, lard. These may better reflect the pressures on supply and demand flowing into industry, rather than speculative flows, and this group is now near an all-time high. Then there are the industrial metals, normally driven by demand from China. While China has been trying to dampen speculation in metals, it hasn’t stopped surging prices, including the highest level since 2012 in the Bloomberg Industrial Metals Index. It all sounds a bit more than transitory.

Amidst all this talk of commodities and inflation, did we mention AMD (112) broke out Wednesday, Nvidia (217) and Microsoft (303) Thursday? Not all of Tech-land is so fortunate, but then there are some new Tech leaders, at least new to us, Snowflake (332), Data Dog (153) and Upstart (380), that are almost stretched to the upside. The market is nothing if not confounding, but in this case in a surprisingly positive way. One thing that never confounds is the ability of those banks to disappoint, even JP Morgan (163). The amazing thing on Wednesday was thanks to the financials the Dow was flat but the Advance-Declines were 1.8-to-1 up – a strong weak day. We used to say most days most stocks go up, but that hasn’t been the case of late – the market has been in a correction, though it has been more consolidation than correction. We can say on the up days most stocks go up, and that has been important. Rather than bearish we’ve been Octoberish, and October is winding down.

Frank D. Gretz

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Welcome a Fourth Quarter Bump

Posted on 10/08/202110/08/2021 by Andrea

The post-Covid recovery period has been a profitable time for investors. By the end of the third quarter of 2021, the S&P 500 was the best performing index with a gain of nearly 15% year-to-date, followed by the Russell 2000 with a gain of 14%, the Nasdaq Composite index was up 12% and the DJIA had a gain of 10.5%. But from the pandemic March 2020 low, the biggest winner was the Russell 2000 with a gain of 120% versus the S&P 500’s gain of 92%. This means that equity performance has been broadly-based and small capitalization stocks have actively participated in the 20-month bull market. This is good news.

WEAKENING UNDERPINNINGS

At the risk of oversimplifying, we believe the 2020-2021 bull market has been supported by two important factors: 1.) a strong rebound in earnings growth and 2.) extremely easy monetary policy. But as we enter the last quarter of 2021 both of these bedrocks are less certain. Whereas consensus earnings forecasts for 2021 and for 2022 moved steadily higher for eighteen months, this began to change in mid-September. Consensus earnings forecasts are starting to edge lower and though estimates still reflect a positive earnings growth rate for 2021 and 2022, these growth rates are falling. This is noteworthy. Steadily rising earnings forecasts have provided a reliable incentive to buy stocks and good fundamental support in the event of any negative news shock. But today, with estimates drifting lower, downside support is less definable and reliable. This change is subtle, but it could result in less demand for stocks and could make speculators more cautious in the final quarter of the year. In short, the equity market could become more volatile in the final months of the year.

Inflation is a core problem for companies. In its third quarter earnings report PepsiCo (PEP – $155.74*) indicated that higher transportation and raw material costs will be passed on to consumers in the form of price hikes this year and again next year. Higher inflation hurts profit margins, particularly if companies cannot pass on these costs. And when companies do pass on higher costs to consumers it can hurt household consumption and lower GDP. Inflation is apt to make earnings growth less predictable in the quarters ahead.

Inflation is also a challenge for the Fed. With CPI and PPI rising well in excess of 5% for three months in a row, inflation can no longer be viewed as transitory. It is a problem. Therefore, the Fed could be forced to change its policy of extreme quantitative easing and low interest rates before the end of the year. The September employment report was weaker than the consensus expected, and this could ease some of the pressure on the Federal Open Market Committee, but all in all, the Fed is in a complex situation. Financial news headlines will continue to focus on monetary policy as a threat to investors, but history shows that monetary policy does not have a negative impact on stock prices until it raises interest rates three times in a row. That is unlikely to occur until 2023.

A GAME OF HOT POTATO

Despite the vote to raise the debt ceiling by $480 billion, the debt ceiling will remain a major financial topic in the weeks ahead. Do not forget that the US government has been shut down several times in the recent past due to a debt ceiling crisis, most notably in 1995 (one 5-day shutdown and one 21 day shutdown), in 2011 (when Treasury Secretary Timothy Geithner utilized “extraordinary measures” such as the sale of assets from the Civil Service Retirement and Disability Fund and the G Fund of the Thrift Savings Plan to acquire funds) and in 2013 (which stretched on for months and also included “extraordinary measures” to pay obligations). Typically, the first step in a government shutdown is the closure of national parks and the layoff of nonessential personnel to save cash flow for obligations such as social security payments and payments on debt. The Treasury has demonstrated a variety of creative ways to survive during a debt ceiling crisis and there has been unverified chatter of the Treasury minting a billion-dollar gold coin to raise capital if the debt ceiling is not raised in the months ahead. The debt ceiling debate can be a useful dialogue in terms of curbing fiscal spending, and it has been a political game of hot potato many times in the past. Nevertheless, while economists can list 23 times that the government has been shut down due to the debt ceiling, the US government has never defaulted on its debt. We do not believe it will any time soon.

CLIMBING A WALL OF WORRY

But if bull markets like to climb a wall of worry, there will be many international concerns to think about in the fourth quarter. China’s energy shortage and the OPEC+ group deciding not to increase the output of oil, has put pressure on energy prices and this lifted WTI crude oil as high as $79 a barrel recently. Higher crude prices will put even more pressure on global inflation. China’s twin energy and Evergrande property crises could trigger slower growth around the world. In the UK, a combination of the pandemic and the county’s departure from the European Union are resulting in a shortage of tanker drivers to transport fuel across the country. In Germany, a lack of clarity about the composition of the next government following Merkel’s departure, is creating a predicament for the European Union. Without a clear government in Germany a range of decisions from economic policy to defense are being delayed in the EU. In the background, many countries in East Asia and the Pacific continue to face major setbacks in their recovery from the coronavirus. In short, there is no shortage of worries in the globe.

THE FOURTH QUARTER

Looking ahead to the last few months of the year we believe there are many areas of the market that will do well despite a rise in inflation and a shift in Fed policy. One of these is energy which is likely to have positive earnings growth in the fourth quarter given the rise in crude oil prices. The second is financial stocks. Banks in particular are insulated from the rise in inflation and will be beneficiaries of a rise in long-term interest rates. As inflation rises, PE multiples come under pressure and this explains why many technology stocks, where PE multiples are the highest, have come under pressure recently. However, to the extent that earnings growth will justify a high PE multiple, any sell-off in technology issues should be considered a buying opportunity. Overall, companies with below-average PE multiples and above-average dividend yields are always good holdings when markets become volatile.

The market indices have more than doubled since the March 2020 low without experiencing any intervening correction of 10% or more. This is well in excess of the average historical gain of 54% prior to a 10% correction. In other words, the equity market is overdue for a normal pullback, and investors should use this as a good opportunity to adjust portfolios for the longer term.

*Priced October 8, 2021 12:00PM

Gail Dudack

Chief Strategist

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Disclosure: The information herein has been prepared by Dudack Research Group (“DRG”), a division of Wellington Shields & Co. The material is based on data from sources considered to be reliable; however, DRG does not guarantee or warrant the accuracy or completeness of the information. It is published for informational purposes only and should not be used as the primary basis of investment decisions. Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security. The opinions and estimates expressed reflect the current judgement of DRG and are subject to change without notice. Actual results may differ from any forward-looking statements. This letter is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity.

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