Uncategorized, Weekly Update

Oh That Inversion? No Big Deal

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Published April 5, 2019


Markets have very quickly put behind them the whole inverted yield curve fear. It lasted all of a couple of days. The cold water was poured on that fear when Chinese manufacturing posted a surprisingly high reading, reversing months of declines.

China’s Manufacturing Purchasing Managers Index (PMI)

China’s Manufacturing Purchasing Managers Index (PMI)

This report fed the bulls’ argument that economic fears are overblown and a recession is nowhere near imminent. A bullish market has a tendency to believe bullish data and largely discount negative inputs (just as we all tend to believe things that support our preconceived notions). Similarly, a bearish market believes every negative data point and theory, discounting quickly any competing ideas.

We saw in December how tenuous these beliefs really are. A temporary lack of liquidity sent asset-backed loan demand plummeting in part on fears the Federal Reserve might be too aggressive in raising rates. The Fed changed their tune, and the fears just as quickly subsided. The Fed has shown repeatedly over the past decade that it is very sensitive to market responses, willing to step in with soothing words when needed. Markets have come to rely on the Fed in this regard, as the good doctor able to make any pain go away. The question then becomes when, how, or even if market participants break this dependence on the Fed.

Stocks are now only a couple of percentage points away from new highs, having dismissed almost all of the fears that drove the fourth quarter slide. Remaining is the ultimate foundation of the market, corporate earnings. Whether and how much they decline from their tax-juiced rise remains unknown and a source of potential trouble. Stocks are not terribly expensive as shown in the chart below, resting in the middle of the long-term valuation channel. This can be misleading, however, because we also see below how little influence this indicator has on the market – e.g. it’s rarely in the middle of the channel, instead swinging widely between over- and under-valued states, and remaining there for extended periods of time.

S&P 500 Forward P/E Ratio

Though earnings estimates have been coming down, the outlook for earnings remains for strong growth after a pause. We would expect these projections to be reduced in coming months. However, the economics would have to substantially change to alter the growth trajectory currently planned in these numbers. It is that outlook that supports the stock market in the face of current weakness. As we get into earnings season, we will see how stocks react to what might be some rather tepid corporate news.

S&P 500 operating earnings per share

Market Update

Stocks kicked off the second quarter of the year with a solid rally, backed by encouraging economic data out of China. The broad market pushed higher by +1.2% with leadership from key cyclical sectors like semiconductors and transports. Tuesday’s market was lackluster by comparison, with shares treading water as business spending came in flat and Walgreens Boots Alliance (WBA) reported disappointing results in news viewed as specific to the healthcare industry consolidation. Semiconductor shares rallied further Wednesday on news of increasing orders from key industry manufacturers like Taiwan Semi (TSM). News that the China-U.S. trade talks are nearing a positive conclusion kept investors optimistic Thursday though indexes ultimately showed little movement. Friday brought a well-received monthly jobs report, calming fears of near-term recession that arose from a weak report the prior month. Stocks bounced +0.5% higher to cap a solid first week of the quarter and leave the S&P 500 with seven consecutive daily gains.

Stocks continued their 2019 rally this week, adding +2.16% in the S&P 500 (SPY) while the Nasdaq 100 (QQQ) rose +2.78%. Small-caps (IWM) closed up +2.80%, finally clearing their 200-day moving average by Friday’s close.

Warm wishes and until next week.