Lowering EPS Estimates but Valuations Remain Healthy

The market hit our 2019 target of SPX 3110 this week and this inspired us to review our price targets, earnings and assumptions for 2019 and 2020. With third quarter earnings results for the SP500 now 90% complete, our second half EPS estimates appear high. Bringing our third and fourth quarter estimates more in line with the S&P Dow Jones consensus benchmark, our calendar 2019 earnings forecast falls from $167 to $160 and our 2020 earnings estimate for the SP500 eases slightly from $186 to $184.

Next, we put our new estimates into our valuation model which is stress-tested for 2020 inflation of 2.6% and a 10-year Treasury bond yield of 3.8%. Despite newly lowered earnings estimates and inflation and interest rates well above our expectations, our valuation model suggests an SPX 2020 range of SPX 2800 to 3450. We prefer to remain on the conservative side and are initiating a new 2020 SPX target of 3300. Should a trade agreement materialize in the next six months, this target would likely be revised. See page 11.

It is worth pointing out that the SPX has been hugging the upper end of our model’s projected fair value range since late 2016. This does not surprise us since an environment of low and steady inflation supports a higher PE multiple. Assuming inflation remains benign, one could expect the SPX to continue to trade in the upper half of the fair value range. The top of this range in late 2020 implies a move to SPX 3450.

Conversely, if the UK fails to solve its Brexit issues, if impeachment investigations wear on investor sentiment, or if unexpected events shock the market, our model suggests equities have substantial valuation support at the SPX 2800 in 2020.

Quarterly EPS Results

IBES Refinitiv is currently forecasting third quarter SP500 earnings to decline 0.4%. However, excluding the energy sector, the earnings growth estimate increases to 2.2%. Of the 461 companies in the SP500 that have reported earnings to date for 3Q19, 74.6% have reported earnings above analyst estimates and 18% missed estimates. This is comfortably above the long-term average of 64.8% and the average of 74.1% seen in the prior four quarters. In a typical quarter, 65% of companies beat estimates and 20% miss estimates. Third quarter revenue is expected to increase 3.8% from a year ago and excluding the energy sector, the revenue growth estimate rises to 5.2%. The healthcare and utilities sectors have the highest earnings growth rates for the quarter at 9.4% and 6.7%, respectively; and the energy sector has the weakest anticipated growth rate at negative 37.8%. Third quarter earnings comparisons for energy help to explain the sector’s underperformance in 2019. However, the good earnings performance by both healthcare and utilities make their price performance less understandable. Both sectors rank just above energy on a year-to-date basis. See page 16.

Economic Reports Support a Dovish Fed

A medley of data was reported this week on retail sales, inflation and trade and overall, it supports a dovish Fed, in our view. Retail sales rebounded modestly in October after falling in September. More specifically, sales rose 0.3% after declining 0.3% the previous month. On a year-over-year basis, total retail sales rose 3.1% In October versus a 4.1% gain in September; however, October sales could have been hurt by Hurricane Dorian, weak iPhone sales and the General Motors (GM – $36.38) strike. October’s sales, excluding motor vehicles, rose 2.8% YOY. See page 3. On the whole, this report was neutral in our view.

The US-China trade conflict has been a major topic of concern for investors, yet it has only made a small dent in the total US trade. The trade deficit is running at an annualized $862.7 billion as of September versus $874.8 billion in 2018. Department of Commerce data shows the trade deficit is currently at an estimated 4% of current GDP, while the Census BOP basis, shows the 12-month running ratio to be 3.1% of GDP. Merchandise trade data is available on both custom-based trade statistics and on a balance of payments (BOP) basis. Note that data on services is only available on a BOP basis, which means the real trade deficit is apt to be closer to the BOP 3.1% of GDP which includes services. See page 4.

While headline trade numbers have not changed dramatically, trade is changing beneath the surface. China is no longer our top trading partner and as of September 2019 fell to third place behind Mexico and Canada. Nevertheless, China continues to have the largest trade deficit with the US at $263 billion year-to-date, which is 3 ½ times larger than Mexico which ranks second with a $76 billion deficit. Ironically, the trading partner with the largest surplus with the US is Hong Kong at $20.3 billion. See page 5.

The inflation backdrop is favorable for monetary policy. PPI final demand prices rose 1.0% YOY in October, while intermediate processed goods prices fell 3.7% YOY. CPI rose a benign 1.8% YOY in October however core CPI rose 2.3% YOY. The rise in core prices was due primarily to services. See page 6. The trade war has not generated the rise in consumer prices most economists predicted for 2019. In fact, import prices, excluding petroleum products, fell 1.5% YOY. The effective fed funds rate of 1.55% is comfortably above September’s PCE index of 1.3% YOY. See page 7.

But we remain bothered by the pace of inflation seen in the medical care sector where prices rose 4.3% YOY in October. All components of healthcare rose, but the 20.1% YOY jump in health insurance is most disturbing. See page 8. This could be a cyclical pricing cycle for insurers, or it could be in anticipation of a new rule requiring more transparency in hospital and insurance pricing. In a new executive order, the Trump administration is requiring hospitals to disclose for the first time the prices they negotiated with health insurers for a wide range of services, as well as the prices they charge patients who are paying with their own money. Hospitals will also be asked to create a list of 300 so-called “shoppable” services that patients can use, targeted to more elective services where customers could have the opportunity to shop around. The Trump administration is hoping a little bit of sunlight could help disinfect the high costs of US healthcare.

Technicals Continue to Support Equities

The technical scoreboard has not changed much in the last week, although the NYSE cumulative advance decline line made a new high on November 15 which now confirms the ongoing advance in the popular indices. The Russell 2000 index continues to lag behind the popular indices, but like last week, it is close, but has not yet broken above the top of its recent trading band of 1450-1600. A breakout would be bullish. An uptrend line that has supported the DJIA since the 2016 low was recently tested successfully and this strengthens the longer-term bullish trend. See page 12. The 25-day up/down volume oscillator is 1.76 and neutral after being in overbought territory for five of six trading sessions last week. This was the fifth consecutive overbought reading of 2019 and it followed an overbought condition that lasted for eight of ten trading sessions between September 10 and September 23. Consecutive overbought readings denote steady buying pressure and only appear in a bull market cycle. In sum, this is a positive sequence in this indicator.

Regulation AC Analyst Certification

I, Gail Dudack, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific views contained in this report.

IMPORTANT DISCLOSURES

RATINGS DEFINITIONS:

Sectors/Industries:

“Overweight”: Overweight relative to S&P Index weighting

“Neutral”: Neutral relative to S&P Index weighting

“Underweight”: Underweight relative to S&P Index weighting

OTHER DISCLOSURES
This report has been written without regard for the specific investment objectives, financial situation or particular needs of any specific recipient, and should not be regarded by recipients as a substitute for the exercise of their own judgment.  The report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell securities or related financial instruments.  The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.  The report is based on information obtained from sources believed to be reliable, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report.  Any opinions expressed in this report are subject to change without notice and Dudack Research Group division of Wellington Shields & Co. LLC. (DRG/Wellington) is under no obligation to update or keep current the information contained herein.  Options, derivative products, and futures are not suitable for all investors, and trading in these instruments is considered risky.  Past performance is not necessarily indicative of future results, and yield from securities, if any, may fluctuate as a security’s price or value changes.   Accordingly, an investor may receive back less than originally invested.  Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report.

DRG/Wellington relies on information barriers, such as “Chinese Walls,” to control the flow of information from one or more areas of DRG/Wellington into other areas, units, divisions, groups or affiliates. DRG/Wellington accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The content of this report is aimed solely at institutional investors and investment professionals. To the extent communicated in the U.K., this report is intended for distribution only to (and is directed only at) investment professionals and high net worth companies and other businesses of the type set out in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report is not directed at any other U.K. persons and should not be acted upon by any other U.K. person. Moreover, the content of this report has not been approved by an authorized person in accordance with the rules of the U.K. Financial Services Authority, approval of which is required (unless an exemption applies) by Section 21 of the Financial Services and Markets Act 2000.

Additional information will be made available upon request.

©2018.  All rights reserved.  No part of this report may be reproduced or distributed in any manner without the written permission of Dudack Research Group division of Wellington Shields & Co. LLC. The Company specifically prohibits the re-distribution of this report, via the internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect.

For more information contact Andrea Costello – Andrea@DudackResearchGroup.com

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This is destined to be a busy week. The next few days will include a first look at third quarter GDP, the October FOMC meeting, personal income and expenditures for September, the Fed’s favorite inflation benchmark – the personal consumption expenditures (PCE) deflator – for September, the ISM Manufacturing index for October and the employment report for October. And in the background, on the one-year anniversary of the Lion Air’s 737 MAX plane crash, Boeing’s Co-chief Executive Dennis Muilenburg is being grilled by members of a Senate panel, Britain has proposed a date of December 12 for a national election to break the Brexit deadlock, Argentina’s center-left candidate Alberto Fernandez was victorious in a surprise upset election, Lebanon’s Prime Minister Saad al-Hariri resigns in response to violent protests, negotiators are warning that a US-China trade deal may not be ready in time for signing at the Asia-Pacific Economic Cooperation summit in Chile on November 16-17, Democrats are presenting legislation calling for a vote on public hearings in the House of Representatives impeachment inquiry against President Donald Trump and wildfires are continuing to rage havoc in Los Angeles.

Record Highs

And in the midst of this flurry of events, the SP500 index inched into record high territory earlier this week. The reason for this apparent dichotomy between the stock market’s performance and disruptive political events could be steadfast consumer demand. Visa Inc.’s (V – $177.63) third quarter profit beat forecasts this week due to stronger household spending. Visa’s total payments volume rose 8.7% to $2.27 trillion on a constant dollar basis, with the US accounting for 45% of that total. The number of processed transactions rose 13.2% to 47.8 billion. Moreover, this week’s FOMC meeting should result in another fed funds rate cut and the combination of lower interest rates and rising wages should continue to support consumption. This should be true for two important segments of the US economy – housing and autos.

In sum, fundamentals are lifting the market to new heights even before a US-China trade deal is confirmed. Technical indicators are also supporting this move and our SPX target of 3110 is unchanged. We believe this forecast could prove to be too conservative.

Economic Data is Mixed but Tilts Positive

The seasonally adjusted annualized-rate for new-home sales was 701,000 in September and this was down 0.7% from a negatively revised figure of 706,000 for August. Nonetheless, September’s sales were up 15.5% year-over-year suggesting that housing momentum is favorable. The University of Michigan’s home buying index was unchanged in September with households saying it was a good time to buy remaining at 65 which is down slightly from a recent high of 70 reported in June 2019. See page 3.

But there was good news in third quarter homeownership as rates rose across the board. The overall percentage for homeownership in the US rose from 64.1% to 64.8%, with the sharpest gains reported in the West and among those under 35 years of age. See page 4.

The University of Michigan’s preliminary consumer sentiment index for October was 95.5, up from 93.2 in September. This rebound was also seen in expected personal finances which rose from 123 in August to 128 in September. Plus, we were encouraged by the survey on buying conditions for vehicles, which rose from 58 in August to 62 in September. See page 5. However, the Conference Board Sentiment for October fell from 126.3 to 125.9, even though the present conditions index rose from 170.6 to 172.3. In addition, the NAR pending home sales index rose 1.5% to 108.7, its highest level in 12 months, which is an excellent sign for the housing sector. See page 6.

Nonetheless, the dark cloud hanging over the equity market is the sluggish economic growth forecasted for 2019 and 2020. Moody’s has been consistently bearish on US and global growth with forecasts of 2.3% and 2.4% for 2019 and 1.7% and 2.5% for 2020, respectively. Moody’s global and country estimates suggest that the only improvement in 2020 growth will be the economic rebounds in Venezuela and Turkey. In our opinion, economic forecasts for global growth could prove to be too pessimistic since it is unlikely that economists are including the possibility of a future trade agreement or current global monetary stimulus. Still, an interesting tidbit from Moody’s data is that China is forecasted to fall from the best growing economy in 2019 to third place in 2020. See page 7. Yet China is not the only country experiencing slower economic growth. Europe has been steadily decelerating and Germany’s GDP growth has been lower than the US since 2018. The only European country with 2019 economic activity estimated to be stronger than the 2.3% expected in the US is Ireland at 5.1%. For Ireland, this 5.1% estimate is down from the 8.3% growth rate seen in 2018.

But Moody’s Analytics has been forced to increase its US forecast several times in the last twelve months and we believe Moody’s US growth estimate for 2020 of 1.7% may prove to be too bearish once again. Even so, it is important to look at how weak European economic activity is since this explains the historically low sovereign long-term interest rates in Europe. These interest rates are the underlying factor behind the low 10-year Treasury bond yields seen in the US. See page 8.

Keep in mind that Friday’s employment report for October will be impacted by the United Auto Workers strike. The Bureau of Labor Statistics released its Strike Report last week and it showed 46,000 workers were impacted by the UAW strike. There is always some spillover effect from an auto strike and economists are estimating an additional 15,000 workers may have been laid off in the month. Therefore, October’s employment report is apt to be weak since it could be reduced by 61,000 jobs as a result of the strike. With the strike now resolved, October should be a one-off event.

Technical Indicators Support the SPX New High

The SPX, DJIA and Nasdaq Composite closed 0.08%, 1.05% and 0.64% away from their all-time highs on October 29, which means they are up 21.1%, 16.1% and 24.7%, respectively, year-to-date. The Russell 2000 index continues to be the laggard index, but it is currently less than 10% below its record high. The technical charts of the individual indices suggest that the uptrends that have been in place since 2009 remain intact. See page 10. In addition, our favorite 25-day up/down volume oscillator is at 1.78 (preliminarily) this week and moving toward another overbought reading this week. The last signal from this indicator was the overbought condition that lasted for eight of ten trading sessions between September 10 and September 23. The September reading was the fourth overbought condition recorded in 2019 without an intervening oversold reading. This was a positive sequence since consecutive overbought readings are a sign of steady demand for equities and a classic characteristic of a bull market cycle. See page 11. The 10-day average of daily new highs rose dramatically to 224 this week and is above the 100 per day level defined as bullish. The average of daily new lows is 52 and below the 100 per day defined as bearish. The combination is positive. The NYSE cumulative advance/decline line made a new record high on October 29, 2019, which confirms the new high in the SPX. In sum, technical indicators are supporting the bullish case.

Regulation AC Analyst Certification

I, Gail Dudack, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific views contained in this report.

IMPORTANT DISCLOSURES

RATINGS DEFINITIONS:

Sectors/Industries:

“Overweight”: Overweight relative to S&P Index weighting

“Neutral”: Neutral relative to S&P Index weighting

“Underweight”: Underweight relative to S&P Index weighting

OTHER DISCLOSURES
This report has been written without regard for the specific investment objectives, financial situation or particular needs of any specific recipient, and should not be regarded by recipients as a substitute for the exercise of their own judgment.  The report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell securities or related financial instruments.  The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.  The report is based on information obtained from sources believed to be reliable, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report.  Any opinions expressed in this report are subject to change without notice and Dudack Research Group division of Wellington Shields & Co. LLC. (DRG/Wellington) is under no obligation to update or keep current the information contained herein.  Options, derivative products, and futures are not suitable for all investors, and trading in these instruments is considered risky.  Past performance is not necessarily indicative of future results, and yield from securities, if any, may fluctuate as a security’s price or value changes.   Accordingly, an investor may receive back less than originally invested.  Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report.

DRG/Wellington relies on information barriers, such as “Chinese Walls,” to control the flow of information from one or more areas of DRG/Wellington into other areas, units, divisions, groups or affiliates. DRG/Wellington accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The content of this report is aimed solely at institutional investors and investment professionals. To the extent communicated in the U.K., this report is intended for distribution only to (and is directed only at) investment professionals and high net worth companies and other businesses of the type set out in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report is not directed at any other U.K. persons and should not be acted upon by any other U.K. person. Moreover, the content of this report has not been approved by an authorized person in accordance with the rules of the U.K. Financial Services Authority, approval of which is required (unless an exemption applies) by Section 21 of the Financial Services and Markets Act 2000.

Additional information will be made available upon request.

©2018.  All rights reserved.  No part of this report may be reproduced or distributed in any manner without the written permission of Dudack Research Group division of Wellington Shields & Co. LLC. The Company specifically prohibits the re-distribution of this report, via the internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect.

For more information contact Andrea Costello –Andrea@DudackResearchGroup.com

Click to download

Words with Impact

The last week of September had the potential to be a calm post-FOMC meeting interval with limited economic and earnings releases and no UA-China trade or Brexit deadlines. However, on Tuesday President Trump and Speaker Pelosi turned what could have been tranquility into turmoil.

In a speech to the UN, President Trump called out China and indicated Beijing had not only failed to keep promises it made in 2001 when it joined the World Trade Organization but China was engaged in predatory practices that had cost millions of jobs in the United States and other countries. Trump also indicated he was not interested in a “partial deal” to ease trade tensions with China, but that he would hold out for a “complete deal.” While President Trump’s criticism of Beijing may be well-earned, these sharp words are likely lowering the odds of a deal materializing in the fourth quarter. The equity market began to weaken.

Stocks began to fall in earnest once the media reported that House Speaker Nancy Pelosi would hold a press conference after the market’s close. As predicted, Pelosi announced that the US House of Representatives would launch a formal inquiry into whether President Trump should be impeached, declaring that no one is above the law. President Trump tweeted that his administration would release a complete transcript of a private call with Ukrainian President Volodymyr Zelenskiy that is at the center of the impeachment controversy. Still, this did not keep the market from closing with a decline of 142 points in the DJIA and 25 points in the SPX.

Our Forecast

In the long run the events of the day may not result in any real economic impact; nevertheless, both incidents immediately put a dark cloud over the markets in the near term. The market is likely to trade in a SPX range of 2850-3050 in the short run as it assesses the impact Tuesday’s comments could have on the broad financial environment. However, there is no change in our SPX target of 3110 for 2019 which is based upon conservative fundamental inputs and forecasts. In recent weeks technical indicators have been distinctly bullish and we will be monitoring them closely to see if this week’s developments change, or reverse, these positive readings.

No Excesses in the Background

Although there were few economic releases in recent days, the Federal Reserve Board and the US Treasury released second quarter data on net worth, equity and Treasury ownership and sector debt levels. We found the numbers reassuring on many levels. Long secular bull market cycles, like the current one, tend to create extremes in terms of equity ownership and debt levels; but none of this was evident in any of the data. In short, while investors are focused on the politics of Washington DC and geopolitical strife between China and the US, the big picture shows that the current bull cycle may have many more months or years to go.

Equity ownership levels have been generally stable since 2009. Households own 36.8% of all US equities, which is just slightly above the 34.1% owned at the March 2009 bear market low. Foreign and equity mutual fund ownership has slowly declined in the same period. US Treasury ownership is far more complex; but foreign ownership of Treasuries rebounded recently after a decade of declines. See page 3.

While foreign ownership of US Treasuries has been waning in recent years, foreign net purchases of all US securities have remained positive, running at $152.2 billion in the twelve months ended July. In this period, foreign investors were larger net purchasers of agency and corporate bonds at $260 billion and $44.2 billion, respectively. Foreigners were net sellers of $97.6 billion of corporate stocks and $54.4 billion of US Treasury bonds & notes in the same timeframe. Note that this selling of stocks and bonds had no apparent impact on US markets and stock and bond prices rose in the last twelve months. See page 4.

In terms of US Treasury holdings, the Federal Reserve Bank is the largest holder with $2.1 trillion in Treasuries (September). Treasury data shows Japan ranked second in July with $1.13 trillion and China ranked third with $1.11 trillion in Treasury holdings. It may surprise most investors that Russia, not China, has been the largest single seller of Treasuries in recent years. Their Treasury holdings declined by $102.2 billion since the end of 2017. See page 5.

The performance of the equity market has been pivotal to household net worth in recent quarters. A 3.5% decline in household net worth in the fourth quarter of 2018 was a result of a 16% decline in equity value in the same quarter. But household wealth increased in 2Q19, boosted mostly by a gain in the value of directly and indirectly held corporate equities. Wealth increased from a revised $111.6 trillion in the first quarter (previously $108.6 trillion) to $113.5 trillion in the second quarter. On a year-over-year basis, household wealth was up 4.9% in the second quarter despite a small gain in household liabilities as home mortgage and consumer credit liabilities rose. But all in all, household balance sheets suggest the consumer is in good shape and should remain a key support for the economy. See page 6.

Debt Levels look Healthy

Debt levels can pose a problem at the end of an economic cycle; however, debt as a percentage of nominal GDP has been declining for all sectors in 2019. This improvement was particularly true for households where debt-to-GDP fell from 75% at the end of 2018 to 73.4% in June. See page 7. More importantly, Fed data shows that debt excesses that preceded the 2007 peak do not exist today. Household debt-to-disposable personal income averaged 131% from September 2007 to September 2009 and peaked at 133% in December 2008. This ratio fell to 95.6% in June. Mortgage debt as a percentage of disposable personal income was 63% in June versus its peak of 98.7% in December 2008. It is also worth noting that outstanding federal government debt has grown in the last three years, but this growth has been in line with the pace of annualized GDP growth. The fact that debt is not growing faster than the economy is a very positive trend. See page 8. In sum, the major sectors of the economy do not show the extremes in equity holdings or in debt levels that often appear at major tops in the market.

Technical Indicators are Looking Fine

Even without this week’s events we would not be surprised that equities are encountering resistance at the psychological SPX 3000 level. All indices are currently trading above their 200-day moving averages which is favorable, but we are watching the Russell 2000 index since its 200-day MA could be tested in coming sessions. See page 10. This week the 25-day up/down volume oscillator is 1.87 (preliminarily) and neutral after being overbought for eight of the previous ten trading sessions. This is the fourth overbought reading without an intervening oversold reading this year. Repetitive overbought readings are classic characteristics of a bull market cycle. See page 11. The A/D line made a record high on September 23, 2019, which is better than the performance of the major indices. With the indices now 2% to 4% below their record highs, the AD line is suggesting there will be new highs in the indices.

IMPORTANT DISCLOSURES

RATINGS DEFINITIONS:

Sectors/Industries:

“Overweight”: Overweight relative to S&P Index weighting

“Neutral”: Neutral relative to S&P Index weighting

“Underweight”: Underweight relative to S&P Index weighting

Other Disclosures

This report has been written without regard for the specific investment objectives, financial situation or particular needs of any specific recipient, and should not be regarded by recipients as a substitute for the exercise of their own judgment.  The report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell securities or related financial instruments.  The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.  The report is based on information obtained from sources believed to be reliable, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report.  Any opinions expressed in this report are subject to change without notice and Dudack Research Group division of Wellington Shields & Co. LLC. (DRG/Wellington) is under no obligation to update or keep current the information contained herein.  Options, derivative products, and futures are not suitable for all investors, and trading in these instruments is considered risky.  Past performance is not necessarily indicative of future results, and yield from securities, if any, may fluctuate as a security’s price or value changes.   Accordingly, an investor may receive back less than originally invested.  Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report.

DRG/Wellington relies on information barriers, such as “Chinese Walls,” to control the flow of information from one or more areas of DRG/Wellington into other areas, units, divisions, groups or affiliates.  DRG/Wellington accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The content of this report is aimed solely at institutional investors and investment professionals. To the extent communicated in the U.K., this report is intended for distribution only to (and is directed only at) investment professionals and high net worth companies and other businesses of the type set out in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report is not directed at any other U.K. persons and should not be acted upon by any other U.K. person. Moreover, the content of this report has not been approved by an authorized person in accordance with the rules of the U.K. Financial Services Authority, approval of which is required (unless an exemption applies) by Section 21 of the Financial Services and Markets Act 2000.

Additional information will be made available upon request.

©2019.  All rights reserved.  No part of this report may be reproduced or distributed in any manner without the written permission of Dudack Research Group division of Wellington Shields & Co. LLC. The Company specifically prohibits the re-distribution of this report, via the internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect.

Contact Andrea Costello, Head of Research Sales for additional information (212) 320-2046 or Andrea@DudackResearchGroup.com

Click to download

On August 15^th (Direct from Dudack “Another 90% Down Day”) we pointed out that the 91% down day on August 5^th had been joined by a 94% down day on August 14^th. This was not a surprise since 90% down days are a sign of underlying panic and panic days tend to appear in a series. Panic days often occur on heavy volume and as a result the combination usually creates a washed-out market. In sum, panic 90% days represent risk and opportunity. The reversal of panic is typically identified by a 90% up day. And historically, one 90% up day has signaled that the lows have been found and downside risk is minimized.

Long-time investors know that markets have the ability to frustrate and vex. Indicators do as well. On August 16^th NYSE upside volume (volume in advancing stocks) was 89% and the downside volume was 10%. Was this good enough to define the bottom? Typically, a reversal day will have a much higher percentage of volume in advancing stocks; but since downside volume was only 10%, we believe that August 16 qualifies as a significant extreme day. In our view the downside risk in the market is limited to the SPX 2800 level, or roughly the low of SPX 2840.60 made on August 14^th.

However, this does not mean that the market is about to have a dramatic advance. There are enough cross currents in the global financial world to contain the market in a neutral trading range for the intermediate term. The boundaries of this range are expected to be the recent all-time highs and the recent lows.

Events in Europe such as Brexit (October 31, 2019) and the resignation of Italy’s Prime Minister Giuseppe Conte are major threats to the European Union and these risks are expected to keep investors cautious. Plus, these developments are combined with China’s decelerating economy, Germany’s economy shrinking in the second quarter and the EU growing at a barely positive 0.2%. In our opinion, European risks are greater than the threat of an escalating trade war between the US and China. Neither the Chinese nor the US economy can truly afford a trading war. However, 19 central banks have joined with the Federal Reserve to implement some form of monetary policy in order to stem the potential weaknesses seen around the globe. China recently unveiled interest rate reforms which are expected to lower corporate borrowing costs. Australia’s central bank has cut rates twice and is discussing further stimulus measures. Mexico’s central bank surprised many by cutting rates last week. The Group of Seven summit will be held in France this weekend and the topics will undoubtedly center on trade friction, slowing economies and monetary policy. In addition, investors will focus on this week’s release of July’s FOMC minutes looking for signs of the timing and size of the next rate cut.

Strong Crosscurrents

The confusion and angst seen among equity investors is understandable given the number of strong crosscurrents battering the financial markets. The weakening economies of China and Europe were discussed and these stand in stark contrast to the US economy which has surprised economists in 2019 with its resilience. The GDP growth rates of 3.1% and 2.1% in the first and second quarters of this year were consistently above consensus estimates and most economists, including the FRB and IMF, were looking for growth under 2% in both quarters. However, the push and pull between the US and global economies makes forecasting future growth difficult, particularly in an environment in which political risk (Brexit, Italy, trade) is high.

The pessimism expressed by many economists may be a result of the crosscurrents within the US economy. The dichotomy between a resilient US consumer and a weak manufacturing sector is perplexing. July’s total retail sales rose 3.4% year-over-year (YOY) and were led by nonstore retail sales which soared 17.4% YOY. These robust nonstore results suggest that Amazon Prime Day was strong. Retail strength was broadly based in July with only a few spots of weakness such as sporting goods and hobby stores, vehicle dealers and drug stores. See page 3. Some of the weakness in US manufacturing stems from July’s soft auto sales. See page 4. Motor vehicle and parts production declined 0.2% in July, after two consecutive monthly gains; though this segment of industrial production was 3.7% higher on a year-ago basis. Nevertheless, production in nonauto manufacturing decreased 0.4% in July and was 0.9% lower on a year-ago basis indicating that weak industrial production was not due solely to flat auto sales. Part of July’s industrial production weakness emanated from Hurricane Barry which triggered a sharp decline in oil extraction in the Gulf of Mexico.

The dichotomy between US and global economies or the contrast between the US consumer and industrial production does not explain the contradiction between the stock market and the bond market. Equities have been at or near all-time highs, reflecting a strong economy while bond yields have dropped to record lows, predicting a recession. After several intra-day inversions in the Treasury yield curve many analysts have begun to worry about a US recession. In our opinion, low bond yields have several sources, but most of them come from outside the US borders. For example, July inflation data shows headline CPI rising at 1.8% YOY, final demand PPI increasing 1.7% YOY and the personal consumption expenditure deflator rising 1.4% YOY. More importantly, import prices fell 1.8% YOY in July and export prices fell 0.9% YOY suggesting that deflation pressures may be seeping into the US economy from abroad. See page 5. Given these statistics and with inflation well below the Fed’s target of 2%, it is not surprising to see bond yields decline. Equally important, even after the fed funds rate dropped to 2.13% this month, the real yield is a positive 30 basis points and gives the Fed room to lower rates. See page 6.

In our view, it is global bond yields that are driving US Treasury yields lower. The weakness seen in the European economies is creating a flight to safety and the Euro Zone 10-year benchmark yield is currently minus 0.689% in line with the German bund. The Swiss sovereign yield is minus 1.00%, the Japanese 10-year government bond yield is minus 0.243% and the UK 10-year gilt yield is positive 0.45%. In this environment it should not be surprising that the 10-year Treasury bond yield is 1.55%. See page 8. In sum, risks are primarily coming from outside the US and though these risks should not be ignored, it should also be noted that most central banks are taking action to ease monetary policy. This may also explain why the financial media is reporting that President Trump is considering lowering the payroll tax rate.

Technical Review

The most important aspect of the market’s technical condition is the 89% up day on August 16 which suggests the worst of the equity decline has been seen. Yet it is also important to note that sentiment indicators never showed excessive bullishness or anything that implied a major top was forming. In fact, the week ended August 7, AAII bullish sentiment fell 10.7% to 27.7% and bearish sentiment rose 24.1% to 48.2%. Bullish sentiment is currently 23.2% and bearish sentiment is 44.8% which is neutral for this indicator. See page 13. On the other hand, the ISE Sentiment Index turned positive in early August – a sign that option traders are defensive. In sum, we remain long-term bullish.

IMPORTANT DISCLOSURES

RATINGS DEFINITIONS:

Sectors/Industries:

“Overweight”: Overweight relative to S&P Index weighting

“Neutral”: Neutral relative to S&P Index weighting

“Underweight”: Underweight relative to S&P Index weighting

Other Disclosures

This report has been written without regard for the specific investment objectives, financial situation or particular needs of any specific recipient, and should not be regarded by recipients as a substitute for the exercise of their own judgment.  The report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell securities or related financial instruments.  The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.  The report is based on information obtained from sources believed to be reliable, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report.  Any opinions expressed in this report are subject to change without notice and Dudack Research Group division of Wellington Shields & Co. LLC. (DRG/Wellington) is under no obligation to update or keep current the information contained herein.  Options, derivative products, and futures are not suitable for all investors, and trading in these instruments is considered risky.  Past performance is not necessarily indicative of future results, and yield from securities, if any, may fluctuate as a security’s price or value changes.   Accordingly, an investor may receive back less than originally invested.  Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report.

DRG/Wellington relies on information barriers, such as “Chinese Walls,” to control the flow of information from one or more areas of DRG/Wellington into other areas, units, divisions, groups or affiliates.  DRG/Wellington accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The content of this report is aimed solely at institutional investors and investment professionals. To the extent communicated in the U.K., this report is intended for distribution only to (and is directed only at) investment professionals and high net worth companies and other businesses of the type set out in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report is not directed at any other U.K. persons and should not be acted upon by any other U.K. person. Moreover, the content of this report has not been approved by an authorized person in accordance with the rules of the U.K. Financial Services Authority, approval of which is required (unless an exemption applies) by Section 21 of the Financial Services and Markets Act 2000.

Additional information will be made available upon request.

©2019.  All rights reserved.  No part of this report may be reproduced or distributed in any manner without the written permission of Dudack Research Group division of Wellington Shields & Co. LLC. The Company specifically prohibits the re-distribution of this report, via the internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect.

Contact Andrea Costello, Head of Research Sales for additional information (212) 320-2046 or Andrea@DudackResearchGroup.com

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Trade fears began to pummel the equity markets this week after President Trump indicated he will impose a deadline of this Friday for a trade agreement with China or tariffs will increase from 10% to 25% on $200 billion worth of Chinese goods. According to Reuters this shift in tone came after US Trade Representative Robert Lighthizer informed President Trump that Chinese negotiators were seeking to deal with policy changes through administrative and regulatory actions, not through changes to Chinese law as previously agreed. A person close to the negotiations indicated that under China’s system — in which the Communist Party has ultimate control — changes in law are the only way to get even a small measure of certainty on compliance. From this perspective, it should not be surprising that President Trump is playing hard-ball with China. A weak or ineffective trade deal with China may not be any better than no deal at all.

China versus US

With a trade deal now in doubt, stock and oil prices declined and bond prices rose. As seen on page 16, over the last five trading days the SPX fell 1.4% but the Shanghai Composite index sank 5.2%, or nearly four times as much as the SPX. The DJIA suffered a 473.39 point, or 1.8% drop on Tuesday, its largest one-day sell-off since January 3 and the SPX fell 1.7%. Nevertheless, the broad indices are less than 2.5% away from their record highs and the current declines are barely visible in long-term charts. In our opinion, the disparity in the performance of the Chinese and the US equity markets is important since it is a reflection of the potential impact tariffs are likely to have on the respective domestic economies.

Given the drama seen in the markets this week we thought it best to bullet point some thoughts:

• President Trump currently has a timely and stronger hand in terms of negotiating with China after the 3.2% GDP growth rate reported in 1Q19 and the record highs recorded by the equity market. Negotiations over intellectual property rights are crucial to a good trade deal.
• Dramatic moves in the stock market tend to be counter-cyclical; that is, major tops tend to be slow and pondering, whereas corrections tend to be sharp and dramatic. The current decline has the earmarks of a correction to the major move.
• A 600-point intra-day decline in the DJIA is intense and tends to bring out bearish commentators however a long-term chart is needed to put the recent 2.5% decline in perspective after the 25% gain seen from the December low. See page 11.
• In early April first quarter earnings growth was estimated to decline 2% YOY, but with roughly 85% of the SP500 now reported, IBES Refinitiv consensus currently shows a 1.5% YOY gain in 1Q19 EPS. This gain may not be strong enough to generate a sustainable advance, but it is nevertheless much better than anticipated. The gain is 2.5% excluding the energy sector.
• Trade contributed to the 3.2% GDP growth rate in 1Q19. Since there was a considerable amount of pre-buying as tariffs were about to go into effect in 2018, 2019’s first quarter could reflect the longer-term impact of the current trade tariffs. And we noted earlier, trade tariffs are negatively impacting US farmers, but agriculture contributes less than 1% to US GDP.

In sum, we do not believe a failed trade negotiation with China will trigger a substantial decline in US equities. Conversely, a successful trade agreement should propel the indices back to their recent highs. There is no change in our SPX 3110 target for this year and we continue to believe our target could prove to be conservative.

Strong Economic Numbers with a Few Weak Undertones

Not only was April’s 3.6% unemployment rate the lowest level reported since December 1969, but the 1.9 million people who applied for unemployment insurance in the last five weeks was the lowest since the 1.8 million seen in January 1970. See page 3. These are signs of a strengthening job market. Non-supervisory hourly earnings rose an inflation-adjusted 1.9% YOY in April, well above the 10-year average of 0.8% YOY. Inflation-adjusted weekly earnings were up a similar 1.6% YOY and were also above the 10-year average of 0.8% YOY. See page 4. Still, April’s confidence indices remain below peak 2018 levels. Confidence may improve as households experience the benefit of rising wages and modest inflation. The sum of inflation and the unemployment rate is often called the Misery Index, and this index was 5.2% in April, the lowest since September 2015’s 5.0%. See page 5.

The preliminary estimate for 1Q19 GDP growth was 3.2%, and despite a government shut-down and poor weather, it was substantially better than the 2.2% pace seen in 4Q18. This improvement came despite a slowdown in consumer spending which was not a surprise given recent retail sales numbers. Inventory accumulation increased as expected since inventories declined at yearend. Growth in fixed investment slowed. Real disposable income growth slowed to 2.4% from 4.3%. The saving rate rose to 7%, from 6.8% in the fourth quarter. However, we found the improvement in the trade deficit to be the most encouraging aspect of the quarter. See page 6.

The current expansion is only a few months from becoming the longest in history, yet this economy is not showing the excesses typical of an aging cycle such as rising inflation or gross private domestic investment generating 19% or more of GDP growth. See page 7. In fact, we see pockets of weakness. A 3-month average of retail sales, adjusted for inflation, rose 1.1% in April, the slowest pace since emerging from a recession in 2009. Residential investment rose 0.6% YOY in 1Q19, the lowest since 2011; and as a result, residential investment represented only 3.76% of GDP growth. See page 8.

A number of economists are fearing there will be higher inflation and weaker profit margins due to rising wages. However, we disagree. The employment cost index (ECI) in the first quarter showed total compensation rose 2.8% YOY and wages declined from 3.1% YOY in 4Q18 to 2.9% in 1Q19. Private industry compensation costs were even milder at 2.7% YOY versus government total compensation costs at 3.0% YOY. Union worker total compensation costs rose 3.4% YOY in 1Q19 versus the 2.7% seen for non-union workers. However, we are focused on the private industry costs of 2.7% YOY which are quite benign when compared to the first quarter CPI rise of 1.9% YOY. See page 9. All in all, we believe the US economy is demonstrating solid growth but is still growing below its potential.

Technical Scoreboard

The recent sell-off is barely visible in the charts seen on page 11 and most indices remain near all-time highs. However, the Russell 2000 has been lagging and is the only index with a down-trending 200-day moving average. This underperformance is in stark contrast to our NYSE cumulative advance decline line which recorded a new high on May 3. We will be monitoring the RUT during market weakness and as it tests its 200-day moving average. Holding above this level would be an encouraging sign of strength. The 25-day up/down volume oscillator is at 0.06 (preliminarily) this week despite the recent sell-off. The oscillator made a two-day overbought reading on April 11-12 and April’s reading followed a long 25-consecutive-day overbought reading in January through March. The 10-day average of daily new highs is 189 and above the 100 per day level defined as bullish. The A/D line made a new record high on May 3, 2019 and is also positive. We remain long-term bullish.

IMPORTANT DISCLOSURES

RATINGS DEFINITIONS:

Sectors/Industries:

“Overweight”: Overweight relative to S&P Index weighting

“Neutral”: Neutral relative to S&P Index weighting

“Underweight”: Underweight relative to S&P Index weighting

Other Disclosures

This report has been written without regard for the specific investment objectives, financial situation or particular needs of any specific recipient, and should not be regarded by recipients as a substitute for the exercise of their own judgment. The report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell securities or related financial instruments. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. The report is based on information obtained from sources believed to be reliable, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report. Any opinions expressed in this report are subject to change without notice and Dudack Research Group division of Wellington Shields & Co. LLC. (DRG/Wellington) is under no obligation to update or keep current the information contained herein. Options, derivative products, and futures are not suitable for all investors, and trading in these instruments is considered risky. Past performance is not necessarily indicative of future results, and yield from securities, if any, may fluctuate as a security’s price or value changes.   Accordingly, an investor may receive back less than originally invested. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report.

DRG/Wellington relies on information barriers, such as “Chinese Walls,” to control the flow of information from one or more areas of DRG/Wellington into other areas, units, divisions, groups or affiliates. DRG/Wellington accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The content of this report is aimed solely at institutional investors and investment professionals. To the extent communicated in the U.K., this report is intended for distribution only to (and is directed only at) investment professionals and high net worth companies and other businesses of the type set out in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report is not directed at any other U.K. persons and should not be acted upon by any other U.K. person. Moreover, the content of this report has not been approved by an authorized person in accordance with the rules of the U.K. Financial Services Authority, approval of which is required (unless an exemption applies) by Section 21 of the Financial Services and Markets Act 2000.

©2018. All rights reserved. No part of this report may be reproduced or distributed in any manner without the written permission of Dudack Research Group division of Wellington Shields & Co. LLC. The Company specifically prohibits the re-distribution of this report, via the internet or otherwise, and accepts no liability whatsoever for the actions of third parties in this respect.

Contact Andrea Costello, Head of Research Sales for additional information (212) 320-2046 or Andrea@DudackResearchGroup.com

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