On the Alert for Inflation

April 7, 2021

The first quarter of 2021 was a rewarding one for most investors. The Dow Jones Industrial Average rose nearly 8%, the S&P 500 gained about 6% and the Russell 2000 index advanced over 12%. However, the real winner in the first quarter of the year was the Dow Jones Transportation Average which soared a stunning 17%. This stellar performance in the transport sector was in anticipation of COVID-19 vaccinations becoming widely available, of the economy opening up, and of abundant government spending on infrastructure. But in general, the gain in the DJ Transportation Average was a continuation of a shift initiated earlier in the year from growth to economically sensitive stocks. Plus, the action of the first few trading days of April is encouraging and suggests equities could move higher in the second quarter.

The first few months of the year were also good to investment bankers as seen by the number of IPO deals priced, capital raised, and new filings. One hundred new deals were priced, versus the 25 a year earlier. Capital raised hit $39.2 billion versus $6.7 billion in a year earlier and 126 new deals were filed versus the 35 new deals filed in the first quarter of 2020. In fact, the only measure of IPO activity that showed any weakness was the IPO after-market, where prices underperformed the overall equity stock market. This detail could be a sign of fading demand and as such, should be watched carefully in coming months.

The first quarter was also memorable since it introduced investors to GameStop (GME -$77.97), a struggling video game retailer whose price rose 1500% in a matter of days. An investment forum on Reddit called WallStreetBets, led a massive buying spree in GME to oppose hedge funds holding large short positions. It was somewhat of a David versus Goliath anti-establishment movement that demonstrated the changes and hazards social media can wreak on the stock market. GameStop’s stock price soared from $18 at the end of 2020 to a peak of $347.51 on January 27 and is now trading below $200.

The quarter also revealed the existence of a new form of leverage called contracts-for-difference, or CFDs. These swaps were at the center of the collapse of Archegos Capital Management, a family office run like a hedge fund. Archegos borrowed capital from at least five different prime brokers to buy CFDs and held a concentrated portfolio of stocks with leverage estimated to be at least five-to-one. When underlying stock prices fell, Archegos was unable to make its margin calls and brokers sold Archegos’ underlying collateral to avert massive losses. Even so, Credit Suisse expects to take a $4.7 billion hit. But during the chaos, stocks like ViacomCBS (VIAC.O – $43.89) fell 60% from a peak of $100 in early March. In short, the first quarter was a time of rising stock prices, but it was not without its pitfalls.

From an economic perspective the quarter ended on a high note. The March ISM manufacturing index jumped to 64.7, its highest level since the early 1980’s. The ISM nonmanufacturing index surged to 63.7, exceeding its October 2018 record of 60.9. March payrolls grew by 916,000 in March while the job figures for January and February were revised higher. Unit vehicle sales rose to an annualized rate of 18.2 million, the highest since October 2017. These reports were signs that the economy was strengthening in 2021. But there have also been warnings that the recovery was not as uniform as it could be. According to the Wall Street Journal, annual SEC reports filed between July 1 and March 31, showed global employment rose by roughly 370,000 for the 286 S&P companies that filed annual reports. However, Amazon (AMZN – $3279.39) added 500,000 workers around the world, creating nearly as many jobs last year as 136 other companies in the index. This means that job gains in some companies were masking job losses in other companies. This is something to be concerned about. In addition, a Census Bureau study in late March reported that 18% of small businesses stated they would need financial assistance or additional capital in the next six months. These are some of the reasons critics warn that raising tax rates in 2021 would hurt entrepreneurs and US companies competing on a global basis. Supporters of the tax increases, including President Biden, say tax increases will not cool down the economy. We think this latter point is unlikely to prove true.

A number of recent surveys show consumer sentiment is rising but other data suggests there is a steady dependence upon government support. February’s personal income report showed a 7% decline from January’s level due primarily to the waning of government transfers. This drop should reverse dramatically in March, however, there are indications of stress in some households. The percentage of subprime borrowers with outstanding auto loans or leases more than 60 days past due hit 9% in the fourth quarter, the highest quarterly figure since 2005. Clearly, some households have navigated the coronavirus downturn and others have not. Car loans can reveal how riskier borrowers are faring. For subprime borrowers who do not have mortgages or college debt, car loans represent the biggest monthly debt payment. Keep in mind that many subprime borrowers work in restaurants, hotels, and bars hurt badly by Covid-19. Getting back to “normal” is therefore critically important for many small businesses, employees, and households.

We believe it is possible that several events are converging at the start of the second quarter that could be the catalyst for a 5% to 10% correction in coming months. The S&P 500 index has breached the psychological 4000 level which is a positive, but it will be important to see more upward follow through from this level. The SPX 4000 is the equivalent of 20 times 2022 consensus forecasts which now center around $200 a share. In other words, at the SPX 4000 level, stock prices are discounting all the good news expected in the oncoming 21 months. Interestingly, this price point is materializing just as first quarter earnings season begins. For the first time in four earnings seasons, expectations are high for earnings growth. This alone lends itself to the possibility of disappointment. But at this juncture, earnings must continue to beat the consensus forecasts if stocks are to continue to advance. Last but far from least, inflation could be a big threat in 2021. Inflation is pivotal to both monetary policy and to price earnings multiples. We believe there is risk that inflation benchmarks for March could show a CPI over 2% and a PPI greater than 4% and spook the market. If so, this could threaten the consensus view of monetary policy remaining stable through mid-2023. Low inflation and low interest rates have been the foundation of above average PE multiples in several years. If inflation becomes a concern, PE multiples will not expand, but could be at risk of contracting. With the election behind us, vaccines becoming more abundant, states opening up for business, and job growth getting a second wind, we are concerned that most of the good news is already priced in. All in all, we are a bit more cautious today than earlier in the year. 

Gail Dudack, Chief Strategist

strategist@wellingtonshields.com

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 judgement 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, 2021.

Wellington Shields is a member of FINRA and SIPC

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Goodbye Annus Horribilis

Many are calling 2020 annus horribilis (a Latin phrase meaning “horrible year”) due in large part to the spread of the deadly COVID-19 virus around the globe and its knock-on effects on the global economy. Yet despite the various challenges 2020 posed to the world, it was a good year for investors. The gains seen in the Dow Jones Industrial Average, S&P 500, Russell 2000, and NASDAQ Composite index were 7.3%, 16.3%, 18.4% and 43.6%, respectively. And as shown by these figures, the year provided excellent gains for many stocks and spectacular gains for others. Moreover, if historical precedents and Wall Street adages hold true to form, 2021 could add to these gains. For example, the Santa Claus Rally which includes the last five trading days of the year and the first two trading days of the new year, produced a small increase which is a favorable sign for the next twelve months. In addition, the market’s performance in January has had a respectable history of predicting the outcome for the entire year. Many believe the first five trading days of January predicts the month and January’s performance predicts the year. We believe January’s action is important since the liquidity generally available to investors early in the year from tax-loss selling, annual work bonuses, IRA and pension funding is typically the best of all the twelve months; therefore, January should produce a positive result for equities. If not, it is a warning. So far, 2021 is off to an excellent start.

While 2020 was a historic period in many ways, it was also record breaking in terms how countries responded to the global pandemic. Most nations boosted their ailing economies with massive fiscal or monetary support, or both. In our view, liquidity was the primary driver of equity gains in 2020. According to the International Monetary Fund, as of September 2020, total worldwide fiscal stimulus amounted to $11.7 trillion, or 12% of global GDP. In the US, the $2.7 trillion authorized by the CARES Act was direct fiscal support to the US economy and the $3.2 trillion increase in the Federal Reserve’s balance sheet provided monetary stimulus to the banking system. Combined, these policies equaled 23% of annualized US GDP. Moreover, Congress passed an additional $900 billion pandemic relief package in late December. Before lawmakers closed the books for 2020, they tacked on a $1.4 trillion catchall spending bill. All in all, the total stimulus authorized in the last twelve months is equal to 38.8% of nominal GDP. This extraordinary stimulus not only buoyed an artificially shutdown economy, but it also helped drive equity prices to record levels.  

It was also fiscal stimulus that drove the personal saving rate to 34% in April. November’s savings rate fell to 12.9%, yet this still remains more than twice the long-term average of 6.2%. A strong personal savings rate is an auspicious sign for the economy as well as for equity performance for the first quarter of 2021. In addition, with Democrats now in control of the White House, both chambers of Congress and with ex-Fed Chair Janet Yellen, a proponent of easy monetary policy, appointed as Secretary of the Treasury, most investors expect more fiscal and monetary stimulus in 2021. The Wall Street adage “Don’t Fight the Fed” will be an important phrase to remember in 2021. For these reasons, one could expect more stock gains ahead.

Still, there is a dark side to liquidity. The main risk of excess liquidity in the system is the potential of a stock market bubble. We expect the phrase “stock market bubble” to be mentioned often in 2021, however, bubbles are not well understood by many investors. Bubbles can materialize in any form of investment. The first bubble in recorded history was the Tulip Mania during the Dutch Golden Age in 1637. Bubbles are complicated and have many components, but they are almost always underwritten by good economies and excess liquidity. They are also distinctive because they incorporate a belief that the cycle “is different this time” and prices can continue to rise even as they disconnect from fundamentals. For all these reasons, including the lofty level of PE multiples at the end of 2020, we are optimistic yet cautious about 2021. It is important to remember that bubbles can persist longer than many expect. This was proven in late 1997 when equities disconnected from normal valuation benchmarks yet continued to rise until March 2000. To analyze a bubble and its growing risks, one must monitor both the level of equity ownership and the amount of leverage in the system. Bubbles typically end only after all potential investors have joined the bandwagon, households reach an over-ownership level in equities, and leverage, or margin debt, has reached its limits.

In the third quarter, equities were 25.4% of total household assets as compared to the 2000 peak of 26.4%. Equities were also 22.6% of financial assets versus the March 2000 peak of 24.2%. Given the recent gains in stock prices, it is likely that equity percentages increased in the fourth quarter and we will continue to monitor ownership levels for extremes. But ownership is apt to move higher. New investors are joining the investment world as a result of new digital venues and websites such as Robinhood.com, Stash.com, and Nerdwallet.com. From an historical perspective, many of the aspects of a bubble such as excess liquidity and new investors, seem to be moving into place. And we would also note that in early January there was a jump in bullish sentiment in the Association of American Individual Investors survey. The one-week reading of 54.0% bullishness was the most extreme since November 11, 2020 of 55.8%. Too much bullishness is not a good timing device, but this does suggest investors should remain alert in 2021.

Even so, the most troublesome characteristic of an equity bubble and the key signal that a bubble is reaching its exhaustion phase is tied to the use of leverage, or margin debt. An extreme is reached when increasing levels of leverage, or margin debt, fail to lift stock prices much higher. This is a serious warning for investors. We can monitor this by comparing the 2-month rate of change in margin debt to the 2-month rate of change in the Wilshire 5000 index. If the 2-month rate of change in margin exceeds two standard deviations (15.3%) and the Wilshire price index does not follow suit, the bubble may be in trouble. The most recent negative signals from this indicator were seen in December 1999, June 2003, and May 2007. In November, the 2-month rate of change in margin debt was 10.4% (below the 15.3% standard deviation warning level) and the 2-month rate of change in the Wilshire was similar at 9.7%. In short, there were no signs of excessive margin or exhaustion in recent data.

To sum up, while it is possible that 2021 could be planting the seeds for an equity bubble it is equally possible that 2021 could become a tricky roller coaster year for stocks. There are signs of rising inflation emanating from rising oil prices, wholesale prices and a weak dollar. More inflation could lead to higher interest rates which could trigger an equity market correction. The weakness seen in the job market at the end of the year could lead to disappointing economic data, hurt investor optimism, and stall stock prices. Given this backdrop, investors should take a multiyear view of equities and seek companies that one wants to own over the next decade. This should be both the path to profits and preservation of capital. Expect 2021 to be an interesting and volatile year.

Gail Dudack, Chief Strategist

strategist@wellingtonshields.com

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 judgement 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, 2021.

Wellington Shields is a member of FINRA and SIPC

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4Q 2020: Be Alert to October Surprises

There is a growing consensus that Democrats will win the White House, possibly increase their majority in the House and could even tilt the balance in the Senate. And economists are now indicating the Biden-Harris platform may not hurt the economy as much as originally expected. However, history has shown that consensus views, and economist’s forecasts, are more often wrong than right. In short, it may be wise to stay alert for October surprises.

In terms of the Biden-Harris platform, former Vice President Joe Biden has stated he will repeal the Trump tax cuts which means taxes will go up for all individuals and businesses. To say that taxes will not increase for anyone making less than $400,000 a year is simply self-contradictory. Moreover, targeting tax increases on incomes of $400,000 or more could hurt millions of small business owners who need positive cash flow to expand. The only effective way to raise taxes on the wealthy and not hurt the average worker would be to eliminate tax breaks focused on the wealthy such as the carried interest loophole. More importantly, to raise taxes while the economy is still struggling to gain its footing from a mandatory shutdown seems reckless.

Some say the positive impact of the proposed Biden-Harris fiscal stimulus will offset the negatives from tax hikes. However, the Biden-Harris stimulus plan is tilted toward infrastructure spending on green and sustainable energy sources. This is an admirable goal, and it should be done, but it will take a long time. Federal infrastructure spending tends to be slow and inefficient. President Obama’s $830 billion American Recovery and Reinvestment Act of 2009 was the largest stimulus-spending package in all of American history, and it promised “shovel ready” construction projects to spark job creation and lift the economy. Unfortunately, only 15% of the money was used for roads, bridges, and other infrastructure projects and it took more than three years to have much of any Impact. * In sum, we would be skeptical that the Biden-Harris stimulus plan will work as promised. The most effective way to stimulate the economy is to give money directly to consumers and businesses either through tax cuts or direct checks. And it should be done quickly. As Federal Reserve Chairman Powell indicated — more stimulus is needed since households need cash to pay rent and support their families.

The financial media appears perplexed by what they see as a disconnect between the soaring stock market and a weak economy; yet this disconnect may not be as big as perceived. As stock market averages are knocking on their all-time highs in October, there are also signs of a solid rebound. This can be found in the strong gains in disposable income, construction spending, auto sales, manufacturing, consumer, and business confidence. The household sector’s double-digit savings rate also points to more potential spending ahead. Perhaps the media is looking at shutdowns and virus trends while the stock market is looking to the future.

If there is a disconnect in the financial environment it is found in valuations. Equity prices are rising without a commensurate increase in earnings. As a result, PE multiples have jumped to record levels. If earnings do not rebound strongly from the big declines seen in the first and second quarters of 2020, the stock market will be trading well-above fair value. This is the crux of the stock market’s risk today.

Predicting Elections
October is an interesting month in many ways. A good equity performance in October during a presidential election year has been a good omen for the incumbent party. October is less than half over, but it is showing an above average gain to date. Furthermore, the equity market’s performance in the three months leading into the election has been a remarkable precursor of the election. A loss in either the S&P 500, the DJIA, or both, in the three months leading into the election has predicted a loss for the party currently in the White House. A gain has preceded a success. There have been few exceptions to this rule. In 1932, the equity market rallied strongly even though President Hoover (Republican), on the cusp of the Great Recession, lost the election to Franklin Delano Roosevelt (Democrat). The market also declined in the three months prior to the successful re-election of Dwight David Eisenhower (Republican) in 1956, following the Korean War. And the stock market did not predict the change in political power in 1968 when Republicans (Nixon) succeeded Johnson (Democrat). However, President Johnson failed to win his party’s nomination at the 1968 Democratic Convention and was replaced by Hubert Humphrey. But aside from these anomalies, a positive performance from the end of July to the end of October has indicated that the party in power would retain the White House.

Outlook
Although high PE multiples imply investors should be cautious and maintain a solid focus on value in the short term, we find many reasons to be bullish long term. Not only are the trends favorable in most economic data but in the breadth of the market as well. The number of daily new highs has steadily increased in October and the advance decline line reached an all-time high. The Dow Jones Transportation Average made a series of new highs in mid-October and the Russell 2000 index has become the outperforming market benchmark. These are all signs of a broadening advance. Supportive monetary policy, solid economic releases, and the potential of new fiscal stimulus sometime in the next three months, also implies equities should do well in the longer term.
Gail M. Dudack
Market Strategist

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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 judgement 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, 2020.
Wellington Shields is a member of FINRA and SIPC

Click to download

3Q 2020: Fasten Your Seatbelts

Market Performance and Liquidity
The first half of 2020 was extraordinary in many ways. The S&P 500 fell 20% in the first three months of the year — the worst performance since the fourth quarter of 2008, or the core of the financial crisis. The second quarter followed with a 20% gain — the best 3-month advance since the fourth quarter of 1998, or during the heart of a major technology boom. GDP surged over 6% in the last quarter of 1998. Looking forward, it would not be a great shock if the second half of 2020 held its own surprises and if markets became even more volatile. Many things are known. Countries still struggle with COVID-19. Brexit is scheduled for the end of the year and it could be messy. Political relations with China have been tense due to a lack of transparency regarding the pandemic, China’s aggressive actions in the South China Sea and a backtracking on the promises of political and economic independence for Hong Kong. And finally, November’s presidential election could be another nail biter. But those are only the risks that are known.

However, despite all the hurdles facing equities since the March low the market has steadily outperformed expectations. There is a list of reasons for this. First, to counter the drag of the pandemic, the US and many countries around the world have implemented unprecedented fiscal and monetary stimulus. Second, US corporations are demonstrating impressive creativity, flexibility, and the ability to adopt to a new post-COVID-19 environment. Third, an historic private/public partnership has been put in place to develop, fast-track, and deliver a US vaccine for the virus. Last, but far from least, the US economy and many Americans have demonstrated surprising resilience to weather this historic economic shutdown. As a result, unemployment never reached the 25% level forecasted by many economists, including Secretary of the Treasury Stephen Mnuchin. To date the unemployment rate appears to have peaked at 14.7% in April and dropped to 11.1% in June.

Massive liquidity programs have been a major factor supporting global markets. European Union leaders agreed on a record COVID-19 stimulus package worth $857 billion. The US government implemented three separate stimulus packages in the second quarter that totaled nearly $3 trillion. And though Phase Three of the stimulus package has not been fully disbursed, the Senate GOP is unveiling another stimulus plan of at least $1 trillion. This new Senate plan would include another round of direct payments to Americans, $105 billion for schools and universities, supplementary assistance for small businesses, $16 billion for testing and contact tracing in states, and $26 billion more to develop and distribute a vaccine. The proposal would extend unemployment benefits, although it would cut the current federal $600 weekly supplement to $200 a week through September. It also provides liability protections for schools, businesses, and health-care providers. To put this into a larger perspective, the combination of the $3 trillion fiscal stimulus already in place, the $1 trillion proposed fiscal plan and the $2 trillion of monetary ease, this $6 trillion equates to 28% of first quarter nominal GDP. In short, the government has “funded” over three months of economic activity!

But more importantly, much of this money is yet to enter the real economy. For example, of the $600 billion authorized for the Fed’s various Main Street Loan Facilities, we estimate only 28% has been tapped by businesses and organizations. The CARES Act was a $1.6 trillion program of direct aid to taxpayers, $600 in supplemental unemployment payments and forgivable loans to small businesses. While this direct fiscal aid has been disbursed, it remains mostly unspent by consumers. This view is based upon the $4.2 trillion increase seen in MZM this year. MZM is one of the broadest of the Federal Reserve’s money supply benchmarks and it monitors all forms of liquidity within and outside the banking system, including coins and notes in distribution, bank deposits, all checkable deposits, short and long-term time deposits, retail money market funds and institutional money market funds. May’s personal savings rate was a stunning 23% and total personal savings hit a record $4.1 trillion, an increase of $2.8 trillion since year end. This explains the record increase in MZM in 2020. Some equity strategists have been bearish on equities on the belief that many individuals are buying stocks with their $1200 COVID-19 checks and comparing the current environment with the speculation seen in 1999. However, the data suggests something quite different. It appears that individuals have actually saved their money, are sitting on large cash piles and could invest much money into equities if they chose. All in all, this sidelined cash represents potential for an extraordinarily strong economy and an even stronger stock market. But questions remain. Can the virus be controlled? When can children get back to school? And when can people get back to work? We believe these questions may be answered soon and if so, confidence will rise, and the economy can look forward to a great second half.

Presidential Election Nears
The third quarter of the year will bring the November election into focus. The traditional political polls currently have President Trump lagging behind Vice President Biden, but if there is a lesson to be learned from the 2016 election it is that polls have become irrelevant. It may be wiser to put your faith in the stock market rather than in political pollsters. There tends to be a unique seasonality in election years, and it usually begins with a weak opening, a rally in March and July and a third rally at year end. But monthly seasonality in an election year can also be broken down by incumbent wins or losses. When the incumbent party wins the White House, normal seasonality is upended, and equities tend to advance in March, June, August, and October. COVID-19 wreaked havoc in March of this year so the market has been trading more in line with a typical incumbent loss. But what is noteworthy about the equity market’s presidential prediction pattern is that the risk of a Trump loss increases if equities are weak in September and October. However, it could also reverse and predict a Trump win if equity prices rally in August and October. This would make August’s performance an important political indicato

Nevertheless, if Vice President Biden wins and Democrats sweep Congress it is almost assured that personal and corporate taxes will rise considerably. The New Green Deal may not get fully implemented but corporate regulations are expected to increase substantively. These two factors alone, coupled with the hit that COVID-19 has dealt to the US economy is a recipe for major economic weakness in 2021. In sum, the major risk of 2020 could be the election. The first presidential debate is scheduled for September 29 and it could be a market moving event. It may be wise for investors to approach the end of September cautiously.

Fundamentals Always Rule
August will also give us greater insight into how well or poorly corporate America coped in the midst of the economic shutdown. Second quarter earnings are predicted to be the nadir of earnings growth in 2020 and for that reason second quarter earnings season is crucial. Expectations were grim as reporting season began but to date results have been better than expected. Of the 312 companies in the S&P 500 that have reported earnings to date, 82% have beaten consensus expectations. This is well above the 65% seen in the typical quarter. But with over a third of companies reporting, the IBES consensus second quarter earnings estimate has recovered from a decline of 43.1% YOY to 33.8% YOY. For the full year, IBES is forecasting S&P 500 earnings to decline 21.5% YOY. Although this is a significant decline, we believe a 25% decline in calendar 2020 earnings was fully discounted when the SPX fell to an intra-day low of 2191 on March 23 (closing price SPX 2237.40). A main driver of equity prices in the second half of 2020 will be expectations of how quickly and how far corporate earnings can recover in 2021. Obviously, the longer the economic shutdown persists in 2020, the more elusive the 2021 forecast becomes. Still, consensus earnings for 2021 are consolidating at the $160 level and given the low level of interest rates and inflation, a PE multiple of 20 times would be appropriate for next year. This combination generates a target of SPX 3200. In sum, we believe SPX 3200 could become a base level for stock prices over the next six months, or until news of a vaccine or presidential election results become known.

Gail M. Dudack
Market Strategist

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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 judgement 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, 2020.
Wellington Shields is a member of FINRA and SIPC

2Q 2020: Patience

Record Setting
The first three months of 2020 were difficult for investors and the 20% loss in the S&P 500 was the worst decline since the 2008 financial crisis. The Dow Jones Industrial Average’s 3-month drop of 23% was its poorest quarterly performance since 1987. But these percentages were only half the story. From the DJIA’s all-time high of 29,551.42 on February 12, 2020 to its March 23 low of 18,591.93, the index plunged 37% in only 40 calendar days (27 trading sessions), exceeding in both time and percentage, the 36% decline made in 55 calendar days in 1987. In short, the global fight against COVID-19 has been an historic struggle and the decline in the US equity market has been equally historic.

The Bottoming Process
Statistics on the coronavirus pandemic are certain to become worse in coming weeks, nevertheless, signs that the equity market is in the process of forming a bottom are accumulating. Between February 24 and March 24 there were eight extreme trading days in which 90% or more of the day’s volume was in declining stocks (90% down days). This is a simple definition of panic selling and it identifies an emotionally wrought market. Historically, once a string of 90% down days is followed by a 90% up day, it signals that the worst of the selling is over, and buyers are re-entering the marketplace. A 92% up day appeared on March 13 followed by a 94% up day on March 24. We believe the bottoming process has begun. More extremes occurred at the March 23 low of SPX 2237.40, when our 25-day up/down volume oscillator fell to its deepest oversold reading since July 2002. The July 2002 reading preceded the October 2002 low by a little over two months. Similarly, at the end of March the American Association of Individual Investors’ survey showed bearish sentiment was over 50% for three consecutive weeks – the longest stretch since the four-week reading in early March 2009. Nevertheless, these signals, just like in 1987, 2002 or 2009, show that a bottoming phase is in place, but it will take time. In most cases, the process takes two to three months. And though two months can feel like eternity in an era of 24-hour news, high frequency trading, smart phone alerts and hourly updates on the COVID-19 pandemic, it is important to remember that a long bottoming process is not only normal, but healthy for the equity market.

The equity market is a discounting mechanism and it can deal with bad news better than it can with the unknown. March’s perpendicular selloff was clearly fear of the unknown. This coupled with margin calls and the unwinding of leverage created a frightening environment in two very intense weeks. And while the real economic fallout of COVID-19 is still uncertain, what is clear is that economists are predicting a recession of huge proportions. Recently, Goldman Sachs’ forecast for second quarter GDP fell from negative 6% to negative 24% and to negative 34% in fourteen days. And as disturbing as this forecast is, the good news is that this negative 34% GDP forecast is in the public domain and one can assume it is now discounted by stock prices. Forecasts of economic weakness and poor corporate earnings are a critical part of the bottoming process. We expect first quarter earnings season, which begins in mid-April, will be another important part of the “informational” bottoming process. Keep in mind that first quarter’s earnings reporting season and peak COVID-19 numbers are apt to coincide in the month of April and both are nearly certain to bring more bad news. Therefore, investors should expect more volatility. However, it is likely that the shock and awe stage of the bottoming process is behind us and the adjustment phase to the new reality has begun. This is when information about the economy begins to appear and bargain hunters usually tip toe back into the market.

It is not unusual for the equity indices to retrace as much as one-half of the decline during this adjustment phase. This would equate to roughly SPX 2810. And while it is too simplistic to suggest that a bottoming process is the equivalent of a trading range, we do believe there are upper and lower levels that will be significant in coming weeks. On March 23 the intra-day low of the session was SPX 2191. This is noteworthy since there is major support between SPX 2120 and SPX 2200 which was major resistance for all of 2015 and 2016. All of this implies that most of the bottoming process in coming months should be contained within a range of SPX 2200 to SPX 2800.

Any test of the SPX 2200 level will be important in coming weeks and we will be looking for a decrease in total trading volume and a less severe oversold reading in our 25-day oscillator to confirm that the lows are clearly established. Again, a bottoming phase takes time and requires patience, but knowing what to expect and having a good roadmap can make the process not only less stressful, but more profitable in the longer run.

The Stimulus Packages
The CARES Act, or the $2 trillion coronavirus relief bill, was a good stimulus package in our view since most of the stimulus was focused on individuals and small and medium sized businesses. The goal of the bill is to keep workers and businesses financially afloat during this mandatory shut down in order to prevent evictions, defaults and bankruptcies. And though we believe most of this money will find its way back into the economy, the onus in the next few weeks is for the government to get the money quickly into the hands of consumers and businesses that need it. President Trump has indicated he would like to follow up with a “phase four” stimulus bill in the form of a $2 trillion infrastructure program. Together these two stimulus packages would equate to more than 18% of nominal GDP which is in line with the four-part stimulus seen in the two-years that followed the 2008-2009 financial crisis. However, the construction of these two stimulus programs is quite different. In 2008 the TARP stimulus went directly to banks and auto companies to bolster failing balance sheets. It was not a direct stimulus for the economy. The 2009 shovel-ready stimulus package went directly to government agencies, employed many bureaucrats, but it did little for the economy. Only the 2010 tax relief bill gave a boost to the economy by lowering FICA taxes and giving workers more take-home pay. In contrast, the current stimulus package is designed through direct deposit, individual checks, business grants and loans, to directly support the employees and businesses that need money now to pay for necessities. As a result, it should help prop up the economy during this difficult time. Simultaneously, the Federal Reserve has stated it stands ready to provide as much liquidity as is necessary to support the banks and debt markets. It has already added aggressively to its balance sheet and this is in conjunction with similar monetary stimulus programs throughout Europe. This robust combination of monetary and fiscal stimulus should not only help relieve the stress on the economy but help reduce tension in the securities markets.

Melding Market Technicals and Fundamentals
The SPX 2120-2200 range was successfully tested on March 23 and is an area of good long-term technical support. Plus, this SPX 2191 intraday low discounted a large amount of the earnings uncertainty seen for 2020 earnings. Using a four-quarter estimate of $156 for the end of March, the trailing PE fell to 14.0 times on March 23 – a PE that is well below the long-term average of 15.5 times . Even after the rebound to SPX 2584.59 at the end of March, the trailing PE rose to 16.5 times matching the trailing PE seen at the December 2018 low. In short, there are many technical and fundamental signs that the market began a bottoming process in March. But as history suggests, lows are made to be tested and that still lies ahead. It will require patience.

Gail M. Dudack
Market Strategist

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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 judgement 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, 2020.
Wellington Shields is a member of FINRA and SIPC

1Q 2020: Corona Fallout

As news broke of a viral epidemic in China, global markets fell sharply, and analysts struggled to assess the economic fallout. The current statistics of the virus are staggering with over 6,000 cases of the coronavirus found in 17 countries, 132 confirmed deaths, and known cases of human-to-human transmission seen in four countries. China has locked down 15 cities, including the epicenter Wuhan, and is quarantining a population of nearly 60 million people in an attempt to stop the spread of the disease. The US and other nations are screening passengers arriving from China, particularly from Wuhan; while Hong Kong and some Russian provinces intend to close their borders with China entirely. There are five confirmed cases in the US, with an additional 100 people being tested in 26 states. Although the incubation period is still under study, the good news is that scientists and doctors have been able to define the coronavirus genome and believe it is more similar to influenza than SARS. This is very promising since influenza has a substantially lower mortality rate than SARS. Equally important, the 2003 SARS experience has provided a guideline for countries on containment methods and the process needed to develop a testing kit and vaccine.

After a dramatic sell-off in response to the crisis, stock prices rebounded, but investors remain concerned about the longer-term ramifications of this outbreak. The crisis may be too young to quantify, but in our opinion most modern-day epidemics are “economically” similar to natural disasters such as earthquakes, hurricanes and fires. There is a sharp negative economic impact in the short run as normal economic activity grinds to a halt, but the economy tends to rebound and recover what it lost during the crisis in subsequent quarters. And in most all circumstances, the economic trend that was in place prior to the epidemic or disaster, resumes once the crisis abates.

The measures being taken to control the spread of the coronavirus suggest the impact of this crisis will be contained primarily to China and other parts of Asia. However, since China is the second largest economy in the world and is also a major manufacturer and supplier to many industries, the longer the crisis continues the greater the fallout could be on the global supply chain. Nonetheless, the biggest near-term economic impact is expected to be seen in airlines, hotels, casinos and energy stocks due to canceled travel plans. But business and leisure travel should resume once the epidemic is in check. In sum, the epidemic is apt to have a significant impact on China in the first quarter and a more modest impact on the global economy. 

Earnings are Crucial
We believe fourth quarter earnings season could soon overshadow the coronavirus as a market influence. There are 141 S&P 500 companies reporting this week and we expect the impact of the virus will be a major topic on earnings conference calls. To date, 68% of the companies that reported have exceed expectations, but it is earnings guidance regarding the first quarter that will have the biggest impact on earnings growth expectations for 2020. In that regard, this week’s earnings report from Apple Inc. (AAPL – $317.69) is quite encouraging. Apple is a high PE growth stock with a large exposure to China in terms of both production and customers. However, not only did Apple’s current quarter beat holiday revenue expectations and consensus earnings estimates, but the company announced revenue forecasts for the quarter ending in March that exceeded current analysts’ estimates. CEO Tim Cook told reporters that due to the coronavirus the company was using a wider range than normal for its quarterly guidance, but Apple has the flexibility to use suppliers outside of the Wuhan area if necessary and its current revenue estimates include the delayed start of Chinese factories after the Lunar New Year holiday and reduced hours at many of its Chinese stores. This is good news and it bodes well for technology earnings in general for 2020.

Fed on Hold
This week marks the first FOMC meeting of the year and we expect the Federal Reserve will keep interest rates on hold. In large part, the current economy is the perfect combination of “not too hot” and “not too cold.” Inflation has been well contained in recent years which means there is no pressure for the Fed to raise rates. The economy is also sufficiently robust that monetary stimulus is not required. However, it is noteworthy that the Fed has been expanding its balance sheet for a number of months. The Fed has stated that this is due to an increase in global demand for US dollars and in order to keep the fed funds rate stable the Fed has had to supply US banks with more liquidity. To do this, the Fed has been buying Treasury bills and short-term Treasuries in the open market and its balance sheet has grown. According to the Fed, this is a temporary change to its longer-term strategy of normalizing its balance sheet. But in terms of the impact on the banking system it is stimulus.

Brexit is Here
This week also includes the formal exit of the UK from the European Union. January 31, 2020 will also mark the start of an 11-month transition period during which the UK will follow all member guidelines while it begins the process of creating new regulations with the EU on trade, security issues, legal rights, data sharing, fishing water rights, aviation standards, electrical and power supplies and the licensing and regulation of medicines. Many are skeptical about the outlook for the British economy after Brexit, but we believe the UK may fare much better than most experts expect. In fact, we believe the UK could begin to rebound now that the uncertainty of Brexit is over, and the country has the ability to control its own economic destiny. If we are correct, this would be a positive for the global economy. 

2020 Review
Despite the killing of Iranian Major General Qassem Soleimani, the impeachment of President Donald Trump, the downgrade of global growth forecasts by the International Monetary Fund and the coronavirus outbreak, we see no reason to change our outlook for 2020. Our SPX target of 3300 is unchanged in the near term, but we remind readers that our valuation model allows for the possibility of SPX 3500 later in the year. However, it is has been our view that to move the equity market substantially above SPX 3300 it would require greater earnings confidence and more political clarity. Both could materialize later in the year. Meanwhile, our bullish long-term view is supported by a strong economy that includes record low unemployment, solid wage growth in excess of 3% year-over-year, near record high consumer confidence, strengthening household balance sheets and renewed vigor in the housing market. All these factors will support equity prices in 2020.

From a technical perspective, this pullback appears to be a normal and healthy pause in a bull market cycle. The indices continue to trade above key support levels and the NYSE cumulative advance decline line made a record high on January 17 in line with the record highs in the indices. In short, this suggests that the bull market remains intact and pullbacks represent buying opportunities.

Gail M. Dudack
Market Strategist

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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 judgement 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, 2020.
Wellington Shields is a member of FINRA and SIPC

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