I’ve just updated my Keeping Score page for S&P 500 performance in June, 2Q18 and year to date.
Two factors are moving the Energy sector higher. The obvious one is the higher oil price during a normally seasonally weak time. In addition, though, the market is actively looking for alternatives to IT. It isn’t that the bright long-term future for this sector has dimmed. It’s that near-term valuations for IT have risen to the point that Wall Street wants to see more concrete evidence of high growth–in the form of superior future earnings reports–before it’s willing to bid the stocks significantly higher. With IT shunted to the sidelines for now, the market is not being a picky as it might be otherwise about alternatives such as Energy and Consumer discretionary.
The fancy term for what’s going on now is “counter-trend rally.” It can go on for months.
As to the oils,
–a higher crude oil price is clearly a positive for the exploration and proudction companies that produce the stuff. In particular, all but the least adept shale oil drillers must now be making money. This is where investment activity will be centered, I think.
–refiners and marketers, who have benefitted from lower costs are now facing higher prices. So they’re net losers. Long/short investors will be reversing their positions to now be short refiners and long e&p.
–the biggest multinational integrateds are a puzzle. On the one hand, they traditionally make most of their money from finding and producing crude. On the other, they’ve spent very heavily over the past decade on mega-projects that depend for their viability on $100+ oil. This has been a horrible mistake. Shale oil output will likely keep crude well short of $100 for a very long time.
Yes, the big multinationals have all taken significant writeoffs on these ill-starred projects. But, in theory at least, writeoffs aren’t supposed to create future profits. They can only eliminate capital costs that there’s no chance of recovering. As these projects come online, they’ll likely produce strong positive cash flow (recovery of upfront costs already on the balance sheet) but little profit.
The question in my mind is how the market will value this cash flow. As I see it–value investors might argue otherwise–most stock market participants buy earnings, not cash generation. Small companies in this situation would likely be acquired by larger rivals. But the firms I’m talking about–ExxonMobil, Shell, BP…–are probably too big for that. Will they turn themselves into quasi-bonds by paying out most of this cash in dividends? I have no idea.
—–why fool around with the multinationals when the shale oil companies are clear winners?
—–as/when the integrateds start to show relative strength, we have to begin to consider that the party may be over. So watch them.
August is the month when many senior portfolio managers are away from the office on vacation. So big decisions on portfolio structure tend not to be made.
Friday is the day of the week when short-term traders’ thoughts turn to flattening their books so they won’t carry risk over the weekend.
It’s raining, which sparks thoughts in traders of sleeping in or leaving work early.
Add all that up, and the heavy betting should be that US stocks will likely move sideways in the morning and fade off toward the close.
That means this is a good day to stand on the sidelines and size up the tone of the market.
In pre-market trading, tech is up and bricks-and-mortar retailing (on the earnings miss by Foot Locker) is down. …nothing new about this. At some point there will doubtless be a fierce counter-trend rally. But the negative earnings surprises are still provoking severe selloffs. So I don’t think today is the day.
Pundits are speculating about the damaging effects on his political agenda of Mr. Trump’s apparent defense of neo-Nazis in Charlottesville. …but the Trump trade has been MIA since January, with the US a laggard among world stock markets during Mr. Trump’s time in office so far. Yes, there may be residual hope for corporate tax reform from the administration, which this latest demonstration of the president’s ineptness as a executive could arguably undermine. My guess is, however, that he is already well understood.
Two questions for today:
–will the market perform more strongly than the season and the weather are suggesting? This would be evidence that there’s still an untapped reservoir of bullishness waiting for somewhat better prices to express itself.
–should we be buying in the afternoon if it’s weaker than I expect? My answer is No. I think there is a lot of untapped bullishness, but we’re in a slowly rising channel whose present ceiling is less than 2500 on the S&P 500. That’s not enough upside for me. I’m also content to wait for any incipient bearishness to play itself out further.
It will be interesting to see how today plays out.
Last Friday the S&P 500 opened at 2436, rose to 2446, fell to 2416 and rallied at the end of the day to close little changed at 2432. Volume was maybe 10% higher than normal. Sounds ho-hum.
Look at Financials, Energy or Technology and the story isn’t one of a sleepy summer-like Friday. It’s violent sector rotation instead.
According to Google Finance, the Energy sector was up by +1.4% for the day and Financials by +0.8%. Technology fell by -2.7%.
But that understates what happened beneath the calm surface.
Oil exploration and production stocks, which have been in free fall recently, rallied by 4% or more. Large internet-related names fell by an equal amount. Market darling Invidia (NVDA) rose by 4% in early Friday trading, then reversed course to fall by 15%, and rallied late in the day to close “only” down by 7%+. That came on 5x recent daily volume.
What’s going on?
Well, to state the obvious, Friday’s stock market action in the US runs counter to recent trends. To my mind, the aggressive buying and selling are both based on relative valuation rather than any sudden change in the fundamental prospects for any of the companies whose stocks are gyrating around. It’s an assertion by the market that no matter how grim the outlook for oil, the stocks are too cheap–and no matter how rosy the future for tech, the stocks are too expensive.
This is part and parcel of equity investing. There’s always someone, usually with a long investment horizon, who is willing to bet against the current trend, on grounds that current price movements are being driven by too much emotion and not enough by dollars and cents.
What’s unusual about last Friday, to my mind, is how sharp the division between winning and losing sub-sectors has been and how aggressively stocks have been both sold and bought.
For what it’s worth, I also think it’s odd that this should happen on a Friday. Human buyers/sellers of this size tend, in my experience, to worry about whether they can execute their plans in one day, preferring not to let the competition mull the situation over on the weekend. But that’s a minor point. (One could equally argue that if the buyers/sells were looking for maximum surprise, Friday would be the ideal day to act.)
If this is indeed a counter-trend rally, meaning that after a period of valuation adjustment the prior trend will reassert itself (which is what I think), the most important investment question is how long–and how severe–the pro-energy, anti-tech rotation will be.
My experience is that it’s never just one day and that a counter-trend movement can run for a month. On the other hand, this doesn’t look like the typical work of traditional human portfolio managers. It looks to me more like trading done by computers. If that’s correct, I’d imagine the buying/selling will cut deep and be over relatively quickly. But that’s just a guess. And I know my tendency in situations like this is to act too soon.
For myself, I’ve been thinking for some time that US oil exploration companies have been battered down too much. As for tech, I still think it will be the most important sector for this year. So I’m happy to use this weakness to rearrange my overall holdings, nibbling at the fallen tech names and offloading a couple of REITS I own that I think are fully valued.
I’ve just updated my Current Market Tactics page.
the Trump rally
From the surprise election of Donald Trump as president through late December 2016, the S&P 500 rose by 7.3%. What was, to my mind, much more impressive, though less remarked on, was the 14% gain of the US$ vs the ¥ over that period and its 7% rise against the €.
Since the beginning of 2017, the S&P 500 has tacked on another +4.9%. However, as the charts on my Keeping Score page show, Trump-related sectors (Materials, Industrials, Financials, Energy) have lagged badly. The dollar has reversed course as well, losing about half its late-2016 gains against both the yen and euro.
Where to from here?
The happy picture of late 2016 was that having one party control both Congress and the administration, and with a maverick president unwilling to tolerate government dysfunction, gridlock in Washington would end. Tax reform and infrastructure spending would top the agenda.
The reality so far, however, is that discord within the Republican Party plus the President’s surprisingly limited grasp of the relevant economic and political issues have resulted in continuing inaction. The latest pothole is Mr. Trump’s refusal to release his tax returns–that would reveal what he personally has to gain from the tax changes he is proposing.
On the other hand, disappointment about the potential for US profit advances generated by constructive fiscal policy has been offset by surprisingly strong growth indications from Continental Europe and, to a lesser extent, from China.
This is why equity investors in the US have shifted their interest away from Trump stocks and toward multinationals, world-leading tech stocks and beneficiaries of demographic change.
The case for dollar strength has been based on the idea that new fiscal stimulus emanating from Washington would allow the Fed to raise interest rates at a faster clip this year than previously anticipated. Washington’s continuing ineptness, however, is giving fixed income and currency investors second thoughts. Hence, the dollar’s reversal of form.
Absent a reversal of form in Washington that permits substantial corporate tax reform, it’s hard for me to argue that the S&P is going up. Yes, we probably get some support from a slower interest rate increase program by the Fed, as well as from continuing grass-roots political action that threatens recalcitrant legislators with replacement in the next election. The dollar probably slides a bit, as well–a plus for the 50% or so of S&P earnings sourced abroad. But sideways is both the most likely and the best I think ws can hope for. Secular growth themes probably continue to predominate, with beneficiaries of fiscal stimulation lagging.
Having written that, I still think shale oil is interesting …and the contrarian in me says that at some point there will be a valuation case for things like shipping and basic materials. On the latter, I don’t think there’s any need to do more than nibble right now, though.
Jim Paulsen, equity strategist for Wells Capital Management, an arm of Wells Fargo, gave an interview on CNBC yesterday. It’s well worth listening to.
His main points:
–the stock market decline we’ve seen since November is all about adjustment to lower future earnings growth prospects. This is being caused by the resumption of “normal” growth as the bounceback from deep recession is completed. Another aspect of the return to normal is the economic drag from gradual end to extraordinary monetary stimulus, at least in the US.
In Mr. Paulsen’s view, the S&P 500 can trade at 16x trailing earnings in this new environment, not the 19x it was at two months ago.
–we may have seen the lows for the year last Wednesday at midday (1812 on the S&P 500). More likely, the market will revisit those lows in the near future. It will break below 1800 on the S&P, creating a fear-filled selling climax.
–assuming, as he does, that the S&P will end the year flat, i.e. around the 2044 where it closed 2015, a buyer at yesterday’s close would have a 9% return (11% dividends) from holding the index by yearend. A buyer at 1800 would have a compelling 14% (16%) return. 11% might be enough to attract buyers; 16% surely will be.
–2017 will be a stronger year for earnings growth than 2015, implying that the market will rise further as/when it begins to discount next year’s earnings growth.
–the current selloff will trigger a market leadership change. The new stars will likely be industrials, small-caps and foreign stocks.