Bad News …It Doesn’t Have To Be Bad

DJIA:  32,033

Bad news …it doesn’t have to be bad.  After all, the market makes lows on bad news, not good news.  It’s bad news that induces selling, and it’s selling that makes lows.  Take that bad CPI number back on October 13, the S&P is up 10% since then.  Then there was the day of the Russian invasion back in February when the market opened down big only to recover that afternoon and pretty much never look back.  Many reasons were offered for the remarkable turnaround on the CPI number, but there’s only one that really makes sense – stocks had become sold out.  To put the day in context, the market had fallen the prior six consecutive days.  And for a little more color, consider the dollar volume of option Put buying was triple that of Call buying, by far a record.  If you were buying that many Puts, you’ve likely done a lot of selling.  It’s selling that makes a low, and leaves a vacuum of sorts for prices.

Is gold the new bitcoin?  The much hyped Bitcoin Strategy ETF (BITO-13) is down some 60% this year.  It hasn’t exactly proven a store of value, and this with inflation everywhere you look.  The best inflation hedge has been oil, and the stocks more than the commodity.  Gold has had its moments but despite the long held view to the contrary, hasn’t seemed moved by inflation.  Then, too, it’s hard to fit gold into a convenient theme.  During the great depression a 10% position in Homestake Mining would have hedged the rest of your portfolio, and that period was all about deflation.  Gold shares have stabilized and without question are improved.  Of the 40 or so gold shares we follow most are above their 50-day average, and all of the silver miners are above their 50-day.  The dollar meanwhile is below its 50-day, which should prove a tailwind for the precious metals.

Is China uninvestable?  That’s certainly the thought we had when those stocks opened on Monday, but we’ve been doing this long enough to know when even we have that thought, the worst is likely over.  That’s hard to imagine given what’s going on, but for China this isn’t the first time things have looked more than a little bleak.  Chinese stocks endured a similar bout of selling in March, after which they rallied some 60% over the next few months.  The stocks peaked in June, however, and most stocks traded to new lows.  On Monday nearly 60% of Chinese Internet stocks traded at new lows, the fourth highest in 15 years according to  There have been six other days when more than 55% of the stocks fell to a new low.  Some big losses follow but all showed gains over the next six months.

Three things to keep in mind here – oil, oil and oil.  Then, too, late last week much of healthcare came to life, and there is much of healthcare.  There are the big pharmaceuticals like Eli Lilly (356), the insurance guys like Humana (545), and the wholesalers like Cardinal Health (75).  Finally, there’s aerospace/defense.  When you think about McDonalds (265) and Pepsico (179) punching near all-time highs, you can’t exactly say strength is all that selective – different, but not selective.  Similarly, Deere (395) and Caterpillar (212) were among the leaders Thursday.  While no one was looking they had turned into more than respectable charts.  Meanwhile, the go-to-stocks we all new and used to love, FANG, the Semis and Tech generally, are underperforming, to be kind.  That the market has been able to ignore the action in these stocks seems an important intangible.

So how long can this keep going on?  We are always tempted to say, until you stop asking.  Sounds pretty rude, but they will stop asking when they’re back close to being fully invested.  These end of the year rallies, especially when good ones, can feed on themselves a bit in the form of job security.  If you think you’re not going to buy until the Fed pivots, you look pretty safe.  Suppose, however, the market changes the definition of pivot.  Let’s say rather than easing the pivot just becomes no more tightening.  A drop in inflation to 2% becomes just a peak in inflation.  When markets want go higher they have a way of creating their own reality.  A less esoteric answer to how far this can go is that it will go higher until it does something wrong.  Wrong typically is about those Advance-Decline numbers.  Strength in the Dow without strong participation is how markets get into trouble.

Frank D. Gretz

Click to Download

US Strategy Weekly: World News

World News

It was a quiet week in terms of domestic economic news, but it was far from dull in terms of global news. In the UK, Rishi Sunak took over as Britain’s 57th prime minister, replacing Liz Truss, whose 45 days in office was the shortest tenure in UK history. Sunak will be the first prime minister of South Asian descent, the first person of color, the first Hindu prime minister, and at 42 years old is the youngest person to hold the office in modern times. He has previously worked for Goldman Sachs, was a managing director of a hedge fund, and might be the richest person to ever hold the office. He formerly served as the Chancellor of the Exchequer (finance minister) in Boris Johnson’s cabinet. Sunak inherits a difficult economic environment, but the market’s first reactions were favorable and British sterling rallied on the news. Separately, the Bank of England is expected to raise interest rates 75 basis points on November 3, one day after the Federal Reserve is expected to raise the fed funds rate by another 75 basis points.

This week Russia took allegations to the UN Security Council implying that Ukraine is preparing to use a “dirty bomb” on its own territory. Western and Ukrainian officials dismissed these charges as misinformation, but many worry that this could be a pretext prior to Putin escalating the war. Simultaneously Putin notified the US of plans to carry out annual exercises of its nuclear forces.  

Over the weekend, the Chinese Communist Party unanimously chose Xi Jinping to be its leader for another term of five years, while also granting him a breadth of institutional power not seen since the days of Mao Zedong. In 2017 Xi removed term limits for the presidency. And in a blatant expression of power, Xi had China’s former president, Hu Jintao, forcibly removed from the final session of the 20th National Congress, a sign that Xi is pushing all but his most loyal allies out of positions of power.

Saudi Arabia’s energy chief Prince Abdulaziz bin Salman blasted the use of emergency oil reserves to manipulate prices in a direct warning to President Biden who just released millions of barrels from strategic petroleum reserves. Saudi’s energy minister stated, “Losing emergency stocks may be painful in the months to come.” President Biden has signed off on historic use of the US Strategic Petroleum Reserve (SPR) this year, releasing 180 million barrels of oil since April, with another release of 14 million barrels this month. This supply has helped to keep a lid on energy inflation in the weeks before the midterm elections, but it is also putting oil markets under pressure with the SPR at its lowest level since 1984. 


At the end of the week, slightly more than half of the S&P 500 component companies will have reported third quarter earnings. This week the S&P consensus EPS estimate for 2022 declined to $206.74 and IBES fell to $222.14 bringing EPS growth rates for 2022 to -0.7% and 6.7%, respectively. These estimates are down from $227.51 and $230, respectively, at the end of April. This means the S&P consensus estimate has declined nearly 10% in the last five months and it is still falling. This week forecasts for 2022 declined 59 cents and for 2023 fell 28 cents. And estimates are apt to fall again this week. Google parent Alphabet (GOOGL.O – $104.48) reported earnings of $1.06 per share versus $1.40 a year earlier, based upon disappointing ad sales. Last week Snap Inc. (SNAP – $9.60) reported its slowest ever revenue growth rate and the stock collapsed. Microsoft (MSFT – $250.66) reported earnings of $2.35 per share in its fiscal year ending in September, versus $2.71 a year earlier, and projected quarterly revenue below Wall Street targets across its business units. Microsoft suffered its worst quarterly net income decline in two years and the weakest revenue growth in more than five years. These results fanned fears of a slump in personal computer sales and slowing growth in its cloud computing business. General Electric Co. (GE – $73.00) trimmed its full-year forecast after reporting a decline in third quarter earnings due to higher raw material costs in its renewable energy business and demand uncertainty due to the expiration of renewable electricity production tax credits. In sum, we expect consensus earnings estimates for the S&P 500 will continue to decline. This fact puts our current 2022 estimate of $209 at risk. We will be reassessing our estimates at the end of third quarter earnings season.

A Bounce

There have already been two bear market rallies that tested the 200-day moving averages in the indices in this bear market cycle, and the recent oversold condition suggests we may be in the midst of a third test. This implies there is room at the top for this rally, but we would keep in mind where resistance could be expected. Key resistance levels are Dow Jones Industrial Average: 32,703; S&P 500 index: 4,126; Nasdaq Composite index: 12,458; and Russell 2000 index: 1891. We are monitoring the Russell 2000 index most closely since it is currently testing key resistance at 1,800. This could prove to be significant this week. Failure to better this level would be a sign that the broader rally is weakening. Remember, the Russell had been a lead indicator of the broad market in 2021 when it failed to move in step with the larger capitalization indices, warning of market weakness ahead. And more recently, October’s decline failed to slip significantly lower than the June low, a subtle sign of outperformance. As long as the Russell 2000 stays between resistance at 1,800 and support at 1,640 the technical trend is neutral. However, a break above 1,800 or below 1.640 could be a trigger for the next intermediate term move. See page 7.

The 25-day up/down volume oscillator is currently neutral with a reading of negative 1.21. However, back on September 30, the oscillator hit an oversold reading of negative 5.6 which was a deeper oversold reading than the negative 5.17 reading seen on July 14, 2022. It was also in oversold territory for 8 of 10 consecutive trading sessions in July and oversold for 18 of the 24 consecutive trading sessions in September/October. This was a longer oversold reading than at the previous low and a sign of intense selling pressure. In short, October’s test of the June lows was unsuccessful by several measures, and the bear market cycle continues. This is true despite the nearly 6% two-day gain seen in the market to open October, the 4% two-day gain seen last week and this week’s 1.6% up day. See page 8.

Our views on the stock market and economy are unchanged. With interest rates apt to move higher, the economy is likely to slow. This suggests a focus on recession resistant stocks and sectors, which means finding companies that can have the most predictable earnings streams in a difficult economic environment. In general, this favors value rather than growth as a strategy. We maintain an overweight status on energy, utilities, staples, and defense-related companies in the industrial sector. Our recommendation on healthcare is a neutral weighting, but we do appreciate its defensive qualities. See page 11.

Gail Dudack

Click to Download


Stocks continued to fall in the third quarter with September, true to form, once again proving to be the most difficult month of the year. For the quarter, the S&P 500 fell 5.3%, the Dow Jones Industrial Average lost 6.7%, and the NASDAQ dropped 4.1%. The NASDAQ 100 (QQQ), populated with mega-cap growth companies, broke below the key technical level market watchers were eyeing, the June 2022 lows, and may be signaling another leg downward.

The two primary issues facing investors remain the central bank’s efforts to arrest inflation and a deterioration of the corporate earnings outlook. These come as the FOMC remains committed to taking the benchmark interest rate to at least 4.25%, and perhaps higher. With the Conference Board’s leading Economic Index now in contraction for six consecutive months, shipping rates and orders in free fall, commodity prices well off the high and many now at pre-COVID levels, investors are becoming increasingly concerned about both faltering growth and the Fed hiking too aggressively into a recessionary economy. The most recent Chicago PMI, a bellwether for economic activity, came in at 45.7, firmly in contraction and far below economists’ estimates.

On the positive news front, the Atlanta Fed, in a surprise move, upgraded the outlook for the third quarter for the U.S. economy, sharply revising real GDP growth estimates from 0.5% to 2.4%. The main driver for the revision was the strong uptick in personal consumption expenditures. Clearly, the consumer has exhibited some firepower, but it remains to be seen whether this is temporary. With weakening leading economic indicators and a deeply inverted Treasury yield curve, we should remain skeptical.

The Federal Reserve has made it quite clear that fighting inflation is its number one priority and, we think a Fed “pivot” towards easier money is premature. The jobs market remains strong, with initial claims for unemployment at record lows, and hiring consistently above 300,000 per month. As long as jobs remain widely available, it is unlikely the Fed will ease its policy stance on interest rates.

With the twin headwinds of further tightening and earnings estimates falling, it is too early to declare the end of the bear market. We believe, however, we are getting closer to that end rather than the beginning. While high-quality growth companies should remain long-term holdings, our position continues to be that a higher-than-average cash level and allocations to short-term investments is a sound tactical strategy in the current environment.                                                                                                                                  October 2022    

Click to Download

If Rainy Days and Mondays Get You Down … How About Those Fridays?

DJIA:  30,333

If rainy days and Mondays get you down … how about those Fridays?  As the week began, eight of the last nine Fridays saw lower closes.   We consulted Freud for any insight into weekend phobias, but found only his usual quip about cigars. The consistent Friday weakness is one thing, more striking is the extent of the weakness.   From August 18 through this past Friday the Dow had lost a total of almost 4400 points.  Of that some 3500 points or almost 80% came on Fridays.  So much for TGIF.  If, indeed, this is about fear of the weekend and the news it might hold, it didn’t seem well-founded – Mondays proved not all that bad.  Over the years we have noticed the market sometimes gets into some hard to explain patterns.  We remember when Fridays and Mondays were positively correlated, or when most of the gains came on Mondays and Tuesdays.  We don’t expect weak Fridays to persist, especially now that we’ve made the observation.  Rather than fear Fridays, we would look to an up Friday as another overall positive sign for the market.

The calendar overall seems to favor the upside.  October is not known as a wonderful month – we have just passed the October 87 crash anniversary.  That said, many lows are made in October as early weakness is followed by rebounds.  Since 1952 there have been five times the market has been 20% lower YTD in mid-October.  Three of these times the market never went lower.  In 1962, a year similar in pattern including a June low, the market fell a few percent in a few days and that was it.  The outlier was 2008 which didn’t bottom until March 2009.  However, we do recall the semis put in the low in November, obviously well ahead of the low in the S&P.  Perhaps most important, in each of these cases the market was higher one year later, according to  While this study comes at it from a different perspective, many of the recent momentum surges suggest a similar one-year outcome.

In mid-June the market put in an interim low which carried some 15%, and most bear markets are interrupted by similar countertrend rallies.  In the dot-com bubble bear market in 2000 and the financial crisis of 2008, you had five rallies in the S&P of 18% to 21% on the way to the bottom.  In the great depression there were five rallies of more than 25% between the crash in September 1929 and the bottom in June 1932, all on the way to losing 86%.  Even bear markets become temporarily sold out, even bear markets have their interim rallies.  A couple of times in recent weeks the market had seemed set up for such a rally.  Back on October 3 and October 4 we saw back-to-back days of 5-to-1 up, but no follow through.  Six consecutive days of declines followed and the backdrop again seemed washed out, this time with another important positive – sentiment.

Last week’s CPI number was disappointing.  You can argue there is a distortion in the way housing is calculated, but the market found the number disappointing and that’s what matters.  While everyone tried to explain how the market was able to reverse and close 800 points higher, the only real explanation was on the news and down opening, the market had become sold out.  Granted there was no follow through Friday, but there was on Monday.  As much as the positive price action, however, the CPI may have pushed sentiment over the edge.  The dollar volume of Put buying to open was triple that of Call buying, by far the most ever.  The sentiment surveys can be helpful, but we prefer transactional data.  Investors may say they’re bearish while they are in fact fully invested.  If you’re buying puts, chances are you’ve done a lot of selling, and it’s selling that makes lows.

It’s important to keep in mind a market low doesn’t mean an instant big new uptrend.  There can be a process of backing and filling, testing as they say.  The June low is a good example in that regard, the low was June 16 and the real start of the uptrend more like July 20.  When markets make a low, most often the stocks down the most turn to up the most – there’s that reflex or coil reaction.  For the most part these are not where you want to be after that initial move.  Leadership, the best charts seem to lie in healthcare, though they didn’t do much for you this week.  Energy is the real standout.  It’s not just that the stocks are up, stocks like Chevron (169) and Schlumberger (46) have nudged above their recent trading ranges.  Meanwhile, the defense stocks had dramatic moves this week, hopefully on the numbers from Lockheed (444) and not worry of another conflict.

Frank D. Gretz

Click to Download

US Strategy Weekly: Staying Recession Resistant

Technical Indicators

Our view of the recent rally is quite simple. The popular equity indices fell well below their moving averages in recent weeks and a rebound to at least the 50-day moving averages is likely in coming trading sessions. The levels to look for are 31,277 in the Dow Jones Industrial Average, 3,915 in the S&P 500, 11,637 in the Nasdaq Composite, and 1,822 in the Russell 2000 index. Note that a test of these levels equates to another 2.5%, 5.3%, 8.0%, and 3.7% upside, respectively, in the indices. See page 9.

The good news is that the current rebound has more potential; but unfortunately, the market’s action in recent weeks also suggests the bear market is ongoing. In short, the lows are yet to be found. Breadth data deteriorated in September, and in particular, the 25-day up/down volume oscillator hit an extreme oversold reading of negative 5.6 on September 30. This was a deeper oversold reading than the one seen at the June low. The 25-day oscillator was also in oversold territory for 10 consecutive trading sessions in September and to date, it has been oversold for a second time in six of the last seven trading sessions. This represents a much longer and persistent oversold condition than the six out of eight consecutive trading sessions seen at the June low. All in all, it indicates an escalation in selling pressure which means the test of the June lows was unsuccessful by several measures and the bear market continues. See page 10.

The current reading in the 25-day oscillator is oversold at negative 3.3, which is rather amazing given the nearly 6% two-day gain seen in the market to open October and the 4% two-day gain seen this week. This oversold reading reveals that despite these sharp rallies, selling pressure has overwhelmed buying pressure over the last 25 trading sessions, typical of a bearish trend. A successful test of a bear market low materializes when a new low in price is accompanied by less selling pressure and a less severe oversold reading. This indicates that selling pressure and downside risk is abating. In other words, a “non-confirmation” of a major low is a positive sign. Sadly, that is not what has been seen in October, to date.

Sentiment indicators have also been extreme recently, but this is favorable. Last week’s AAII readings showed bullishness at 20.4% and bearishness at 55.9%. Also noteworthy was the 17.7% bullish reading seen the week of September 17th since it was among the 20 lowest readings since the survey began in 1987. Bearish sentiment has been above 50% for seven of the last eight weeks which is also rare. Equity prices tend to be higher in the next six and/or twelve months following such extreme readings. Keep in mind that sentiment indicators are never good at timing market peaks or troughs, but they are good at indicating which way to lean. In this case, it suggests that investors should not be overly bearish on equities and should be looking for a buying opportunity ahead. See page 12.

Earnings Forecasts

We are happy to report that some anchors on CNBC are now pointing out that even though some companies are reporting third quarter earnings results that exceed consensus expectations, these earnings are nonetheless weaker than a year earlier. That is a step in the right direction, since the market had been ignoring the fact that earnings have been weakening in 2022.

This week the S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $0.79 and $2.62, respectively. Refinitiv IBES consensus earnings forecasts fell $0.76 and $1.17, respectively. To date third quarter results are triggering larger earnings cuts than what was seen in the second quarter. The S&P consensus EPS estimate for 2022 is now at $207.33 and the IBES estimate fell to $222.58 bringing EPS growth rates for 2022 to negative 0.4% and positive 7.7%, respectively. See page 8. Our 2022 and 2023 estimates are currently $209 and $229, respectively, but remain under review. Based on early releases, our S&P 500 earnings estimates could come down significantly before year end. Unfortunately, this means the fair value range for the SPX will also fall. The range in our valuation model currently shows a low of SPX 2354, a high of SPX 3430, and a midpoint of SPX 2890. It is the midpoint of the range that is the most likely to contain downside risk, in our view. However, this explains why lowering our earnings forecast poses even more downside risk in the marketplace.


September’s inflation data disappointed many and this disappointment will continue in coming months unless analysts look deeper into CPI data. Forecasters were expecting lower inflation numbers because energy prices fell 6.2% month-over-month in September. Nevertheless, September’s CPI was unchanged year-over-year and core CPI rose. And note, this was not due entirely to owners’ equivalent rent, as some are saying. See page 3.

As we expected, healthcare prices are rising in the fourth quarter which tends to be a seasonal trend. Housing prices may be peaking in some regions of the country, but housing is still rising in the CPI index. More importantly, unnoticed by many is the fact that food and beverage prices rose 10.8% YOY in September. This should be a concern for all investors because food inflation is not impacted significantly by energy (except for transportation costs) but will be impacted by the conflict in Ukraine since Ukraine – the breadbasket of Europe — is a major grain producer. We expect grain shortages will drive prices higher for the foreseeable future. In addition, Hurricane Ian damaged large portions of agricultural land in central Florida which could have an impact on the supply of fruits, vegetables, and beef. In our view, food shortages are likely to add to inflation in the months ahead. See page 4.

Some economists are fixated on owners’ equivalent rent which has a 24% weighting in the CPI and rose 6.7% YOY in September. They are challenging the validity of homeowners’ equivalent rent as a measure of housing costs since it is measured not by transactions, but from a survey of home prices and rents in various neighborhoods. Some say the surveys are not reflecting the deceleration in home prices. This is true since rents always lag home prices, sometimes by quite a few months, but this has always been true. Still, when we compare the history of owners’ equivalent rent to the National Association of Realtors median single-family home price, we find the homeowners’ equivalent rent has been much more subdued than home prices and has been a slow and steady measure of costs over time. However, the 6.7% increase seen in September was above the normal range of zero to 6%. See page 6. Rents are likely to fall in time since housing is clearly in a down-cycle. Signs of a housing recession are numerous, including the year-long decline in NAHB confidence. See page 6. However, this is not the problem that we see. Food and beverages have a 14.5% weighting in the CPI and rose a greater 11% YOY. This combination concerns us. Moreover, inflation is rising 8.2% YOY and wages are rising 4.8%. This equates to a 3.4% loss of purchasing power. See page 5. We remain cautious and continue to favor recession resistant sectors and stocks.

Gail Dudack

Click to Download

Scoop…There’s Inflation

DJIA:  30,038

Scoop…there’s inflation.  Let them know at the grocery store.  And remember, you heard it here first.  Another scoop, the Fed is tightening.  Meanwhile, someone should tell the market which doesn’t seem to get it.  Then, too, we’ve long noticed the market sees what it wants to see, and trods along on its own discounting schedule.  A couple of times over the last several weeks the market has seemed set up to rally when bad news reared its ugly head.  What we don’t really get is the bad news isn’t exactly new bed news.  Still, things may not be as bad as they look, especially if you’re not just looking at Tech.  It’s Tech that has taken a beating of late, while many stocks have held their June lows.  We understand that holding isn’t rallying, but rallies start somewhere.

While we don’t care much for predictions, an easy one might be more volatility.  Over several time frames the number of 1% swings in the S&P has exceeded anything in the past decade.  Even the Wall Street Journal recently took note of the violent reactions to several earnings reports.  Then, too, they say volatility occurs at tops and bottoms.  Despite the volatility some bemoan the inability of the VIX (32) to Spike. The VIX, or the CBOE Volatility Index, reflects the weighted average prices of options on the S&P.  It is calculated using the S&P 500 puts and calls that mature in roughly the next 30 days.  There are several reasons for the somewhat subdued VIX.  One is that hedge funds and institutional investors have enhanced returns by selling volatility, a potentially risky move for markets.  In any event, even without the anticipated spike, the VIX is elevated to the point where recent lows have occurred.

Does something have to break? The answer of course is no, and the answer of course is something probably will.  Jamie Dimon pretty much suggested as much.  He also suggested the S&P could fall another 20% from here which, if you’re expecting an accident or two, should hardly come as a surprise.  If you make a list of all the things that worry you, in six months’ time the list is often laughable.  Usually it’s where you’re not looking that gets you.  The three day 22% drop in the UK gilts could be a problem that doesn’t go away.  And the dollar itself could always break something, as its strength has had a significant impact on the countries that have to fund in dollars.  And to look at the semiconductor stocks, this chip issue with China seems unlikely to end well.  Then, too, markets don’t bottom on good news.

Adobe trades around 290-300, down from an August high around 450.  The all-time high late last year was around 700.  The stock is more than 25% below its 200-day average, but it’s the 50-day that seems intriguing.  The price difference there is some 15% which is rare, and testament to how battered Tech has become.  We don’t believe in catching falling knives, but this is one of those stocks arguably still in a long-term uptrend.  And its reversal Thursday seems a positive for both it and Tech generally.  Intel (26) also is stretched relative to its 50-day, but there’s not the long-term uptrend there.  Still the best acting area is energy – the oils.  The idea that strength is predicated on production cuts seems a bit of a stretch.  When did everyone start believing the Saudis, oil has outperformed all year.

Pick a number, any number.  The jobs number, the CPI, PPI, whatever it doesn’t matter.  We remember when everyone hung on the weekly money supply number, or remember the semi book-to-bill?  The number doesn’t matter, it’s how the market reacts to the number.  Good numbers sometimes have had bad reactions, bad numbers good reactions.  That’s when you learn something, when the market doesn’t do what it should, so to speak.  Which brings us to the market over the last few weeks.  The market seemed set up to rally but at least so far, has not.  Of course, who are we to say what the market should or should not do.  However, we have often observed when the market has had a chance to go up and does not, or a chance to go down and it does not, it often has proven important.  The market had a chance to go down on Thursday, but did not.

Frank D. Gretz

Click to Download

US Strategy Weekly: Finally A Focus on Earnings

Earnings season will begin later this week as financial stocks begin to report third quarter results. And for the first time this year, investors seem to be taking a close look at the quality of earnings and earnings guidance. Expectations turned lower for the banking sector after several global banks indicated they plan to raise reserves in anticipation of a weakening economy. Friday will be our first look at how the financial sector managed in the third quarter.

Global Woes

But the economic backdrop for earnings has come under review recently. This week The International Monetary Fund warned that “colliding pressures from inflation, war-driven energy and food crises and sharply higher interest rates were pushing the world to the brink of recession and threatening financial market stability.” Citing new 2023 global growth forecasts from its World Economic Outlook, the IMF said that countries representing a third of the world’s output could be in a recession next year. More disturbingly, the IMF highlighted that financial stability risks have increased, and it warned of disorderly repricing in markets.

Disorderly markets are not new news actually. Instability has already appeared in Britain. Last week the Bank of England expanded its program of daily bond purchases to include inflation-linked debt. It noted a “material risk” to British financial stability and “the prospect of self-reinforcing ‘fire sale’ dynamics” leading to chaos in its gilt market. The Bank pledged as much as 65 billion pounds of long-dated government bonds to allow for a more orderly disposal of assets in the pension fund sector. However, the risk continues, and investors are watching to see what happens when, or if, the Bank of England ends its purchasing program, perhaps as soon as later this week. History has shown how disorderly markets often reflect illiquidity and this instability can ripple through the global financial markets in unexpected ways. This is one of our main concerns for the latter part of the year.

It is important to note that these financial problems emanate partly from the US. The combination of inflation and rising interest rates in the US has driven the trade-weighted dollar to its highest level in 20 years. The Federal Reserve’s new nominal broad dollar index is currently at a 50-year high. See page 7. The strength in the dollar, coupled with rising interest rates, means that other central banks, like the Bank of England, will have to raise their interest rates to prevent their currencies from collapsing. In cases like England, where economic growth is already weak, rising interest rates compound the problem it already faces from higher energy costs, inflation, and a weakening economy. It can become a circular problem that is difficult to solve. Moreover, since crude oil is priced in dollars, energy becomes more expensive to non-US buyers, adding to inflation.  

Exacerbating these financial woes were reports from China that Shanghai and other cities have seen COVID-19 infections rise. Some local authorities began to close schools and entertainment venues, reigniting fears of more shutdowns, slower Chinese growth, and global supply shortages. Again, there are a number of issues outside the US that could have a significant impact on our financial markets in the remaining months of the year. This keeps us cautious.

Focus on Earnings

In terms of earnings, FedEx Corp. (FDX – $152.08) shocked investors last week when it revealed that it was preparing for a further decline in the number of e-commerce packages it would handle in the upcoming holiday season. The stock is down nearly 30% in the last month.

This week S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $0.63 and $0.25, respectively. Refinitiv IBES consensus earnings forecasts fell $0.38 and $0.86. But the most important news of the week was that the S&P consensus earnings estimate for 2022 declined to $208.12 and is now below 2021’s level of $208.17. This means that if economists are correct about a recession in 2023, investors could be facing two consecutive years of little or no earnings growth in equities. However, keep in mind that earnings in the energy sector continues to be strong, and when excluded from the S&P total, earnings growth in 2022 is already negative. We want to reinforce our view that investors should continue to focus on recession resistant stocks, such as energy, utilities, consumer staples, and special areas like defense-related companies.

Technical Indicator Update

The charts of the popular indices are quite similar this week with all four of the popular indices trading below all their moving averages. This is bearish. However, the one positive sign is the Russell 2000 index which is outperforming the other indices at the moment since the June lows have not been decisively broken. We focus on this small capitalization index since it was an early leader at the market top, and it could also be an early leader at the lows. Conversely, the Nasdaq Composite is the worst performing chart in a major decline. See page 10.

The 25-day up/down volume oscillator can be one of the best technical indicators at defining peaks and troughs. The oscillator fell to an oversold reading of negative 5.6 on September 30 which was a deeper oversold reading than the one seen at the June low, and it was in oversold territory for 10 consecutive trading sessions. This was longer than the oversold reading for six of eight consecutive trading sessions in June. In short, the test of the June lows was unsuccessful by this measure, and the bear market continues. The 25-day up/down oscillator is currently neutral with a reading of negative 2.93 but this is close to an oversold reading. A second oversold reading of greater than five consecutive days would confirm the market has not yet found its capitulation low. See page 11.

The 10-day average of daily new highs is 29 and daily new lows are 547. This combination is negative with new highs below 100, and new lows above the 100 benchmark. More importantly, the 10-day moving average of new lows was 1038 on September 26 and exceeded the previous peak of 604 made in early May. In addition, NYSE the advance/decline line fell below the June low on September 22 – is currently 56,191 net advancing issues from its 11/8/21 high – a negative sign. See page 12.

Jobs The increase of 263,000 jobs in September and a decline in the unemployment rate to the post-pandemic low of 3.5% was enough for investors to believe that the next Fed meeting will result in a 75-basis point increase. However, the number of people no longer counted in the labor force – 229,000 –increased nearly as much as job growth. This led to the participation rate falling 0.1 to 62.3% in September. Data also shows that 5.7% of those no longer counted in the labor force want a job. See page 5. And it is important to note that this is an economy of “haves” and “have-nots.” College educated workers are seeing growth in employment while those with less than a college degree struggle. But all workers are seeing a negative trend in real weekly earnings this year due to high inflation. See page 6.

Gail Dudack

Click to Download

Even Convicted Criminals Can be Paroled … Why Not a Bull Market

DJIA:  29,926

Even convicted criminals can be paroled … why not a bull market.  The bull market has done its share of hard time, including a stint in solitary of sorts – recently only one percent of Nasdaq issues were above their 10-day average.  And that’s what these reprieves are all about – getting the sellers out of the way.  In markets like this oversold doesn’t matter, what matters is getting to the point they’re sold out.  Part of that process seemed evident a week ago when energy took a hit, along with Apple (145).  Bear markets get to everything in the end, but when they do that typically is the end, that last push to the give up phase.  We don’t mean to say the bear market is over, we don’t think it is.  Then, too, we like to remind ourselves every new bull market began with a bear market rally.  Sufficient onto the day, but parole ends when these rallies do something wrong.

As usual something wrong, so to speak, involves lagging participation.  It’s not the bad down days, it’s the bad up days that cause problems.  The numbers so far have been exceptional, but that’s to be expected from a low like this.  It’s pretty much what they look like from here, the all-important follow through.  We have our list of favorite charts, but off of even an important low, down the most often turns to up the most, at least temporarily.  The ARKK ETF (40) is loaded with poor charts, but could do well if Tesla (238) behaves.  The ETF’s performance overall actually has some positive implications for the market. When the major averages went to new lows last week, weekly 12-month new lows did not – a positive divergence.  As it happens, ARKK held its July low which, in turn, was above its May low.  This means that despite the weakness in the averages, the market’s weakest stocks have been holding.

Slum-Burger – how many on Wall Street learned to speak French.  It seems a telling commentary on oil’s strength they finally got around to Schlumberger.  There was a time when if you wanted to play oil, SLB (43) was the go to stock.  Now it’s stocks like Devon (72) and EOG (128).  Oil has led right out of the gate, perhaps not surprising in that the last to get hit are the first to come back.  Oil started the year leading which historically has led to happy endings.  OPEC has helped recently, but this again seems a case of the market making the news.  Had the stocks not wanted to go up, OPEC can be pretty easy to ignore.  Few believe oil is going away anytime soon, but somewhat surprising are recent numbers showing fossil fuel at 81% of total fuel consumption, down a whopping 1% in ten years.  And to further pique your fundamental interest, we are told Exxon’s pre-cash flow last quarter was the same as that of Microsoft (247).  The ongoing technical appeal, of course, the stocks remain under-owned.

We have displayed a number of positive charts, names like Aspen Technology (254), Cheniere Energy (173), Digi International (38), Humana (499), Eli Lilly (333), Snowflake (189), Sarepta Therapeutics (115), Shockwave Medical (280) and Vertex Pharmaceuticals (299), though there are others.  Remember, too, stocks like Humana and United Health Group (519) with their long term uptrends should be stocks for all seasons.  If this rally proves another false dawn, those uptrends should provide a backstop of sorts.  Meanwhile, with back to back days of more than 5-to-1 stocks advancing, most stocks are finding relief.  It will take time to see how much might have really changed in terms of leadership.  There is a change in gold, though an insipid one.  And as we pointed out last time, one that seems dependent on the likely peak in the dollar.  We looked at defense stocks as a bit of a nuclear hedge, but charts there are unremarkable, except perhaps for Northrop (485).  Though not a particularly good chart, we are intrigued by Palantir Technologies (8) in light of their contribution to Ukraine‘s success.  It’s one of those companies that if you know what they do, they have to kill you.

Hope springs eternal.  And once again the hope is the Fed can’t go as far as they say they will.  The market became sold out, yields came in and we have a rally.  For many the worry now is earnings.  If you don’t think earnings will be bad, you should be falling all over yourself to buy.  The market by most standards would be considered cheap.  If like most you believe earnings will be bad, isn’t that why the S&P had that little 28% pull back?  Disappointing earnings won’t be a surprise, the question is whether those earnings will disappoint investors.  How much bad is priced in?  The rally is off to a more than decent start, but it’s follow through that’s important.  The backdrop here is similar to June.  The low back then was June 16, the real uptrend began July 20.  Some volatility for now would be more the norm than the exception.

Frank D. Gretz

Click to Download

US Strategy Weekly: Watch Earnings Not the Fed

The S&P 500 index jumped nearly 6% in the first two days of October, as investors once again focused on the possibility that a Fed “pivot” is near. The incessant focus on a Fed pivot lacks an understanding of how difficult the Fed’s job is in terms of conquering an inflationary trend that has persisted for two years and reached double-digit levels. In our view, the Fed pivot mania is an attempt to simplify a global financial environment that is getting more complicated by the day. More importantly, it could be a misguided and potentially dangerous strategy for a number of reasons.

Forget the Pivot

First, it underestimates the Federal Reserve’s commitment to fight inflation. Most Fed governors have indicated that they are serious about lowering inflation and that they will remain vigilant and steadfast until it gets back to the Fed’s 2% goal. That will take a long time. Second, even if prices remain unchanged for the next several months, headline CPI will still be above the 6% level. This is far from nearing the Fed’s goal. The one piece of good news for inflation is that oil prices appear to be stabilizing at lower levels. But this will not be enough to get to lower levels of inflation. Even with WTI futures (CLc1 – $86.35) below $90 a barrel and down 25% from its May closing high, WTI is up 3.3% on a year-over-year basis. And in the background, OPEC+ is discussing cutting output. In short, the CPI is unlikely to come down substantially until 2023. Third, what could get the Fed to “pivot” on interest rates would be a financial crisis, or more specifically, a liquidity crisis in the banking system. However, such an event would be a disaster and rather than sparking an equity rally it would likely trigger a sizeable selloff. Unfortunately, this risk cannot be ruled out, particularly in an environment of rising rates and a strengthening dollar. There is instability in the global system as seen by the fact that the Bank of England had to employ emergency gilt purchases when British pension funds were swamped by margin calls. There are rumors of liquidity issues at Credit Suisse Group AG (CSGN.S – $4.29) and the government of Finland had to extend credit packages totaling 3.55 trillion euros to stabilize the power industry and the energy debt derivative sector, due to a deteriorating debt market. These events may seem unrelated, but we have seen lesser matters ripple through the global banking system and create chaos. It brings back memories of the financial crisis of 2008.

In other words, the focus on a Fed pivot is not a practical exercise in our opinion. Even if the Fed were to pause rate increases, it would not necessarily reflect a change in monetary policy and bring back the easy money policies that had encouraged speculators to the markets. All in all, it is a very short-term view. But it did spark an impressive two-day rally, to date.

A Focus on Earnings

We think a more appropriate focus for investors would be on corporate earnings. Although the financial press places its emphasis on whether or not a company has beaten its quarterly consensus earnings forecast, we think it would be more insightful to focus on whether quarterly earnings growth is positive or negative on a year-over-year basis. Companies have been beating consensus earnings, but that is a bit of a charade since corporations have lowered guidance and analysts have reduced estimates as earnings season approaches. Therefore, the charts from Refinitiv on page 10 are important. They show that the earnings estimate revision trend has been negative for most weeks at least since the middle of July. For the week ending September 30, the earnings revisions for S&P 500 companies were 67% negative and 33% positive. For all US companies, revisions for the week were 62% negative and 38% positive. And it is important to note that since April, according to S&P Dow Jones consensus estimates, the 2022 forecast has declined 8.2% and the 2023 forecast has decreased 4.4%. At present, the S&P Dow Jones earnings growth rates for this year and next are 0.3% and 14.3%. Both of these numbers include earnings for the energy sector which is providing most of the growth.

However, if the Fed continues its tightening policy the risk of recession increases and earnings forecasts for 2023 are apt to fall from positive to negative. In our opinion, this is where the financial press, analysts, and investors should concentrate. And this is what keeps us cautious.

Technical Breakdown

The two-day October rally has been impressive and included a 91% and 95% up day in volume. The advance was triggered from a deeply oversold condition and gained momentum on softer economic news and a smaller than expected increase of 25 basis points by the Reserve Bank of Australia. This combination refueled predictions of a Fed pivot. However, despite the strength of the two-day rally, breadth statistics remain negative. Sadly, the 25-day up/down volume oscillator hit an oversold reading of negative 5.6 on September 30 and was in oversold territory for a string of 10 consecutive trading sessions. The current reading is neutral at negative 2.66. Nevertheless, the 10-day oversold reading was more extreme than the oversold reading at the June low. This means September’s test of the June lows was unsuccessful and the bear market continues. See page 12.

This was not the only indicator that broke down at the end of September. The 10-day average of daily new lows reached 1,038, exceeding the previous peak of 604 made in May. The NYSE cumulative advance/decline line fell below its July 2022 low and is now 47,465 net advancing issues away from its all-time high. See page 13. The charts of the indices show prices are well below their 200-day moving averages and could rally back to test their 100-day moving averages. However, the long-term trend would still remain bearish.

The one positive is sentiment. Last week’s AAII bull/bear readings showed a 2.3% increase in bullishness to 20.0% and a 0.1% decrease in bearishness to 60.8%. Last week’s 17.7% bullish reading was among the 20 lowest readings since the survey began in 1987. Sentiment indicators are not good timing indicators, but they do suggest that this is not the time to become too bearish. Equity prices tend to be higher in the next six and/or twelve months following such extreme readings.

Economic Review

Many housing statistics were released in the last week, and they paint a picture of a housing sector experiencing an accelerating slowdown. Pending home sales have been declining since October 2021. Affordability is at its lowest level since 2006. Median home prices reached a record level relative to income in June 2022, and when coupled with rising mortgage rates, make this a difficult time to buy a home. The NAHB confidence index has been falling all year and in the September survey, dropped to levels last seen in 2014. Census Bureau data indicated that building permits fell in August to its lowest level in two years. But in a surprise, housing starts picked up from 1.404 million to 1.575 million in August. The ISM manufacturing index fell from 52.8 in August to 50.9 in September. New orders dropped from 51.3 in August to 47.1 in September and have been below 50 (neutral) for three of the past four months. Employment fell from 54.2 to 48.7 and has been below 50 for four of the last five months. These weak statistics may increase the hope of a Fed pivot, but they will not be good for earnings growth in coming quarters. Stay cautious.

Gail Dudack

Click to Download

Staying Defensive

September has a long history of being a difficult time for the equity market and in 2022 this seasonal precedent held true once again. For the month, the S&P 500 fell 9.3%, notching its worst one-month decline since March 2020. The Nasdaq declined 10.5%, as soaring bond yields weighed heavily on high PE stocks and the Dow Jones Industrial Average tumbled 8.8%.

In terms of the third quarter, the S&P 500 fell 5.3%, the Nasdaq dropped 4.1%, and the Dow Jones Industrial Average lost 6.7%. Plus, for the first time since 2009 the S&P 500 and the Nasdaq suffered three consecutive quarterly losses. For the Dow Jones Industrial Average, it was the first time since 2015 that the index experienced three straight quarterly losses.

September’s poor performance was not a total surprise. As we noted in our July 2022 Quarterly Market Strategy Report, by the end of June, the S&P 500 had suffered its worst first-half performance since 1970. But more importantly, these two declines had something in common — they both took place during an economic recession. In general, it has been our view that economic activity was at risk for most, if not all of 2022, due primarily to the brunt of double-digit inflation and the negative impact this has on consumers’ purchasing power, profit margins, PE multiples, and monetary policy. Our opinion has not changed.

Earnings Recession

Although the two quarters of negative GDP growth seen in the first half of this year have not officially been declared a recession by the National Bureau of Economic Reseach, there is little doubt that it has been a difficult time for both consumers and businesses. One example is corporate earnings. Despite the headlines in the financial press indicating that most S&P 500 companies beat earnings expectations in the second quarter of the year, the back story is that these earnings estimates were substantially reduced ahead of reports. In reality, the S&P Dow Jones consensus earnings estimate declined more than 8% from its April high. The full year estimate for year-over-year earnings growth has now collapsed to breakeven according to recent S&P data. More importantly, full year earnings growth would be negative if earnings for the energy sector are excluded from the total.

In short, many companies are experiencing a deterioration in earnings in 2022, as is typical of a recession. We lowered our S&P 500 earnings forecast twice in the last eight weeks, but a further weakening of the economy could put even our reduced $209 per share estimate in jeopardy. It is this uncertainty surrounding earnings growth that has shaken investor confidence in recent weeks and taken stock prices lower.

Pivotal September

Plus, a number of global events helped trigger a negative shift in investor sentiment in September. Early in the month, the two-year advance in energy prices led to Finland announcing a 10-billion-euro credit package for the long-suffering Finnish power industry. The country also extended an additional 2.35-billion-euro package to its largest state-owned energy company which provides power to several countries in Europe. Some analysts estimate that the broader EU energy derivatives market may require as much as $1.2 trillion in government backing due to deteriorating debt in the sector.

Later in the month, the newly installed UK Prime Minister Liz Truss initiated a surprise tax cut intended to boost England’s struggling economy. However, concern about the new government’s fiscal responsibility and fear that this stimulus would inspire even more inflation led to turmoil in the financial markets. The British pound plummeted to an all-time low against the dollar, yields in 10-year British government gilts jumped above 4% for the first time in twelve years and the Bank of England hiked interest rates 50 basis points to its highest level in 14 years.

In addition, the Bank of England was forced to buy bonds after British pension funds struggled to meet margin calls on debt instruments, some of which lost a third of their value in four days. This chaos in the global debt market is a big concern, and we worry that rising interest rates can continue to have unexpected consequences in the months ahead.

All in all, the fear of recession in Europe and the US increased at the end of September and the feedback loop between stock and bonds became blatantly apparent.

Recession Proofing

In our opinion, the US is either in the midst of a recession or at risk of falling into a recession in coming months. Meanwhile, the Federal Reserve will continue to increase interest rates which will slow many sectors of the economy even more. Therefore, we continue to remain defensive and look to protect portfolios as much as possible for the likelihood of weak economic activity. This means emphasizing areas of the stock market that have predictable revenue growth and earnings streams. Many individual stocks can have these characteristics but in general, this suggests household necessities such as utilities, staples, and energy. The Russian invasion of Ukraine has stimulated demand for aerospace and defense, which is another recession-proof sector. In an environment of rising interest rates, we expect value stocks to continue to outperform growth stocks.

October: The Turnaround Month

The good news is that October has often been a time of reversing downtrends. In fact, twelve of the 48 declines of 10% or more seen since 1931 have taken place in October, which is why October has been called “the bear killer.” And though many technical indicators broke down at the end of September, investor sentiment hit historic extremes.

The AAII sentiment readings recently showed a decline in bullishness to 17.7% and an increase in bearishness to 60.9%. This 17.7% bullishness reading is among the 20 lowest readings since the AAII survey began in 1987. Optimism was at a similar level in May. This is favorable since equity prices tend to be higher in the next six and/or twelve months following such extreme readings in sentiment.

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

This communication is intended solely for use by Wellington Shields clients. The recipient agrees not to forward or copy the information to any other person without the express written consent of DRG.

Copyright © Dudack Research Group, 2022.

Wellington Shields is a member of FINRA and SIPC

Gail Dudack, Chief Strategist

Click to Download

© Copyright 2024. JTW/DBC Enterprises