Apple, industrial activity, the jobs report

the Employment Situation

The Bureau of Labor Statistics made its monthly Employment Situation report this morning:  +312,000 new jobs, +58,000 upward revision to the prior two months’ data, annual wage gains of an inflation-beating +3.2%.  Yes, it’s just one month and, yes, the margin of error is +/- 100,000 jobs, but it’s still a very strong report, indicating a robust domestic economy.

 

Despite this show of employment strength, the stock market has been on a sharply downward path since late September.  What is the market thinking/anticipating?

–the 10-year Treasury, which was yielding 3.22% in late September now yields 2.56%;  the middle of the yield curve is now mildly inverted.  This suggests bond buyers believe a marked slowdown in economic activity in the US is in the offing–one that will force the Fed to soon begin to lower short-term interest rates again.  Why would that be?

–the Trump tariff war with the rest of the world seems to be affecting publicly traded companies much more negatively than one might have imagined

–only about half the earnings of the S&P 500 come from the US.  Both the EU, dealing with Brexit and Italy, and China are slowing down

–some pundits argue from the bond market situation that the Fed is the problem, having –they think–raised short-term interest rates too far.

 

Two pieces of data from yesterday seem, on the surface at least, to reinforce the sharp slowdown narrative:  Apple (AAPL) and business investment activity.

AAPL

–AAPL announced Wednesday night that its December quarter revenues would be about 8% below the midpoint of the guidance it gave in October.  What makes this significant, besides AAPL’s size, is that the company rarely misses its quarterly estimates.

Two reasons given:  falloff in sales in “greater China” and slower than expected takeup of the newest generation of iPhones by existing customers (the smartphone market is completely saturated–there are no more “new” customers).  Neither reason is clearly a sign of broad-based consumer distress, however.

AAPL recently said it would no longer reveal unit sales of its smartphones, a decision I take to mean it intends to make revenue gains through price increases rather than unit volume gains.  Is the slowdown in replacement demand caused by economic weakness or AAPL pricing new phones so high that other, cheaper phones are suddenly more attractive?

Also, the latest issue of Foreign Affairs reports that popular sentiment in China has turned sharply against the US in the past half year or so as Washington initiated its tariff war.  Maybe, in addition to higher prices, flaunting the newest iPhone is no longer as culturally acceptable in China (think:  the century of humiliation), as having a home-grown product.

ISM

–the Institute for Supply Management issued its monthly report on US manufacturing activity yesterday.  It shows a continuing slowdown in industrial activity.  The reason most often cited in survey respondents’ comments is the administration’s tariff war.  Manufacturers are, predictably, shifting production out of the US to avoid import tariffs on raw materials and export tariffs on finished goods.

It’s important to remember, too, that manufacturing is not the key to US economic strength that it was a generation or two ago.  Spending on software is the largest investment item for most service companies.  Yes, this activity is also being shifted abroad as the administration makes it more difficult for foreign-born computer scientists to work in the US.   But I don’t think the ISP report is “new” news, so I’m not sure why it had such a negative effect on the market yesterday.

my take

In the short term, figuring out the root cause of the worries about the US economy is probably less important than trying to gauge how far along in the selling we are now.  Better to figure out when the storm will be over than debate the direction of the wind.  My guess–and it may be more of a hope–is that we made the lows on Christmas Eve when stocks broke decisively through the February 2018 lows.

Personally, I think the ultimate problem is Washington and the tariffs, not the Fed.  I’m all for protecting US intellectual property, but the levies on, say, steel and aluminum seem so arbitrary and generally harmful.  In a way, it would be a lot better if the Fed is the issue, since then the problem would be a familiar one, the market situation clearer and the fix relatively easy.

 

 

 

 

 

stock market issues for 2019

I see four main issues, which–now that I’m on semester break–I’m planning to write about over the next few days.  They are:

machines vs. humans.  This is the question of increased short-term volatility.  How do we cope with the apparently mad dashes in and out of the market by trading robots using, by historical standards, half-baked trading algorithms?

 

decelerating earnings growth.  EPS growth in 2018 for publicly traded companies was around +20%.  Increases for 2019 will likely come in at +8% – +10%.  This kind of sharp falloff is normally a bad sign for stock prices.  In the current case, however, the 2018 EPS surge is only in after-tax earnings and is due mostly to the one-time decrease in the Federal corporate tax rate from 35% to 21% that went into effect last year.   Pre-tax earnings grew at a much more sedate rate of around 10%, I think.  While the 2019 situation isn’t wildly positive, it would seem to me to imply a flattish market where the investor’s job is to identify areas of potential strength to buy and areas of potential weakness to avoid.

But is this the way algorithms will operate?

 

the business cycle and interest rates.  Typically, the Fed raises short-term rates when it perceives the economy is overheating.  Higher rates make bonds less attractive.  They make other financial instruments, like stocks, less attractive, too.  But the negative effect of higher rates is offset by surging earnings growth.  Is +10% enough to do the job in 2019?

 

–tariffs.  (A side note first:  it seems to me the Trump administration argument that it can usurp Congress’s power to set trade policy because everything economic is a matter of national security is ludicrous.  Not a peep from Congress, though.  To me, this implies that Mr. Trump is simply the spokesmodel for policies the forces in Congress want enacted but don’t want to be held responsible for.)

Tariffs have, at best, a checkered history.  They invite retaliation.  They have unforeseen/ unintended negative effects: Apple’s preannouncement of weaker than expected results in its current quarter may only be the first.   In addition, the rapid and seemingly arbitrary way tariffs have been enacted in the US has already given both domestic and foreign corporates pause about expanding operations here.  One thing is certain, though –tariffs slow economic growth.  The question is by how much and for how long.

 

the independence of the Federal Reserve.  By conventional measures, there’s still too much money sloshing around in the US.  So there’s every reason for the Fed to continue to shrink its bloated balance sheet and to slowly raise short-term interest rates (the specter of Japan’s three decades of stagnation–resulting in large measure from saveral bouts of premature policy tightening–continues to be a cautionary tale against moving too quickly).  Because of this, Mr. Trump’s musing about firing Jerome Powell has a distinctly Nixonian ring to it, conjuring up echoes of the runaway inflation and currency collapse in the US of the 1970s.  From a stock market point of view, threatening the Fed may be the single most damaging thing Mr. Trump has done so far.

 

More details over the next few days.

technical analysis–November 20th

During the course of trading on Tuesday of last week, the NASDAQ 100 touched the closing (though not the intraday) lows of February, before rebounding sharply.  Simultaneously, the S&P 500 did a similar thing, only its stopping point was the higher lows of April.

 

It looks increasingly likely to me that this action is going to serve as the marker for a selling climax–the point where short-term speculators feel all hope of a rebound is lost and dump out their holdings in a final surge of selling with little regard for price–for the market downturn that began in October.

This positive sign for the market has been reinforced by the statements of influential Fed members that short-term interest rates are presently just below neutral, meaning that that body sees little need to continue to push them upward.

Barring any further damage to the economy from Mr. Trump’s bizarre tariff policies, it looks like we’ll enjoy enough market stability for us to return to the business of picking stocks.

how the market looks to me today

It may be that the market downdrift we’ve been experiencing since early October started out as a bout of yearend mutual fund selling, as I’ve been writing for a while.  Maybe not.  In any event, the selling has continued for far longer than the mutual fund hypothesis can explain.

It may be that the market has been thinking that the prices of IT-related shares had gotten far too high, given their earnings prospects.  Strike out the “far” and I’d have to agree; in my mind, the big issue preventing at least a temporary market rotation away from tech has been, and remains, what other group to rotate into.

It’s also possible that the operative comparison has been between stocks and bonds.  The ongoing upward yield curve shift now has short-term Treasury notes yielding around 2.5% and the 10- and 30-year yielding above 3%.  Arguably this is a level where income-hungry Baby Boomers could feel they should allocate somewhat away from stocks and into fixed income.

Whatever the market’s motivation, however, I’m sticking with my idea that the S&P bottomed on October 29th.

 

Many times, when the market has hit a low and has begun to rebound, it will reverse course to “test” the previous low.  Also arguably, that’s what has been happening over the past week or so–formation of what technicians in their arcane lingo call a “double bottom.”  The main worry with this idea is that two weeks after the initial low is an unusually short time for the double bottoming to be happening.  Still, it’s my working hypothesis that this is, in fact, what’s going on.

The things to monitor are whether the market breaks below the late October low and, if so, whether it breaks below the April or February lows.

 

Another topic:  oil.  Crude oil and oil stock prices have been plunging recently.  Most non-US producers added extra current output to offset the assumed negative impact of the US placing renewed sanctions on the purchase of oil from Iran.  At the last minute, however, Washington granted exceptions to large purchasers of Iranian crude.  Because of this, oil has continued to flow in addition to the extra oil from OPEC.  Since demand for oil is relatively inflexible, even 1% – 2% changes in supply can cause huge changes in price.  Whether or not the US deliberately set out to deceive OPEC and thereby cause the current oversupply, the price of oil is down sharply since the US acted.

Saudi Arabia and Russia have just announced supply cuts.  Given that Feb – April is the weakest season of the year for oil demand, it’s not clear how long it will take for the reductions to lift the oil price.  It seems to me, though, that the more important question is when rather than if.  So I’ve begun to nibble at US shale oil producers that have been flattened since Washington’s action.

all clear?

My worst flaw as an investor–at least, the worst that I’m aware of–is that I’m too bullish.  So I have to be careful at a time like this when the stock market has been on a downtrend, to ensure that I don’t call a tactical bottom too early.

I should also point out that mutual funds have most likely been out of the market for the past few days, so the wicked intraday spikes we’ve been seeing in recent trading are more likely the work of algorithms than humans.  So the end of the mutual fund fiscal year is in itself no reason for these swings to stop.

Still, it looks to me as if the lows the market established early in 2018 are holding.  Also, many tech stocks, having lost a third of their value, are beginning to move up on what seems to me to be the flimsiest of positive news–a so-so earnings report or an upgrade by a brokerage house analyst.

So my guess is that the worst is over and that stocks will go sideways to up from here.

 

Several things to note:

–intraday swings have been unusually large, based on past instances of correction.  This may just be what machine-driven markets look like

–a change in market leadership often occurs after a correction.  I’m not sure what that would be in this case.  I’m still thinking that IT will lead, noting, though, that chip manufacturing businesses appear to be entering one of their periodic phases of oversupply (driven by the fact that capacity is added in huge chunks, and usually by everyone at the same time)

–the long-term economic negatives recently created by Washington–large-scale deficit spending; emphasis on reviving older, inefficient industries; policy directed at breaking down global supply chains–haven’t gone away.  The considerable social/cultural damage being done by the administration hasn’t, either.  At some point, these factors will begin to retard stock market progress, although they may be issues for 2019.