S&P 500 Weekly Update: Irrationality Isn't Always Associated With 'Exuberance' And 'Euphoria'

Corrections only are considered “natural, normal, and healthy” until they actually happen. Tony Dwyer, Canaccord Genuity

Many like to take past economic and market environments and use them to forecast what will happen next. While I do employ past market seasonality and statistics to form an opinion, I also try to keep in mind that each economic cycle will have its own nuances and challenges.

The past can afford us an idea of the risks involved when investing in the markets, but it doesn’t tell you where and when those risks will come from going forward. Trying to predict the future is impossible. What is then left forces every investor to analyze the present, while understanding the past. You have to make high probability decisions in the face of uncertainty, but those probabilities aren’t etched in stone.

That sounds like a maddening challenge for market participants. Hence the wide spectrum of opinions that are handed out daily. This bull market cycle has perplexed many experienced investors. That is confirmed by the continued skepticism being shown for the better part of this cycle, and it continues today.

It is my conclusion that too many analysts have been trying to use their historical notes and theories for how they assumed the markets should react. Their signals and patterns haven’t worked as well as they once did in markets that have evolved in the past. Many are calling that this is the end of the bull market. In their view, it will coincide with the end of the business cycle.

What they have failed to see for years now is that there are no time limits imposed by these cycles. Ahh, but now they believe they have the Fed in their corner to deliver the knockout punch to the equity market. A rising rate environment. Maybe they do. The typical U.S. business cycle is ended by the Fed, which hikes rates to levels that are too high in response to inflation. Then again maybe these analysts are wrong again.

Seems to me the Fed is raising rates in response to an improving economy. While inflation may be lurking, it isn’t here to the point of concern just yet. Of course, those that have their minds set on the Fed spoiling the party will always tell us the Fed is already behind the curve. Problem is it was supposedly behind the curve in 2014!

The ability to remain flexible and evolve with the environment is key. I have concluded that the best way to do that is to follow what THIS market is telling you. Those who have been the most wrong seem to be the people or firms who are the most entrenched in their own views.

It might be better to take the view of how you would handle the market in the future than speaking to how you would have handled it in the past. Any issue that one wants to bring up and debate surely does matter, but only to the extent of what the stock market is telling us.

A PhD can write four pages on the negative aspects that can be seen now with the Fed, economy, interest rates and inflation, and if I see an uptrend that is firmly in place, I’ll put that article aside.

No matter how certain you are in your market views, no one really knows how things will play out. It is all about probabilities. In my experience, I can draw a profile and rate the probability of how a particular situation may or may not play out based on price action.

Now before any reader believes I have lost touch with reality and buried my head in the sand dismissing what is happening around me during the recent selling stampede, think again. In times of stress and irrationality, the place to look is the LONG-TERM trend. Otherwise you will be whipsawed just like many others who then let emotion rule the day.

Chart courtesy of FreeStockCharts.com

At the close of trading on Friday, the S&P closed 5% below its all-time high. I’m not sure what some pundits use to define a bear market, but that isn’t it. All we hear now is that it is the start of something more serious. There is ZERO evidence to support that claim. Drawing conclusions from any SHORT-TERM chart or any of the negative rhetoric is a fatal mistake.

Didn’t we just witness that at the beginning of this year? It’s easier to embrace that idea because it is based on fear. For most of this week, our fears were heightened because we are seeing the values of portfolios decline. When we are afraid, we act irrationally.

Remaining in control coincides nicely with the other important factor in forming my investment strategy. Keep it simple. Complex strategies may be fine for some, but the average Joe and Mary investor will have a hard time keeping it all together when the situation gets tumultuous.

After that is accomplished, you have to be willing to accept the old adage that it’s better to be roughly right than precisely wrong. Following the “fear” rhetoric has been a recipe for disaster.

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The economy clearly is performing at a higher level with the recent positive economic reports. In my view, that is the catalyst for the recent run-up in 10-year Treasury yields. With inflation stable, the bond market seems to be focused on re-rating U.S. economic growth higher. There is little credit risk present as high-yield spreads are making new cycle lows vs. Treasuries. Lower tax and regulatory burdens are also contributing to economic strength.

It’s all about what trade will do to everything we touch. It seems that many have already lost sight of the fact that a pro-growth business environment is very much in place here in the U.S.

The headline PPI decelerated again last month down to 2.73% year over year from 2.83% the month before. This continues a trend over the past few months of the headline measure surprising lower.

Core PPI which removes food and energy accelerated slightly to 2.48% year over year from 2.4%. A more refined measure of PPI excluding foods, energy, and trade services increased the most, up 3.02% year over year compared to 2.84% in August. This is the first time this measure of core PPI has been higher than the headline number since June 2017.

CPI rose 0.1% in September with the core rate up 0.1% too. CPI rose 0.059% and the core increased 0.116%. There were no revisions to August’s respective gains of 0.2% and 0.1%. The 12-month pace on the headline slowed to 2.3% y/y versus 2.7% y/y, and the core was steady at 2.2% y/y.

Michigan sentiment fell to 99 from 100.1 in September, but left the measure still above its 7-month low of 96.2 in August, and at an historically high level that lies below the 14-year high of 101.4 last March and the 100.7 peak in October of 2017, but above the peak before that of 98.5 in January of 2017.

A solid employment picture is removing a huge thorn on the side of the taxpayers.

Other programs like food stamps and welfare are also on the decline. These were issues that were not sustainable, and the reduction that we are seeing is a plus for the government, the average taxpayer and the economy. Funny how that doesn’t make the headlines.

Earnings Observations

The banks started off this earnings season, and as expected, there were positive reports. Consumer banking was solid at JPMorgan (JPM) as it beat on both the top and bottom line.

Citigroup (C) also reported a positive quarter as well. If investors want “value,” the banking sector represents the best value in the stock market today.

FactSet Research Weekly Earnings insight for Q3 2018:

  • Earnings Scorecard: With 6% of the companies in the S&P 500 reporting actual results for the quarter, 86% of S&P 500 companies have reported a positive EPS surprise and 68% have reported a positive sales surprise.

  • Earnings Growth: The blended earnings growth rate for the S&P 500 is 19.1%. If 19.1% is the actual growth rate for the quarter, it will mark the third highest earnings growth since Q1 2011 (19.5%).

  • Valuation: With the rout in stock prices this week, the forward 12-month P/E ratio for the S&P 500 is 15.7. This P/E ratio is below the 5-year average (16.3) but above the 10-year average (14.5).

Unless the earnings forecasts coming into this earnings season are totally wrong, corporations are making a lot of money because of the pro-growth backdrop that suddenly is being forgotten.

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The Political Scene

You wouldn’t know it with all of the focus on China these days, but in reality the tensions in the geopolitical environment have eased amid a reconfigured NAFTA. The EU negotiations are ongoing on the trade front with positives being reported. Analysts remain focused on the negatives, while dismissing the positives.

It fits nicely with the other negative commentary that is concerning investors.

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The Fed and Interest Rates

For those that think bond yields are “telling you something,” the same was said a month ago, when the UST 10-yr yield was declining to 2.8% and people were calling for disappointing data that could be a harbinger of economic weakness.

I have been adamant during this entre bull run that the bond market isn’t telling me anything at all. These comments are simply rolled out to fit the interest rate story of the day.

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From the AAII survey of individual investors, bullish sentiment had its largest one week drop since mid-November 2017, falling 15.05 percentage points. Bullish sentiment is now down to 30.6% from 45.66% last week. This is the lowest level for bullish sentiment since the first week of August, but it’s still pretty far from the lowest level on the year that we saw in April when it fell to 26.09%. Bull markets don’t end with this type of pessimism.


Crude Oil

The EIA weekly inventory report posted a larger-than-expected build in inventories of 6 million barrels for the week. Two large increases in a row totaling 14 million barrels. At 410.0 million barrels, U.S. crude oil inventories are at the five-year average for this time of year. Total motor gasoline inventories also showed an increase. Rising by 1 million barrels last week and remaining about 7% above the five-year average for this time of year.

The five straight weeks of gains came to an end as WTI closed the week at $71.51, down $2.83. Profit taking, bearish inventory numbers, or the fear of a global slowdown are all reasons for the selling, take your pick. Then again, perhaps it is just normal trading activity after five weeks of gains.

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The Technical Picture

October has not started out like many had envisioned. Initially we saw plenty of carnage under the hood as the indices were holding their own. That is not the case anymore. The market has narrowed. Since late August, even the strongest of the market breadth measures, the NYSE Daily Advance/Decline Line, has failed to confirm highs, while the weakest, 52-week highs and lows, has continued to erode.

Meanwhile, all of the cumulative Advance/Decline (A/D) lines were negative on a short-term trading basis. As we have seen in other major selling events, key support levels were taken out as if they weren’t really there at all. There remains a lot of negative energy out there, and it still could be released on the downside.

However, we are at an oversold level that usually indicates the selling is about to abate. Of interest is that the NASDAQ’s A/D line closed last week below its 200-DMA, which historically has signaled a short-term trading bottom.

The DAILY chart shows just how much short-term damage has been done. It also reveals how scary the price action looks compared to the S&P WEEKLY chart displayed earlier.

Just look over to the left of this chart. We have been here before, a wicked selling stampede, and the 200-day moving average is once again in play. This one is more of a surprise to me because the market was NOT wildly overbought like it was in January. I added another point on the chart indicating a severely oversold condition. These are points in time where we have seen rebounds.

Friday’s close was a small victory for the Bulls, a retake of the 200-day moving average (2,866) right at the close. I suspect that will now be the battleground in the next few days. The low that the Bulls will be defending is S&P 2,710.

So depending on your time horizon and station in life, this is as good a time as any to dig out the watchlists and the lists of stocks that were tossed away in the wild selling. Companies that were showing solid earnings growth and raising guidance are the babies that were tossed out with the bathwater in the last few days.

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Individual Stocks and Sectors

One of the best places to start looking for that baby that has been tossed out with the bathwater is to look at those companies that just reported solid earnings results. Take note of any company that raised their guidance last quarter.

Good fundamentals and good earnings will trump all of the issues that the market faces when it runs into one of these emotional selling stampedes.

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We’re now close to one half of the way through October, which has historically been a good month for equities. Not so this year. After watching what developed during the summer, I did have a sense that many pundits had it backwards this year. Far too many were telling investors to get out of stocks for the summer, based on historical patterns. The idea was to sit out the summer and come back on board in October.

That didn’t work. June, July, and August saw the S&P gain 7.7% and the Dow 30 post a 9+% gain. So while October isn’t over, all that believed October HAD to be bullish are getting a nasty surprise.

This bull market has been in force for years, yet some continue to highlight that ONE issue calling it the Achilles’ heel for stocks. Not so today, this time around they have a slew of issues that point to the end of the bull market story.

Each time any or all of these issues surfaced, they presented OPPORTUNITIES. Remember, this is exactly what happens during a bull market. As long as that primary backdrop remains, it will continue to play out that way. Those that abandon the trend before it changes are ALWAYS left in a quandary.

Anyone remember something called Brexit? This isn’t a one trick pony market, no matter what the skeptics try to sell. There are far too many positives, and no need for panic just yet. Remember, just a few short weeks ago, ALL indices were making new highs in sync. A Dow Theory buy signal was just generated. In the past, these signs led to much higher stock prices down the road. It would be unprecedented to have that across the board strength just disappear. So for those telling me that is THE top, I ask where is the evidence when no primary, intermediate- or long-term trend has been broken. While its prudent to remain vigilant and proceed with an open mind, this appears to be just a pause in the primary trend.

There is no playbook for stock market corrections. Every correction doesn’t have to turn into a crash. However, that’s a tough sell to investors watching the violent swings we have seen in the equity markets lately. You could make the case that we are in a different market environment now where the bears have control. Every single trading day seems like we see extreme selling going on in the final hours of trading that takes the major indices out at the lows for the day.

Bouncing off the lows and remaining in a trading range isn’t the worst thing now. Earnings season is on tap, and the economic data is still positive. The earnings picture is the brightest we have seen in a few years.

Of course, it is best to keep all options on the table. No one can predict the future, believe it or not, that includes the naysayers. The game to play is simple. Ask yourself WHAT is the PROBABILITY of an event, or issue that is troubling you, actually occurring? Hanging your hat on pure speculation, supposition, or a hypothetical isn’t the way to manage money.

What I also hear are the retorts from analysts indicating that they are searching for reasons why the stock market can’t go higher. Trust me when they do find them, the market will be higher and may be headed down. Failure to look at ALL of the data, issues, and the investing environment that exists is a recipe for disaster.

The long-term underlying trend is still in control. When that isn’t the case, changes will be made. Strong corporate earnings, and at the moment, low investor expectations, add to the positive outlook. Despite all the turmoil around me, I see no reason to abandon the trend and the Bull market. Therefore I remain invested and adding stocks when I see an opportunity.

I would also like to take a moment and remind all of the readers of an important issue. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore it is impossible to pinpoint what may be right for each situation. Please keep that in mind when forming your investment strategy.

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to all of the readers that contribute to this forum to make these articles a better experience for all.

Best of Luck to All!

Disclosure: I am/we are long JPM,C.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: My portfolios are ALL positioned to take advantage of the bull market with NO hedges in place.

This article contains my views of the equity market and what strategy and positioning is comfortable for me. Of course, it is not suited for everyone, as there are far too many variables. Hopefully it sparks ideas, adds some common sense to the intricate investing process, and makes investors feel more calm, putting them in control.

The opinions rendered here, are just that – opinions – and along with positions can change at any time.

As always I encourage readers to use common sense when it comes to managing any ideas that I decide to share with the community. Nowhere is it implied that any stock should be bought and put away until you die. Periodic reviews are mandatory to adjust to changes in the macro backdrop that will take place over time.