US Strategy Weekly: Breaching the Highs

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.

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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.




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

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

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

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2019 Third Quarter Review – The Home Stretch

Stocks rose modestly in the third quarter, but the S&P 500 is roughly flat versus a year ago, while bond yields are down approximately 160 basis points. The Federal Reserve raised interest rates in September and December of 2018 and cut them in July and September of this year. Corporate profits have slowed and will most likely be down on a year/year basis for the quarter just ended, but are forecast to improve in the fourth quarter as earnings comparisons become easier. The net effect is that weaker earnings and much lower interest rates have offset each other when it comes to equities.

The U.S. economy is in decent shape but still slowing, while the U.S. consumer and employment rates are the bright spots. Manufacturing is very weak, primarily due to trade. The weakness started abroad in 2018, but is more evident in the U.S. with the U.S. Purchasing Managers Index (PMI) for September at 47.8. Anything below 50 signals contraction. The export component was 41.0. Manufacturing is a small part of the U.S. economy but matters for corporate profits—which are a leading indicator for capital expenditures and future job growth. The weaker PMIs have caused some economists to forecast a 2020 recession, but we disagree. The PMIs have a long lead time and both monetary and fiscal stimulus recently have been revived, both here and abroad. The most likely scenario is for the U.S. economy to keep expanding at the 1 ½ to 2% rate. A favorable resolution to our trade issues, particularly with China, would increase these odds.

With all the negative headlines around, there has been talk of the end to the U.S. bull market, which now has passed its tenth year. Again, we find fault with this reasoning since none of the usual symptoms are present. To begin with, bull markets do not end with investors in a cautious mode but with euphoria, something far from present-day sentiment. They also typically feature heavy inflows into equity market funds, the opposite of what has been currently happening. A further condition is a big pick up in merger and acquisition activity, as well as initial public offerings, and, instead, both remain restrained. Lastly, market tops are associated with rising real interest rates and widening credit spreads. In contrast, current credit spreads are well-contained, and interest rates are falling, not rising.

In our July letter we referred to the fact that sometimes it pays to listen to the markets themselves, rather than the headlines. We see more evidence that this should continue to be the case today. The market internals are strengthening both in terms of advances and participation, and the percentage of stocks with an upward sloping two hundred-day average has recently reached a new high. Also worth noting is the calendar, since mid-October usually marks the start of the year-end rally. With any favorable resolution to our current trade disputes, we would not be surprised to see the popular averages at new highs.

October 2019

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