Turtle Dove … or Black Swan?

DJIA:  28,377

The trade war, impeachment, Brexit, all have had their moments, but none have proven the market’s undoing.  And so it goes.  The “knowns” rarely prove the problem, it’s those nasty unknowns.  The obvious catch is how to know the unknowns.  In some cases, the overall market sniffs out trouble and it shows up in breadth divergences and the like.  There is, however, a specific indicator designed to detect Black Swans called the SKEW.  What the SKEW measures, and what it is telling us now, is that traders are paying up for out-of-the-money Put options.  They’re buying insurance on what who knows, and they’re paying up for it.  Like the “Titanic Syndrome” and other esoteric measures, the SKEW has had its moments, but fortunately not that many.  Ironically, the Volatility Index, or VIX, a short-term measure of fear, is only around 12-13, well below the average of around 19 since 1990.

A Black Swan is a significant and market moving event.  Most important, it’s unforeseen.  That makes any prediction little more than a guess, other than it’s not where you’re looking.  And, indeed, that would describe most of the market’s problems, they’re never where you’re looking.  The impeachment, rather than a Black Swan, has proven a non-event.  Then, too, a conviction in the Senate might well qualify.  We’re thinking, however, a little further from home, specifically China.  It’s not our trouble with China, it’s trouble in China.  China’s financial system is struggling under the weight of an enormous borrowing spree.  Companies piled up plenty of debt as they expanded, as the world’s investors rushed to lend even more money.  Now defaults are rising, a sign the world’s No. 2 economy is feeling the stress from its worst slowdown in nearly three decades.  Fortunately for the rest of the world, that’s yet to show up in the China charts, so no worries for now.  That said, we’ll keep bird watching.

It has been a great year despite the lack of true believers, or maybe because of it.  Investors have fled funds this year despite the market’s performance.  That is among the reasons for optimism about next year—good years typically follow years with outflows.  Then there are the Wall Street strategists who are looking for only a 4% gain next year, their smallest projected gain in 20 years.  Historically they’ve proven a modestly good contrary indicator, much like fund outflows.  Following double-digit up years, the odds of being up the next are 85%, it’s as simple as that.  Earlier this week 7% of NYSE and NAZ stocks reached 12-month New Highs.  Last year at this time, 40% were at 12-month New Lows.  The Advance/Decline Index is at an all-time high—peaks here typically lead peaks in the market averages by 4-to-6 months.  It’s reasonable to worry that we may be borrowing something from next year, and at the start it could be true.  The end and start of years can be tricky, but there’s no reason to think next year won’t be another good one.

Many so-called long-term investors didn’t start that way.  They were poor short-term investors who didn’t sell.  The obvious key to long-term investing is to find stocks in long-term uptrends.  Even when it comes to short-term investing or trading, life is that much easier when you have the wind of that long-term uptrend at your back.  Still everyone likes to buy low, who doesn’t like a bargain?  They do come around, and in the context of long-term uptrends.  We’re thinking here of Home Depot (220) and McDonald’s (197).  Both have had a 30-point, or 10%-15% corrections, with barely a dent to their long-term uptrends.  Both also have patterns that have stabilized, MCD is even about to cross back above its 50-day moving average.  Even good companies have their problems, or their stocks simply fall out of favor.  More than a specific business, long-term uptrends more often than not are a reflection on management.

Seeing the light?  For most of the year we’ve seen how pessimistic individual investors have been, and how persistently so.  Given the myriad of reasons—trade war, impeachment, economic malaise—they were expecting the market to drop.  Historically, the market rarely does so when so many are expecting it.  It has taken a while, a historic high, but those investors finally may be beginning to believe.  The latest AAII survey shows bulls to bears above 67% for the first time in nine months.  While this may seem worrisome, it’s hardly so.  When it comes to individual investor or public sentiment, they are wrong at the extremes, but right in between.  We are, at worst, at the start of in between.  Meanwhile, if momentum trumps sentiment, the number of daily advancing issues has been 2000 or more each of the last 7 days, and 10 of the last 12.  It takes a lot of money to push up that many stocks.  When it’s finally all in, the numbers will change.

Frank D. Gretz

Click to download

The most wonderful time of the year… if often a little confusing.

DJIA:  28,132

Hedge funds don’t seem confused.  After being under-exposed for much of the year, in the past week there has been an abrupt change—equity funds are now carrying their highest exposure since the beginning of the year.  There must be something about “group-think,” because the record here isn’t altogether better than the general public.  It’s not a perfect indicator, but high levels of hedge fund exposure have tended to lead to below average future returns in the S&P, and vice versa.  In the meantime, the new-found religion here could be help to a name like Google (1350), and should help names like Microsoft (153) and Apple (271), which don’t really need much help.  Meanwhile, the confusing part of this time of year is the tendency for the downtrodden to rise again.  And pretty much synonymous with downtrodden is Energy, which is acting better.

Rotation is nothing new to this market, and the past week was no exception.  We’ve touted Health Care as a leadership group, which didn’t have its best week, though there were a couple of doubles in small Biotechs.  While the group covers an array of very different companies, taken as a whole more than 90% of Health Care stocks are above their 50-day moving average, the most of any sector.  A number like this says “overbought,” but as we’ve pointed out, overbought isn’t a bad thing.  As it happens, modestly overbought can be a bad thing in that it indicates only modest momentum.  Health Care has the kind of momentum consistent with trends that persist.  We are also impressed with this group considering what seems a difficult political backdrop.  On the good side of the rotation go-around, the recently dormant Semis, based on the Vaneck Vectors ETF (SMH-140), seem in the process of reasserting themselves.

At a basic level, technical analysis can be divided into two parts, momentum and sentiment, or investor psychology.  As has been the case for much of the year, momentum trumps sentiment.  Overbought doesn’t mean over, the trend is your friend, we’ll spare you the rest.  Meanwhile, sentiment has remained rather subdued and rightly so—trade war, impeachment, dubious economic numbers, and how about that Uber (29) and the other IPOs?  That said, momentum by some measures has itself been a bit dubious.  Despite the market’s stellar performance in 2019, for more than a year and a half, fewer than 60% of NYSE stocks have managed to move above their 200-day moving average.  This could be taken negatively and it has been a concern for us.  It’s not just the fewer than 60% above the 200-day versus new highs in the S&P, even 60% is below the 70% in 2016-2018.  That’s the picture of momentum unwinding—unwinding momentum is the picture of bull market tops.

We’ve learned not to make excuses for the indicators.  In the case of stocks above their 200-day, an excuse is hard to come by.  After all, the Advance/Decline Index is at a new all-time.  It’s a similar case as well if we adjust for price by using the QCHA, a measure of the percentage price change in stocks up versus down.  A possible explanation could be the rotation that we often mention.  Stocks don’t go down, but there are these rolling corrections in groups like the Semis.  The good side of that is it has kept most stocks from becoming too extended, and in that sense it has kept the market healthy.  You may miss the days when it was FANG and only FANG, but the balance now likely will prove more durable.  In an overall sense, moving to 60% of stocks above their 200-day is good.  Getting to 70% is the Holy Grail for durable uptrends.

The market has had a good year, up something like 26% in the S&P.  Then, too, were it a 15-month year, it would be up only about 9%—last year’s fourth quarter was that bad.  There are no perfect indicators, but the Advance/Decline Index also had a good year, and that after a prescient warning last year.  That most days most stocks go up is pretty much all you needed to know.  That’s unlikely to change in the New Year, which history suggests could be another good one.  Wall Street strategists are looking for only a 4% gain in 2020, their most pessimistic call in 20 years.  They have proven a modestly good contrary indicator.  Also, about $200 billion has come out of funds this year, small as a percent, but surprising in light of the market’s performance.  The record of good years after outflows is also good, especially when outflows occur in an up year.  The so close and yet so far trade deal seems one that has come down to groceries.  Still, it’s clearly something the market wants, if only to get it out of the way.

Frank D. Gretz

Click to download

US Strategy Weekly: A Notable Time

Historic Events

This week can be marked as historic with Democrats from the House of Representatives, led by House Leader Nancy Pelosi, announcing two articles of impeachment, abuse of power and obstruction of Congress, against President Trump. This was long anticipated. But in an odd act of timing, Leader Pelosi followed one hour later with a press conference indicating the House is likely to pass an amended and long-delayed USMCA trade deal. Earlier this week, The Washington Post exposed a confidential trove of government documents showing that, throughout an 18-year campaign, senior US officials failed to tell the truth about the war in Afghanistan, made pronouncements they knew were false and hid evidence from the press and the American public that the war had become unwinnable. In short, Washington DC is all abuzz.

This week will continue to be busy since it includes the December FOMC meeting, a December 12th UK parliamentary vote, the results of which could determine the fate of Brexit, EU monetary policy and the debut press conference of the new head of the European Central Bank, Christine Lagarde. Key economic reports on the CPI, PPI, import and export prices and retail sales will also be released. We do not expect any change to monetary policy in December, so the key report of the week is apt to be November’s retail sales report. This release should have preliminary data for Black Friday sales, but it will not include Cyber Monday online sales which are reported to have totaled $9.4 billion, up nearly 19% YOY according to Adobe Analytics. Estimates for Black Friday sales are currently $7.4 billion. All in all, these retail sales numbers point to the start of a healthy holiday selling season and it bodes well for the fourth quarter economy.

Employment is Better than Expected

November’s payroll numbers also suggest the economy is doing better than many economists have been predicting. Job gains for the month surged to 266,000, their best performance since January, while revisions to the two prior months added 41, 000 more jobs. Although the reversal of October’s auto strike losses was expected to add 54,000 jobs to the month, payroll gains still exceeded 200,000 in November. This was an impressive increase since the usual holiday lift in retail payrolls failed to materialize. Employment gains in November were strongest in healthcare and professional and technical services. See page 3.

Our favorite job statistic is measuring year-over-year growth in both employment surveys. The establishment survey had a 1.47% YOY increase in jobs in November, slightly below its long-term average of 1.77%. The household survey had a 1.14% YOY increase in jobs, just under its long-term average of 1.5%. In fact, both surveys have exhibited below average growth for most of 2019, even though the pace of employment gains have been positive and steady. Yet slow and steady is much different from a sharp deceleration in the rate of job growth; deceleration is a typical precursor of a pending recession. But this is not a concern today. In the 12-months ended in November there have been 2.2 million new jobs created and this contributed to a 3.5% unemployment rate which matches September 2019. These are the lowest unemployment rates since the 3.4% reported in June 1969. See page 4.

November’s participation rate of 63.2% is only slightly above the September 2015 low of 62.4% and this lackluster performance is due to Baby Boomers leaving the labor force. Baby Boomer retirements mean this ratio is unlikely to improve in the years ahead. Conversely, the employment population ratio was 61% in November and has moved steadily higher since its July 2011 low of 58.2%. This is an indication of a strengthening labor market. The fact that the percentage of people who are not in the labor force but want a job was 4.7% in November, close to previous month’s all-time low of 4.6%, is another sign of a strong market. See page 5. Historically, a 3-month average of job gains or losses has had a strong correlation with consumer confidence. In November the 3-month average job gain rose from 189,330 to 205,000; confidence is also rising. This relationship has been stronger than that of the unemployment rate and GDP. See page 6. November’s average hourly earnings grew 3.7% YOY, an acceleration over the 3.4% YOY rate seen a year ago. Average weekly earnings rose 3.0% YOY in November which is down from the 3.4% YOY pace seen in November 2018. In sum, November marked a deceleration in the pace of weekly earnings growth, but the rate still well above the 2.2% YOY pace seen between 2011 and 2016. See page 7. Based upon this, it is no surprise that consumer confidence is on the rise.

Trade is Better than Expected

Trade data also points to fourth quarter strength. The trade deficit narrowed from $51.1 billion in September to $47.2 billion in October, the second consecutive monthly decline and the fourth decline in the past five months. On an annualized basis, the trade deficit is running at 4% of GDP versus the 4.25% of GDP recorded in 2018. See page 8. Most of this improvement in the deficit is the result of declining trade with China. The US trade deficit with China is running at 1.6% of GDP this year versus 2.04% in 2018. Some of this falloff with China is becoming a boon for other countries. Trade is expanding with countries in the European Union, Japan and Canada; but Mexico has been the biggest beneficiary of the trade war. Imports from Mexico are up 4.5% and exports have declined 2%, year-to-date. As a result, the trade deficit with Mexico is running at 0.48% of GDP versus the 0.39% seen in 2018. Another factor improving US trade is energy. This can be seen by the fact that in the first 10 months of 2019, the US is experiencing a $7.7 billion surplus with OPEC nations. See pages 9-11.

Technical Indicators Continue to be Strong

After strong advances from the mid-October lows to December’s record highs, the popular indices are consolidating this week. But trends remain favorable and indices are trading above all moving averages. The Russell 2000 index has been our biggest concern in 2019 since it has lagged the larger capitalization indices most of the year. However, the RUT has broken above the 1600 resistance level and it continues to hold above this level which is bullish. See page 13. The 25-day up/down volume oscillator is at 0.83 and is neutral this week. But the last reading in this indicator was a five-day overbought reading, the fifth such reading in 2019, which represents a bullish pattern of solid buying pressure. See page 14. Average daily new highs remain above 100 per day and average daily new lows remain below 100 per day, which is classically bullish. The NYSE cumulative advance decline line made an all-time high on November 27th confirming the new highs in the indices. And last, we are encouraged that sentiment indicators remain in neutral territory even as the market continues to climb to new heights. In short, there are no signs of excessive optimism that tends to mark major bull market peaks.

Summary

Economic data including reports on jobs, trade, sentiment, housing, and GDP continue to show a stellar US economy led by a consumer supported by the best job market in years. This bodes well for the fourth quarter economy and for earnings. We continue to believe that our 2020 SPX target of 3300 could prove to be conservative.

Next week we will publish our Outlook for 2020 on Wednesday December 18th.

November’s payroll gain of 266,000 jobs was strikingly strong even after adjusting for the 54,000 job increase attributed to the UAW settlement. Moreover, revisions added 41,000 jobs to the prior two months. The 6-month averages rose to 196,330 in the establishment survey and to 305,830 in the household survey.

Regulation AC Analyst Certification 

I, Gail Dudack, hereby certify that all 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. 

©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. 

Click to download

© Copyright 2021. JTW/DBC Enterprises