And the days, those up-days, dwindle down to a precious few…when you reach September

DJIA:  34,751

And the days, those up-days, dwindle down to a precious few…when you reach September.  A lyric, somewhat paraphrased, that’s borne out by history – September is a tough month for stocks.  How else would you explain a market that goes from 8 of 10 up days through September 2, to 5 consecutive down days.  The disturbing part of this change is it came on news we would argue should have been considered positive – a benign jobs number and, hence, a benign Fed.  The Labor Day holiday saw Europe higher, but no rally when NY reopened Tuesday.  It didn’t get better until Monday which itself was another of those mixed days – Dow up, NAZ down, and down big for some of those strong stocks.  The good news is the rally saw respectable A/D’s on the back of financials and energy stocks, of which there are many.  Still, the numbers are the numbers.  Rotation has characterized this market all year, but in this case risk comes with it.

In this market characterized by rotation, suppose we were to suggest Uranium is the new Bitcoin, and Oil is the new Tech.  We haven’t completely embraced this idea, but we can see the possibility.  To begin, as measured by GBTC (38), Bitcoin is stalled but still seems trending higher.  Meanwhile, Uranium has become the Bitcoin of yore – see, for example, the URA ETF (28) or the go-to stock here, Cameco (24). As for Oil versus Tech, it’s a stretch if not outright dubious, it’s tantamount to buying anti-growth versus growth.  To get there you have to make that leap that’s very difficult for most – you have to distinguish between companies and their stocks.  Not that long ago there were no oil stocks above their 50 day average, in a sector that is down to about a 3% weight in the S&P.  That strikes us as sold out, and that has begun to change – XOP (89), the S&P Oil ETF, now is above its 50 day.  At the other end of the spectrum, five tech stocks are a quarter of the S&P market-cap.

Tech/growth stocks are here to stay, and you can quote that.  The question is, which ones?  For now the FANG stocks and a few others are like bologna on Wonder Bread with Miracle Whip – they’re this market’s comfort food.  As long as the market holds together, it should stay that way.  What is of concern, though, is the idea of “durable technology,” an oxymoron if ever there was one.  RCA really did change the world.  Is it real, or is it Memorex? Burroughs and Digital Equipment – those were go-to stocks. And then there are the zombies of Tech, Xerox (21), Blackberry (10), Hewlett-Packard (28), Nokia (6) and so on.  Even when it comes to the best of Tech, you have to ask, when is too much enough?  Companies are not their stocks, stocks are just pieces of paper.  Even great companies can find their paper without anyone left to buy.

Lithium. It doesn’t quite have the ring of “plastics” in The Graduate.  Yet batteries are all the rage – they even have their own ETF, BATT (18) – and batteries are about lithium.  And yes, there’s an ETF here as well, LIT (84).  The problem here, and with BATT and other of these ETF‘s, many of the components are Chinese companies.  While we doubt Beijing is about to come down on lithium as they have Tech and now Gaming, who needs it.  Companies like Albermarle (231) and Lithium Americas (23) offer attractive alternatives.  Another play on batteries, rather than lithium, is Tesla (757), the largest position in BATT – together with other names you don’t say in polite company.  Somewhat ironically, most of the secondary EV makers, the Fiskers (13), and so on, do not look good.

The recent jobs numbers seemed benign enough to preclude any hasty Fed action. This Tuesday’s less than expected CPI number seemed the same.  Both, in other words, were numbers the market could have taken and run with.  The idea that the market did not and, in Tuesday’s case, declined sharply, is troublesome.  When good news isn’t good news, it’s a bad market.  For the first time in 10 months fewer than 75% of stocks in the S&P 500 are above their 200 day average.  This kind of change doesn’t kill uptrends, but it is a reminder of how dominant the S&P has been.  For all of the NYSE the number is only around 60%, while for an even more extensive database like that of Worden, the number is only 43%.  Wednesday’s rally was respectable – with A/D’s two-to-one up, not the weak rally about which we worry.  Thursday’s mess had the look of an option expiration week, which this is.  September is a tough month, we expect it to stay that way.

Frank D. Gretz

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The Trick Divergences Play… They Make You Think They’re Not Working

DJIA:  35,213

The trick divergences play… they make you think they’re not working.  If you prefer the movie version, in The Usual Suspects, the line was the biggest trick the devil ever played was making you think he doesn’t exist.  So what’s a divergence, and what do we mean by not working?  The divergence in this case is between the large-cap averages, the Dow and S&P, and the average stock, measured by the Advance-Decline index.  As demand lessens the average stock and, hence, the A/D index peaks, while large-cap winners continue to climb higher.  As we have suggested before, the A/D index is more than just another technical indicator, it’s an insight into demand.  It takes money to push up 2500 stocks every day.  As demand lessens so, too, will the number of advancing issues.  Eventually the bad drag down the good, the average stock drags down the stock averages.  All well and good in both theory and reality, the problem comes down to timing.  In 2018 a few days resulted in a 20% decline, in 1987 the divergences lasted months.

Therein lies the problem.  There’s risk in a backdrop like this, a two month plus divergence between the averages and the A/D index, yet there’s plenty of money to be made.  By definition, the big stocks go up – will Nvidia (221) ever stop?  The dangerous part is that if you’re not in Nvidia, Microsoft (299) or the S&P, but instead you’re in the average stock, you’re in the A/D index.  You’re not making money but it’s okay because there’s hope.  As long as the S&P moves higher most days, there’s hope, hope your stocks will catch up.  Hope is a virtue in life, but a curse in the stock market.  The virtue in the stock market is discipline – stay with uptrends, cut your losses.  Divergences can go on and you can reap the S&P, or you can hope for the rest.  The longer these divergences last, the more you come to believe they don’t matter.  We’re not saying do nothing, we are saying whatever you do, do it carefully.

The market has taken on a better tone in the last few days, as often has been its way.  Just how it can go from three consecutive 2-to-1 down days to three consecutive 2-to-1 up days in a market that really isn’t trending, is a bit of a mystery.  Then, too, this market has tended to dodge technical pitfalls all year.  That said, there are still technical issues.  In a market that was at or near its high, NYSE new highs and new lows were even last week, while on the NASDAQ new lows were close to 3-to-1the number of new highs.  If you look to the percent of stocks above their 200 day average, that is, in uptrends, the number is around 50%–60% depending on whether you’re looking at NYSE stocks or a broader measure.  The markets, the big stocks, are making new highs with limited participation.  As a practical matter, to participate you pretty much have to go big.

A colleague recently pointed out a couple of stocks that no longer are what they may seem – in this case, a good thing.  SVB Financial (561) recently dropped “bank“ from its name, appropriate since the long term chart here looks nothing like that of a bank.  The chart is more that of a Tech stock, fitting given the former name of Silicon Valley Bank.  If not share alike, seems SVB has contrived to share and not just bank.  Another company possibly misunderstood is Honeywell (231).  It seems there’s more here than just the thermostat on your wall – not very techy, tech, as Penny would say.  Seems they’re now big in quantum computing, whatever that is, and other things that are techy, tech.

If you’re reading this hot off the presses, so to speak, Jay Powell may well be offering his much anticipated comments at Jackson Hole.  Nothing dire is anticipated, not even mention of “taper.”  Still, if he mentions the Fed balance sheet something could be made of that.  It has been pointed out that there is a correlation between the Fed’s balance sheet and the performance of secondary stocks, and we know the Russell 2000 has gone nowhere since early February.  The overall backdrop also makes his remarks worrisome – it’s one of those, the market makes the news sort of things.  The S&P is making new highs while there are as many 12-month lows as highs, and only about half of stocks are in uptrends – you don’t need us to tell you that’s not healthy.  Yet there are stocks acting well, the Big, making it hard to keep your hands out of the cookie jar.  Just know there’s a risk.

Frank D. Gretz

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US Strategy Weekly: Earnings Estimates and Inflation

Raising S&P Earnings Estimates

In our opinion, the crux of the 2021 stock market can be defined by two components: 1.) a strong earnings rebound and 2.) historically easy monetary policy.

Securities markets are always complex and cannot really be explained by two simple factors. Clearly there have been other influences this year such as the positive support from fiscal stimulus and promises of more stimulus ahead or the negative drag from the spread of the Delta virus variant, China’s crackdown on technology companies and the threat of rising corporate and individual taxes and fees. But perhaps the most unique and interesting development of 2021 is the appearance of a new generation of investors and the growing influence of social media on stock market activity. As a result, market volatility has increased driven predominantly by enthusiastic day traders monitoring message boards such as WallStreetBets on Reddit. Plus, there are a slew of geopolitical issues this year such as the slowing of the Chinese economy, China’s tightening grip on Hong Kong and Taiwan, the geopolitics of climate change, reversals in US energy policies and rising prices of oil, disputes between Poland, Hungary and EU institutions, Japan’s struggle with the Delta variant, and more recently the unfortunate global threat that the US pullout from Afghanistan, the fall of Kabul and the rise of the Taliban poses for the world.

Still, despite all these factors, investors can and will absorb a lot of bad news if earnings growth is strong – and to date, growth has definitely been strong. According to IBES Refinitiv’s report “This Week in Earnings”, with 476 of the 500 S&P companies reporting second quarter earnings, growth is expected to be nearly 95% YOY. Companies have been reporting quarterly earnings that are nearly 16% above estimates which compares to the long-term average surprise factor of 3.9%. This follows on the heels of IBES Refinitiv’s earnings growth estimate for the first quarter of 53% YOY. So as the second quarter earnings season ends, we are raising our 2021 SP 500 earnings estimates from $190 to $200, a 5% increase. However, this is a 19% increase from our December 2020 estimate of $168.60. We are also raising our 2022 estimate from $211 to $220, a 4% increase. In both cases we believe these estimates could prove to be conservative. See page 15.

This is good news for investors and this surge in earnings growth certainly supports equities. However, the easy comparisons from the pandemic-wreaked earnings quarters in the first half of 2020 are mostly behind us, and earnings growth is expected to slow to more typical levels of 30% in the third quarter and 21.6% in the fourth quarter. Despite the fact that strong gains in earnings have supported gains in the SPX, as seen in the charts on page 3, the run-up in the SPX relative to the gains seen in earnings has produced a significant valuation gap in both trailing and 12-month forward operating earnings. This valuation gap is similar to the one seen prior to the 2000 top. Another similarity between the 1997-2000 bull market and the current advance is the participation of a new generation of investors. A new generation of investors and a valuation disparity often go hand in hand and this characteristic of today’s market concerns us.   

Inflation is a tax on consumers and investors

While earnings have been strong in 2021, valuations still remain unusually high, and this is particularly true when inflation is taken into consideration. We often use the sum of inflation and the trailing PE as a benchmark to indicate when PE multiples are appropriate for the current level of inflation or as a warning when multiples get too high. In July with the CPI rising 5.4% YOY and the trailing PE at 24.5, the sum becomes 29.9, well above the standard deviation range. Since the top of the standard deviation range is 23.8, we call this The Rule of 23. See page 4. Note that the unusually high and sustained readings seen in this indicator recently are similar to those seen in 1999-2000 prior to the second worst bear market in history. Again, similarities to the 2000 market continue to grow.

Inflation will impact all investments. With 3-month and 10-year Treasury rates at 0.05% and 1.29%, respectively, equities remain competitive investments to fixed income. However, the chart on page 5 compares the history of interest rates and inflation and this chart suggests that unless inflation quickly drops below 1% YOY, interest rates on both the short and long end, are much too low and are likely to move higher. More ominously, a close inspection of the chart on page 5 also shows that a sharp rise in inflation, like that seen in 2021, has triggered eight of the eleven recessions seen over the last 75 years. This helps to explain the predicament the Federal Reserve faces this week as it meets in Jackson Hole WY. Interest rates are too low and accommodating given the level of inflation and the strength of the US economy. However, the pandemic-stricken economies of Europe and parts of Asia imply global growth may not be strong enough to withstand a change in Fed policy. Yet if the Fed allows inflation to continue to rise, it will inevitably end with even tighter and hawkish monetary policy in the years ahead which will almost guarantee an economic recession. It is not a simple problem. But it has been our view that the Fed needs to, and should have already, moved to neutralize its easy monetary policy in order to stifle inflation before it becomes ingrained in the system. This week we expect the Fed to steadily move the consensus view toward a reduction and possible elimination of quantitative easing. This is a necessary step to ensure the Fed is not stoking the flames of inflation. However, it will eliminate one of the two components that has underpinned the stock market’s advance.

Inflation is also having a negative impact on businesses. The NFIB Optimism Index decreased 2.8 points in July to 99.7, nearly reversing the 2.9-point gain in June’s report. Six of the 10 Index components declined, three improved, and one was unchanged. The NFIB Uncertainty Index decreased 7 points to 76, sales expectations decreased 11 points to a net negative 4 percent, owners expecting better business conditions over the next six months fell 8 points to a net negative 20, and earnings trends over the past three months declined 8 points to a net negative 13 percent. In sum, small businesses are becoming more concerned about their future given the current inflation and political environment. See page 6.

Technical Update

We are still focused on the Russell 2000 index (RUT – 2230.91) which has been trading in a sideways range for all of 2021. We believe it may give us clues about the stock market’s intermediate term direction. At present, the 200-day moving average (2160.82) is acting as support and the converging 50-day (2241.27) and 100-day (2247.88) moving averages — which are now decelerating — are acting as resistance. A breakout in the RUT from this narrowing range may define the broader market’s intermediate-term trend. There have been similar patterns in the RUT (trading between a rising 200-day moving average and decelerating 50- and 100-day moving averages) in the first half of 2011 and the second and third quarters of 2015. In both of these previous cases, the RUT broke below the 200-day moving average and this was the trigger for relatively sharp and fast corrections totaling 19.4% and 14%, respectively, in the SPX. Also worthy of note is the continued weakness in the 25-day up/down volume oscillator, which at 0.64 this week, is minimally above the lower half of neutral. This low reading implies that since early July volume has been as strong or stronger in declining issues as the volume seen in advancing stocks, i.e., investors have been selling into strength. And this week the 10-day average of new lows hit 101, before dipping to 99 on Tuesday. Nevertheless, this is close to the 100 new lows per day that defines a bear market. Daily new highs are still averaging 194, but the rise in daily new lows has shifted this indicator from positive to neutral. In short, we remain cautious and would focus on stocks with good value.  

Gail Dudack

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Good … but no DiMaggio!

DJIA:  35,499

Good … but no DiMaggio!  Some degree of adulation has been placed on the S&P, by the media at least, for its 47 new highs this year.  DiMaggio’s streak was 56, and it was consecutively!  And they don’t mention there was a similarly long streak before the crash of 87!  Let us hasten to say, this isn’t 87, but what’s important here is the trend, and not every tick in that trend.  This streak is easily explained by the fact we haven’t had a 5% correction since late last year, and that is impressive.  If you never go down, it’s not all that hard to make new highs.  We are all for uptrends, but we prefer the good old days pre-July 2, when it was the A/D index seemingly making daily new highs.  There’s more to those numbers than technical analysis Voodoo.  It takes money to push up 2700 stocks as was the case Wednesday.  The numbers are an insight into supply and demand.

It has been tough to know the players even with a scorecard.  Or has the distinction between re-open and stay-at-home simply become blurred?  Last week’s payroll number was taken to signal re-open, and bonds were sold.  The beneficiary here were the Financials, which had been more or less holding but clearly lagging.  The change was dramatic, with 60% of the sector hitting 20 day new highs, and names like Goldman Sachs (415), Morgan Stanley (105) and Wells Fargo (51), of all things, scoring impressive breakouts.  Another impressive move this week was in Steel.  Even Copper has acted better, despite the apparent slowdown in China.  Oil, too, with his own set of problems, has stabilized.  If all this speaks well to re-open, stay-at-home and, specifically, work from home, hasn’t exactly suffered – there’s an ETF for the latter.

The vaccine stocks Wednesday caught a downgrade by Isaac Newton, something about that gravity thing of his.  We mentioned on our Tuesday call that for Moderna (391) to be some 80% above its 50 day average was obscene.  Of course, there are no magic numbers here, we were more thinking along the lines of Supreme Court Justice Potter Stewart and his description of obscenity, “I know it when I see it.”  Down 77 points on Wednesday looked like a real buying opportunity, but down 30 seemed the same.  This latest move/break out was around 250, and carried to roughly 500.  A 50% retracement would be around 375, and Wednesday’s low was 372.  Were it that easy, this would be coming to you from the South of France.  If you would rather not sleep like a baby, that is, wake up crying every five minutes, you might consider the comparatively boring iShares Biotech ETF (IBB-169), where both Moderna and BioNTech (375) are among the top 10 holdings.

Speaking of gravity, Cathie Wood has had a tough go of it this year, understandable when Tesla (722) goes trading range on you and it’s 10% of several of her portfolios.  And to our thinking, stocks like Teladoc (145) and Roku (369) give her a leaning toward not “work from home,” but stay-at-home.  A move through 720 should get Tesla going again, and in her Ark Next Generation ETF (ARKW- 150) she has taken a liking to bitcoin, or cryptos in the form of COIN and GBTC (37).  As it happens, by the end of last week we had as well.  To use GBTC as a proxy, these stocks peaked in April coincident with the IPO of Coinbase (257). After basing for a couple of months, the gap above the 50 day caught our attention.  The stock recently seems to have resolved a little consolidation, as the 50 day begins to curl up.  After bottoming in May, COIN has stumbled around, but the recent move above 260 seems important.

August, September and October are a tough three months for the market, averaging less than a 1% gain in post-election years.  It’s even tougher for Ford (14) whose cumulative return since 1972 is minus 92% – your $1000 would have become $77, according to  The period might explain the lagging A/D’s since early July, though the better action in Financials should help – there are a lot of them.  Still, we are never comfortable with A/D’s diverging and would become particularly wary of up days in the averages with negative or flat A/D’s.  It’s easy to say the trend is up, but what trend?  The only real consistent uptrend has been in the S&P, as everything else just seems to rotate in and out of favor.  As the S&P’s performance would suggest, big has been better.  Even on the NASDAQ, 70% of stocks in the NASDAQ 100 are above their 50 day average but within the broader NASDAQ Composite, fewer than 40% of stocks are above the 50 day.  This speaks well of Tech, as does the S&P itself.

Frank D. Gretz

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It’s Tough to Beat the S&P 500…Even S&P Stocks Can’t Do it

DJIA: 35,085 It’s tough to beat the S&P 500… even S&P stocks can’t do it. We’re thinking here of the S&P 500 Index as we know it, versus the 500 or so stocks which comprise it – the S&P Equal Weight Index (RSP-153) where market cap is not a factor. The S&P makes new highs seemingly most days, the equal weight version has gone nowhere since early May. The Russell 2000 (IWM-223), that measure of secondary stocks that everyone loves to love, has gone nowhere since February. So where is the big bull market? Arguably it’s in five stocks, Apple (146), Amazon (3592), Alphabet (2733), Facebook (359) and Microsoft (287). As of last Friday these five account for 22.9% of the S&P‘s market cap, the highest combined market cap of any five ever. Given all five are pushing twelve-month highs, and given their market cap weight, you kind of have to join ‘em to beat ‘em, or to even keep up. There are stocks and groups which have outperformed from time to time, but the frequent rotation has made it difficult to keep up. And, realistically, it’s not what most do. Is piling into five stocks healthy? In the early 70‘s at least there were 50 of these little darlings. And the’s obviously saw many more. The answer, of course, is it’s not healthy – extremes rarely are. Divergences, in this case within the S&P itself, are never healthy. And they’re not without risk. If you don’t care about valuations, how about simple supply and demand – after a while, who is left to buy? Certainly these all are great companies, but so too were GE (13) and Cisco (55) back in 1999 when they were among the S&P‘s top-five by market cap. The saving grace now, what makes this time different, dare we say, is the overall background, specifically the Advance-Decline index. Unlike those other periods, this market still has decent, though deteriorating, participation. Facebook beats! The most advertised or anticipated “beat” in the history of markets? Who is to say, but if the stock can survive this kind of anticipation and the temptation to “sell on the news,” indeed, we will be impressed. We pointed out many times, stocks that outperform are those where analyst estimates are too low and, of course, vice versa. So is a match as good as a beat? As it is one of the chosen, could be. If instead it is priced in/discounted, that tells us something as well. It’s the market that makes the news, even for the chosen few. When good news isn’t good news, it’s time to think about it. By definition, in divergent markets the strongest are the last to give it up – therefore, the market averages versus the AD’s. If Facebook and Apple can’t right themselves after these little reporting setbacks, it’s something to think about. Then, too, a little rest for these will not hurt. Investor sentiment or psychology is always difficult to measure. Even indicators like the VIX (18) which seems objective, over the years has ranged from 30 to 80 at market lows. And when it comes to the investment surveys, they are notoriously early. By the time it’s time to worry, most have stopped doing so. We’re also thinking here of those intangibles which escape measure altogether and, hence, no pretense of objectivity. How, for example, would you have measured the bubble that was the “nifty 50” or the’s? Being there you couldn’t help but know it, but with no objective measure it was easy to ignore. This seems the case now, one could argue we’ve seen several bubbles – the SPACs, the MEME stocks and even bitcoin. Easy to think Robin Hood will be some seminal event, but we suspect it’s more the big picture – the top five of the S&P reach 30% plus? A final thought on bubbles. From the King Report, banks are giving families with wealth of 100 million or more the ability to borrow at less than 1%. We remember, or think we do, back in the days of “Japan Inc.,” a business woman being denied a loan. The same bank a couple years later approached her with double the amount if she wanted to join a golf club. There are plenty excesses in the market and the economy. Problems in the technical background are increasing, including the recent lag in financial stocks. The ratio of financials to the S&P is at a 90 day low, a condition that typically has bled into the overall market over the next 2 to 4 weeks. Despite the strength in Tech, there were more twelve-month new lows than new highs on the NASDAQ last week, and despite the S&P strength, only about half the stocks there are above their 50 day. Most important seems the lagging A/D‘s. It would be nice to get back to those days when most stocks went up.

Frank D. Gretz

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More Clouds on the Horizon

The second quarter of 2021 was a good one for the popular averages, but—similar to the first—was notable for its rotation from value to growth, and small capitalized companies to large, then back again. Volatility and speculation picked up, adding to the difficulty for portfolio and fund managers to outperform, and most did not.

The story for the year may be the rapid rebound in the U.S. economy, but earnings growth has been and still is the story for most companies as we enter the second half of 2021. It has been nothing short of remarkable. Before the pandemic, 2021 earnings growth was expected to be just shy of 11%. But thanks to unprecedented massive government stimulus, these expectations were rapidly revised higher. At the start of the year consensus estimates were for growth of about 23%. Today earnings growth is approaching 40%. These numbers are obviously unsustainable, and 2021 earnings may be beginning to eat into 2022’s growth rate. From an historical standpoint, since 1950 the compound annual growth rate for S&P 500 earnings has been slightly above 6%.  Similar to how earnings growth has been robust, equity market returns have far exceeded their historical compounded returns of just shy of 8% since 1950.

Our April letter pointed to a robust equity market but with clouds in the future. Since then we think these clouds have intensified. Without further enactments, the effects of fiscal policy stimulus are fading, a divided Congress is pushing its own priorities, monetary policy is becoming more confusing, COVID-19 variants are emerging, regulators are becoming more aggressive, and geopolitical challenges are building.

We continue to believe the fading fiscal policy tailwind is one of the more important of these impacts on the economy, corporate profits, and equity prices. Regardless of what happens with the infrastructure package, the U.S. will have at least a $1.5 trillion fiscal drop in 2022. This is primarily because infrastructure spending takes years to be distributed, new social spending is just offsetting what has been spent, and tax increases, if included, are immediate. $2 trillion of COVID aid is not the same as $2 trillion of infrastructure spending. The net impact, under the most optimistic scenario, is roughly $130 billion of new spending, which hardly dents the $1.8 trillion run-off. Without a new round of rebate checks going out, there is the possibility that the U.S. is headed for its largest fiscal contraction since the drawdown of WWII.

Of course, a lot of this is conjecture at this point, and will remain so until we see what actually comes out of Washington D.C. There are also offsets to the fiscal cliff: corporations and U.S. consumers are flush with cash, jobs are plentiful and wages are rising, U.S. corporations are increasing cap-ex intentions to meet resurgent demand and the realignment of global supply chains. Importantly, productivity is surging, thanks to technology and automation investments, partly caused by the COVID shutdown.

We continue to believe that we are in a secular bull market that is characterized by higher corporate profits and lower long term inflation. There are enough uncertainties, however, that near term caution is advised.  

July 2021

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US Strategy Weekly: Pluses and Minuses

Not surprisingly, the second half of the year is proving to be more volatile than the first half and we believe this is due to several reasons. On the positive side is the strength seen in first and second quarter earnings results for the S&P 500 companies. This encouraging news on earnings is coupled with extremely easy monetary policy which includes low interest rates and $120 billion of monthly security purchases by the Fed, and child tax credits and a potential infrastructure bill in terms of fiscal stimulus.

On the negative side is the fact that earnings growth may be peaking. Although earnings growth should remain positive, the growth rates of 143% YOY in the first quarter and an estimated 65% YOY in the second quarter are unsustainable in the long term. In fact, consensus earnings forecasts suggest that earnings growth in the final quarters of the year will be less than half the pace seen in the second quarter. This decline in the growth rate is not a big negative; however, it does suggest that PE multiples may also have peaked. PE multiples tend to move higher when earnings growth is rising, but a decline in the earnings growth rate will not justify any further multiple expansion. PE multiples could also come under pressure in the second half given the extremely high levels of inflation recorded by all the inflation benchmarks.

Also on the negative side is the fact that monetary policy is apt to change in the second half. Although the Fed insists that inflation is temporary, it is unlikely to decrease soon, and this could force the Fed to alter its quantitative easing. There have already been some innuendos that the Fed may change its tone on inflation at this week’s post-meeting press conference. It has been our view that the Fed would initiate the discussion of reducing quantitative easing at its August symposium. The significance of this potential shift cannot be underestimated. The Fed has been flooding the US banking system with liquidity for more than 17 months. This historic level of liquidity has supported the economy, but it has also supported equities since March 2020. It has helped boost stock prices and investment in general. The absence of this support will not hurt stock prices per se, but investors will no longer have the wind at their backs.

Yet it is important to note that history has shown that the anticipation of a change in Fed policy can have a bigger and more immediate impact on stock prices and investor psychology. Therefore, any hint of a change in the Fed’s monthly purchases is apt to trigger a correction. In sum, expect more volatility ahead. Assuming this is true, some of the safest investments in the second half could be stocks with lower-than-average PE multiples and higher than average dividend yields.  

Another possible negative in the second half relates to China. There are already signs that China’s growth is beginning to slow and profit margins are being negatively impacted by higher raw material costs. But the larger risk regarding China may be its increasingly aggressive posture towards corporations inside of China and its posture with the US. Beijing has begun a sweeping crackdown on companies such as Tencent Holdings (0700.HK – $446.00) which it ordered to give up exclusive music licensing rights. China fined Alibaba Group Holdings (BABA.K – $186.07) for anti-monopoly violations. And it denied Huya Inc.’s (HUYA.K – $11.96) planned game streaming merger with DouYu International Holdings (DOYU.O – $3.77). Yet, most disturbing, is China’s increasingly aggressive stance with the US. This week’s meeting between US deputy Secretary of State Wendy Sherman and Chinese Foreign Minister Wang Yi ended with Chinese officials accusing the US of “coercive diplomacy,” and warned the US to stop meddling in Taiwan or Xinjiang issues. They also presented deputy Secretary Sherman with two lists of action. These included revoking sanctions on Communist Party officials, lifting visa bans for students, making life easier for state-affiliated journalists and reopening the door for Confucius Institutes. This meeting, which took place in the Chinese city of Tianjin, was not open to foreign press, although the Chinese press were allowed. All in all, this suggests that issues with Hong Kong and Taiwan may continue to escalate.

Economic News

New-home sales in June fell for a third month in a row as homebuilders contend with high construction costs and a burgeoning pipeline of single-family projects. New-home sales fell 6.6% to 676,000 annualized units in June, which was the lowest level since April 2020. We noticed that builders show that inventory for new homes for sale are currently low, but new homes under construction are up strongly. An even sharper uptrend can be seen in new home construction yet-to-be started.

Existing-home sales rose 1.4% in June to 5.86 million units annualized, fully reversing May’s losses, and breaking the four-month losing streak registered since the start of the year. The recent dip in mortgage rates along with a rebounding labor market contributed to the pickup in home sales. Single-family sales and condo/co-op-sales both rose 1.4% from the previous month. Sales were higher in all census regions except the South, where they were flat from the prior month.

Sentiment indicators are mixed with the Conference Board showing July gains in the broad index, present conditions and a flat reading in expectations. The University of Michigan sentiment reported losses in all indices and a particularly large drop from 83.5 to 78.4 in expectations. The difference may be due to timing of the surveys and the dispensing of stimulus checks. See page 3.

Technical Update

The 25-day up/down volume oscillator is at negative 1.27 and neutral this week after recording one day in oversold territory on July 19. This is an unusually low value for this oscillator particularly since there have been two 90% up volume days in the last 25 trading sessions. We do not remember ever seeing strong 90% up days with our oscillator remaining in the negative half of the neutral zone. This means that over the last 25 days there has been more volume in stocks declining than in those advancing.

The last time the 25-day up/down volume oscillator showed strong buying pressure was when it recorded one day in overbought territory on April 29. Prior to that there was a minimal five consecutive trading days in overbought territory between February 4 and February 10. In sum, the February readings confirmed the record highs in the broad indices at that time; but since then, there have been no confirmations of recent highs. The July 19 drop to negative 3.49 was the first oversold reading since the pandemic, or in March-April 2020.

Our 25-day up down volume oscillator is warning that demand is fading, and investors are selling into strength. The longer this volume non-confirmation of new highs continues the greater the downside risk to the broader market. In short, the recent erratic trend in the market has been expected and should be considered healthy. However, if a new rally fails to generate a new overbought reading, it would be a signal that the major trend is weakening. Should a future pullback in the equity market generate an oversold reading without an intervening overbought reading, it will confirm that the major cycle has shifted from bullish to bearish.

Gail Dudack

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From Worst…to First

DJIA: 34,823 From worst … to first. That was the pattern Monday and Tuesday. The 700 point Dow loss on Monday made the headlines, but as always we are more about the average stock than the stock averages. Monday’s bashing saw Advance-Declines 5-to-1 down, and up volume less than 15%. This, of course, cannot be called a complete surprise. The A/D numbers had flattened recently, negatively diverging from the averages like the Dow. The S&P was making new highs with fewer than 40% of components there above their own 50 day average. On the NASDAQ, a new high with more 12 month new lows was another warning. This deterioration simply caught up with the market on Monday. Monday did see a spike in Put/Call ratios and the S&P did hold its own 50 day average. Then pretty much out of the blue came Tuesday’s rally. It was not your dead cat bounce. The Advance-Declines cycled to 4.5-to-1up and up volume was greater than 85%. Since 1962, this kind of reversal has led to higher prices a month later every time, according to Covid seemed to catch the blame for Monday’s selloff, though we easily could have blamed China. Covid isn’t new, why was it important Monday? That’s just the way the market works – news follows price. The selloff was about the technical deterioration, specifically those A/D numbers. It’s important to look at them in conjunction with the averages. If the Dow is down 200 points the A/D’s will be negative, and they should be. If the Dow is up 200 points and the A/D’s are flat, let alone negative, that’s a problem – Thursday was that kind of negative day. As we pointed out last time, the performance of the “average stock” has been the best feature of the technical background, and now that seems to have changed. This also shows up in the Equal Weight S&P which has gone nowhere since early May, and the Russell 2000, a measure of small caps, which has gone nowhere since mid-March. Both are concerns, but alone are not uptrend killers. Rightly or wrongly, the Dow Theory doesn’t get much attention these days. Wrongly, because over time it has been quite often accurate. Rightly, because in recent years, not so much. The concept is sound enough – if you’re making the stuff you should be shipping the stuff. The transports should confirm the industrials. These days, of course, the Industrials are as much financials and the Transports have their airlines. And while the concept is simple enough, the nuances of the theory are a bit more complex. In any event, what seems important is that the transports peaked in early May, pretty much when the reflation trade peaked. If not a good indicator of market direction, they have seemed a good indicator of leadership, broadly speaking. Looking at the 20 component stocks, it’s a stretch to find a good chart. That’s even true of the truckers, which should come as a surprise if you have driven the Northeast Corridor lately. Breaking the downtrend here might suggest a move back to that reflation trade. The rotation, meanwhile, has become seemingly daily. Some of this, of course, is Covid related. The recent better action in Procter & Gamble (138) is a reminder of those bad old days. Most of the other staples aren’t on a par here, though Coke (56) and Pepsi (155) both have had upside breakouts. Seasonally it’s a good time for staples generally. Yet to get going are stocks like Zoom Video (361) and Teledoc (152) – guess they’re just not Domino’s (544). The industrials have had a tough go of it, but have come through so far more neutral than negative – see for example, XLI (103). It’s the metals and energy stocks that have taking the biggest hit. Together with bonds, a seeming telling commentary on inflation. Somewhat contradictory, economically sensitive real estate has done quite well. All hail the 50 day! Where would we be without it? That’s easy – lower. We are referring to the S&P and its 50 day moving average, though most apply it to individual stocks as well. Including a few minor dips below it, the S&P has bounced off its 50 day 13 times in the past year. It’s enough to make you wonder – could there be more chart guys than funnymental guys? You have to pay attention if only because most do. It’s with rare exception that we buy or hold a stock below its 50 day. Everyone likes to talk about the 200 day, but in an uptrend like this, by the time you get to the 200 day you have given up, or lost a lot of money. That said, the 200 day is important. It’s important in that it’s your last chance to remain solvent. The S&P remains some 11% above its 200 day, versus an average 13% in this year‘s first six months. Perhaps more importantly, the 50 day is some 8% above the 200 day. All the money is made against this backdrop – the 50 day above the 200 day. Frank D. Gretz

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US Strategy Weekly: Volatility

The Dow Jones Industrial Average rose 549.95 points, or 1.62% on Tuesday after falling 725.81 points, or 2.1%, on Monday. This surge in volatility drove the VIX index (VIX – $19.73) over 25 earlier this week which was a concern to many investors, perhaps because many call the VIX the “fear index.” We are not surprised if the level of fear is increasing among investors given the spread of the Delta virus, the rich level of equity valuations and the potential of a change in monetary policy. However, the VIX is not a good short-term indicator in our opinion. It is actually most useful at the end of a bear market when fear is at its highest. VIX readings between 45 and 85 have marked recent bear market lows. This being true, a high VIX reading, particularly above 80, can denote a buying opportunity. See page 6. In comparison the recent readings of 25 are mild and are not a worry. Keep in mind that fear is emotional and often unpredictable, and this may be the message in the VIX’s rise – more volatility ahead. It has been our view that the second half of 2021 will be more volatile and is likely to include a correction of 10% or more.
In terms of technical indicators, we are more concerned about breadth data and specifically volume in advancing stocks. The last time the 25-day up/down volume oscillator showed strong and consistent buying pressure was when it recorded a single day in overbought territory on April 29. Prior to that there was a modest five consecutive trading days in overbought territory between February 4 and February 10. The February readings were a confirmation of the record highs made at that time. But since mid-February, there has not been any volume confirmation of recent highs. Currently, the 25-day up/down volume oscillator is at negative 2.19 after recording a negative 3.49 reading earlier this week. Monday’s drop to negative 3.49 was the first oversold reading since March-April 2020, or during the depths of the global pandemic.
In short, since early February, our 25-day up down volume oscillator has been showing us that as the indices were moving to new record highs, volume in advancing stocks was declining and volume in declining stocks was increasing. This is a sign of waning demand and/or investors selling into strength. The longer this non-confirmation of new highs continues, the greater the downside risk to the broader market. From this perspective, the recent selloff was expected and should be considered healthy.
Nevertheless, after any brief oversold reading, a bull market should rise to new highs and have an accompanying overbought reading. This demonstrates solid buying pressure. If not, and if a rally fails to generate a new overbought reading, it would be a signal that the major trend is weakening or changing. If a subsequent decline in the indices generates a second oversold reading without an intervening overbought reading, it would indicate that the major cycle has shifted from bullish to bearish. In sum, these are the scenarios that concern us. These are the patterns we will be monitoring in coming weeks.
In June, major inflation benchmarks were rising at hefty year-over-year rates: CPI 5.3%, PPI 9.4%, GDP deflator 2.0% (March), import prices index 11.2%, and import prices excluding petroleum 6.8%. And core benchmarks were CPI 4.5%, PPI 3.6%, and core PCE deflator 3.4%. In short, inflation is widespread, and as high, or higher, than it was in 2008 and it is not apt to end soon. This pressures current monetary policy.
Plus, easy monetary policy tends to fuel inflation and the real fed funds rate is already at an all-time low. Most importantly, stock prices have not performed well during periods of high inflation. In fact, the chart on page 3 shows that high inflation and stocks prices tend to be inversely correlated. Also noticeable in this chart is that high inflation tends to precede recessions. All in all, it is not surprising that fear is rising.

Gail Dudack

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All good things must end…the odds are

DJIA:  34,987

All good things must end … the odds are.  The good thing in this case is the pattern in the S&P.  The index has spent the entire first half above its 200 day, by an average of some 13%.  This has happened only 34 times since 1929, according to Bank of America’s Steven Suttmeier.  The problem is only 13 times did the pattern continue through the second half.  The odds, of course, are often to be defied.  It is a concern, though, that only about 60% of S&P stocks are above their 50 day average, indicating weakness short-term versus the longer-term strength.  This becomes even more worrisome against the backdrop of new highs in the index itself.  Another little divergence comes in the form of the Equal Weight S&P, which has gone nowhere since early to mid-May.  None of this is reason to sell everything, but together it’s beginning to add up to an increased likelihood of a correction.

The divergence that most concerns us is one which has developed between the Dow and the Advance-Decline index.  What’s going on in the “average stock” as measured by the A/D index, we consider of greater importance than what’s going on in the stock averages.  The A/D index recently failed to match the highs in the averages.  Granted this is very short term stuff, and last Friday’s 3-to-1 up day wasn’t exactly the feel of a divergence.  Still, the divergence is there, and what seems important is the change.  The A/D‘s had been outperforming the averages, now they’re lagging.  It is relatively minor – a strong, broad rally would resolve the problem. Then, too, back in October 2000 it took only three days of this kind of action to lead to a 20% correction.  There also are concerns about the NASDAQ, despite growth’s clear revival.  Last week’s new high saw only 31% of stocks advance, and more twelve-month new lows than new highs.  That’s a pretty thin new high, and worrisome.

Whatever happened to the rebounding post pandemic recovery?  Since the beginning of last month bonds have rallied and the yield curve flattened, suggesting little inflation and a less robust economy.  For stocks, value has outperformed growth for the year to date, but concerns about that trade have come to the fore.  Clear examples are the airlines, hotels, resorts and cruise lines.  All were hit by the pandemic and sold off sharply last year, but rebounded strongly in February.  Since then they have seriously lagged the S&P.  Meanwhile, growth stocks, bought when growth is thought to be scarce, have performed well compared to value.  Whether correctly or not, concerns about the economy and, therefore, about the reopening trade now seem to dominate the thinking.  Time will tell, to coin a phrase, but there’s reason not to give up on the value/reflation trade.  Over the last month or so the ratio of value to growth stocks has plunged.  The drop, however, is in the context of a long-term trend.  Previous drops have tended to resolve in the direction of that trend.

The background worries seem obvious – the economy, inflation, cyber and Covid.  These we all know.  What always seems to cause the problems, we’ve noticed, are the worries we don’t know or we know but don’t consider worries.  We’re thinking here of China.  Recent headlines have been full of China’s latest clampdowns on companies and their listings, its growing attempt to eradicate bitcoin and the hassles for Tesla (651).  The impact on stocks like BABA (215) and the others has been noticeable, not to mention the recently listed DiDi (12).  To look at both manufacturing and services data, one could conclude China’s rebound is over.  As the country that led the US, Europe and the rest of the world into the Covid-related slow down and out of it, and as the driver of much of the world’s growth, this is not good news.  Technical patterns there, of course, have turned very weak.

It has been a good market, but not always good when it comes to making money.  Many hedge funds, for example, have had a tough start to the year.  From the Wall Street Journal, “Morgan Stanley and Goldman Sachs showed that fundamental stock-picking hedge funds posted negative alpha – trader talk for poor performance – in the first half of the year.  Part of the challenge for professional stock-pickers is that markets have been heavily rotational, several hedge funds said.  Markets this year have whipped back and forth between growth stocks and value stocks, making it difficult for managers to find winning trades.”  For now growth seems to hold the upper hand – see, for example, the SPDR ETF (XLK – 152) where Apple (148) and Microsoft (281) dominate.  And the recent breakouts in Amazon (3631) and Google (2540) are impressive.  In market corrections, however, it’s rare they don’t get to everything.  Meanwhile, bubbles are coming undone – the SPACS, Bitcoin, AMC (36).

Frank D. Gretz

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