Words with Impact
The last week of September had the potential to be a calm post-FOMC meeting interval with limited economic and earnings releases and no UA-China trade or Brexit deadlines. However, on Tuesday President Trump and Speaker Pelosi turned what could have been tranquility into turmoil.
In a speech to the UN, President Trump called out China and indicated Beijing had not only failed to keep promises it made in 2001 when it joined the World Trade Organization but China was engaged in predatory practices that had cost millions of jobs in the United States and other countries. Trump also indicated he was not interested in a “partial deal” to ease trade tensions with China, but that he would hold out for a “complete deal.” While President Trump’s criticism of Beijing may be well-earned, these sharp words are likely lowering the odds of a deal materializing in the fourth quarter. The equity market began to weaken.
Stocks began to fall in earnest once the media reported that House Speaker Nancy Pelosi would hold a press conference after the market’s close. As predicted, Pelosi announced that the US House of Representatives would launch a formal inquiry into whether President Trump should be impeached, declaring that no one is above the law. President Trump tweeted that his administration would release a complete transcript of a private call with Ukrainian President Volodymyr Zelenskiy that is at the center of the impeachment controversy. Still, this did not keep the market from closing with a decline of 142 points in the DJIA and 25 points in the SPX.
In the long run the events of the day may not result in any real economic impact; nevertheless, both incidents immediately put a dark cloud over the markets in the near term. The market is likely to trade in a SPX range of 2850-3050 in the short run as it assesses the impact Tuesday’s comments could have on the broad financial environment. However, there is no change in our SPX target of 3110 for 2019 which is based upon conservative fundamental inputs and forecasts. In recent weeks technical indicators have been distinctly bullish and we will be monitoring them closely to see if this week’s developments change, or reverse, these positive readings.
No Excesses in the Background
Although there were few economic releases in recent days, the Federal Reserve Board and the US Treasury released second quarter data on net worth, equity and Treasury ownership and sector debt levels. We found the numbers reassuring on many levels. Long secular bull market cycles, like the current one, tend to create extremes in terms of equity ownership and debt levels; but none of this was evident in any of the data. In short, while investors are focused on the politics of Washington DC and geopolitical strife between China and the US, the big picture shows that the current bull cycle may have many more months or years to go.
Equity ownership levels have been generally stable since 2009. Households own 36.8% of all US equities, which is just slightly above the 34.1% owned at the March 2009 bear market low. Foreign and equity mutual fund ownership has slowly declined in the same period. US Treasury ownership is far more complex; but foreign ownership of Treasuries rebounded recently after a decade of declines. See page 3.
While foreign ownership of US Treasuries has been waning in recent years, foreign net purchases of all US securities have remained positive, running at $152.2 billion in the twelve months ended July. In this period, foreign investors were larger net purchasers of agency and corporate bonds at $260 billion and $44.2 billion, respectively. Foreigners were net sellers of $97.6 billion of corporate stocks and $54.4 billion of US Treasury bonds & notes in the same timeframe. Note that this selling of stocks and bonds had no apparent impact on US markets and stock and bond prices rose in the last twelve months. See page 4.
In terms of US Treasury holdings, the Federal Reserve Bank is the largest holder with $2.1 trillion in Treasuries (September). Treasury data shows Japan ranked second in July with $1.13 trillion and China ranked third with $1.11 trillion in Treasury holdings. It may surprise most investors that Russia, not China, has been the largest single seller of Treasuries in recent years. Their Treasury holdings declined by $102.2 billion since the end of 2017. See page 5.
The performance of the equity market has been pivotal to household net worth in recent quarters. A 3.5% decline in household net worth in the fourth quarter of 2018 was a result of a 16% decline in equity value in the same quarter. But household wealth increased in 2Q19, boosted mostly by a gain in the value of directly and indirectly held corporate equities. Wealth increased from a revised $111.6 trillion in the first quarter (previously $108.6 trillion) to $113.5 trillion in the second quarter. On a year-over-year basis, household wealth was up 4.9% in the second quarter despite a small gain in household liabilities as home mortgage and consumer credit liabilities rose. But all in all, household balance sheets suggest the consumer is in good shape and should remain a key support for the economy. See page 6.
Debt Levels look Healthy
Debt levels can pose a problem at the end of an economic cycle; however, debt as a percentage of nominal GDP has been declining for all sectors in 2019. This improvement was particularly true for households where debt-to-GDP fell from 75% at the end of 2018 to 73.4% in June. See page 7. More importantly, Fed data shows that debt excesses that preceded the 2007 peak do not exist today. Household debt-to-disposable personal income averaged 131% from September 2007 to September 2009 and peaked at 133% in December 2008. This ratio fell to 95.6% in June. Mortgage debt as a percentage of disposable personal income was 63% in June versus its peak of 98.7% in December 2008. It is also worth noting that outstanding federal government debt has grown in the last three years, but this growth has been in line with the pace of annualized GDP growth. The fact that debt is not growing faster than the economy is a very positive trend. See page 8. In sum, the major sectors of the economy do not show the extremes in equity holdings or in debt levels that often appear at major tops in the market.
Technical Indicators are Looking Fine
Even without this week’s events we would not be surprised that equities are encountering resistance at the psychological SPX 3000 level. All indices are currently trading above their 200-day moving averages which is favorable, but we are watching the Russell 2000 index since its 200-day MA could be tested in coming sessions. See page 10. This week the 25-day up/down volume oscillator is 1.87 (preliminarily) and neutral after being overbought for eight of the previous ten trading sessions. This is the fourth overbought reading without an intervening oversold reading this year. Repetitive overbought readings are classic characteristics of a bull market cycle. See page 11. The A/D line made a record high on September 23, 2019, which is better than the performance of the major indices. With the indices now 2% to 4% below their record highs, the AD line is suggesting there will be new highs in the indices.
“Overweight”: Overweight relative to S&P Index weighting
“Neutral”: Neutral relative to S&P Index weighting
“Underweight”: Underweight relative to S&P Index weighting
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