by Harry G. Katica, Saut Strategy LLC
September 13, 2019
For the Week Ended 9/12
Source: Finviz
The Bear Case
Despite its reputation as a portfolio killer, September has been a good month for US stock market so far. It’s two biggest challenges received good news over the past week. The Trade War with China has moved off the front-page headlines and seems to be headed in the right direction. Central bankers, starting with the ECB Thursday morning, are still inclined to provide more monetary stimulus. If everything goes according to the script, economically sensitive cyclical groups will lead the market higher, as they have the past week. Have the Bears retreated?
The answer depends on the response from the global economy over the next 3-6 months. Though most developed countries are experiencing slowing economies, positive news on Brexit and China trade took a deeper downturn off the table for now. The Bear case largely rests on weak economic reports, a negative turn on political events (Brexit, Hong Kong, Middle East), or an economy that is healthy enough to absorb higher rates. The verdict for these events could be a few months out.
Another concern that looms on the horizon is the impact of Quantitative Easing. If the world’s Central Banks can buy $15 trillion of government bonds with no economic impact, it would turn economic theory upside down. Now, instead of gradually unwinding, the Central Bankers are considering even more purchases. If successful, the economy will pick up and could experience greater inflation. If unsuccessful, the economy goes into a fledge recession and rates go down even further. It’s tricky.
At the very least, the large-scale purchase of government debt reduced their supply. During early August, demand for those bonds surged, as investors rushed out of equities on economic concerns. While most investors can stay on the sidelines, some must own bonds to provide pristine collateral in the repo market. They could be buyers at any level and may not care too much about the yield. Then there is the Central Bankers and their efforts to buy bonds. It could cause a short squeeze.
Maybe it did. If that is what happened a week ago Wednesday, it will be reflected in markets soon enough. It’s a coin flip whether these actions will ultimately lift or depress interest rates. Either is possible, depending on a series of unpredictable economic and political events over the next few months. When bonds do make another move, expect more volatility. If rates start to make sudden movements, it could put a scare into equity investors.
Source: Stock Rover
Sector Spotlight
Since the British Parliament postponed Brexit, risk on Cyclicals have been the best performing stocks. Defensive sectors, such as Consumer Staples, Utilities, and Real Estate, have underperformed the S&P 500 in the last week. This is typical behavior for an early cycle move. While it is too soon to see if the economy responds to stimulus measures, the stocks are following the early cycle playbook perfectly.
Other macro indicators are flashing more of a mid-cycle signal. As if on cue, Small Caps broke out to the upside on Monday. The Russell 2000 was one of the hardest hit equity averages during August, as economic slowdowns hit smaller companies (and banks) first. Large cap stocks with attractive dividends usually hold up better during downturns. It’s almost as if the computers decided to pile into small cap futures on Tuesday. Is it a positive signal about the economy?
A comeback in Value stocks has been another interesting development in this rally. Since January 2018, when the outlook for the global economy first came into in question, growth stocks, particularly those levered to the US consumer have done well, names like MSFT, AMZN, V, MA, GOOG, FB, etc. They broke trend in the last week. The rotation went into Small Cap Banks and Cyclicals may signal that institutional investors are re-positioning themselves for a recovery and higher rates. Will the economy come through?
Financials outperformed the S&P 500 over the last week, up 4.5%. This strong performance reflected an oversold condition for the sector, which has been battered by declining interest rates and an inverted yield curve since mid-July. Rates lifted during the past week, on rumblings of a Central Bank easing and a softish Brexit. The three key groups – Banks, Brokers, and Insurance – have all participated in the upswing. One of the largest sectors in the market, Financials may be needed to keep the averages chugging to more 52-week highs. Sentiment remains low.
XLF $28 Range $26 to $28.50. Point of Control $27.00. Support $26.00. Resistance $27.50.
Source Fidelity
The chart below shows the recent downtrend in Interest Rates compared to the rise of the $. While the currency usually runs in the same direction as interest rates, weakness in Europe (and Japan) and Brexit are pushing their rates down as well. Brexit may have a surprisingly large impact on recent capital flows, as investors seek to avoid parking funds in the UK with the risk of being frozen in. As a result, the higher rates in the US combined with the probability of a rising $ have created a profitable arbitrage spread with German bond. It’s hard to make this stuff up.
Transportation (DJI & IYT) stocks rose roughly 4% in the last week, as the hope for a recovery continues to spark the group. The gain came despite higher interest rates, which are usually bad news, perhaps because the direction of rates is now telegraphing the outlook for the economy. This trend did show some signs of fatigue Thursday, as Airlines, Air Freight, and Truckers started to underperform late in the day. It will be interesting to see how the group handles a further rebound in rates. Short term, a pullback of the sector would likely be the result of weaker economic reports. IYT $193 Range $175-$194. Point of Control $182.50. Support $191. Resistance $195.
Industrials increased 4% over the past week, outperforming the S&P 500. It now trades at the upper end of its range since January 2018. More compromising language out of the China/US trade talks and good news on the Brexit saga have boosted prospects for the economy, temporarily taking a deeper downturn off the table. Aerospace & Defense continues to lead the sector. Even BA has received good news. Building Products and Machinery also were up strong, indicating that investors are still willing to bet on a stimulus inspired recovery.
XLI $76 Range $73 to $79. Point of Control $75. Support $77. Resistance $80.
Materials outperformed the SPX over the past two weeks, as markets signaled a less bad economy and better news on China trade and Brexit. DD (Specialty) and DOW (Commodities) led the Chemical industry higher. Is it reflecting a better outlook for the economy or did interest rates go down for other reasons (Brexit)? If it was more of a technical adjustment, the move may be short lived. There was evidence of just that on Thursday afternoon. In a polarity flip, rising rates seemed to trigger a negative reaction. The same can be said of Transportation, Homebuilding, and Semiconductors.
Mining & Metals also experienced a trend change on Thursday. The group had been rallying since mid-August, as a beneficiary of more stimulus (which can lead to higher commodity prices). Economically sensitive metals like Copper (SCCO) and Aluminum (AA) could also face pressure if rates continue to rise. Even Gold Miners (GDX) played a different tune after another delay in Brexit, falling 15% since last Wednesday.
XLB $59 Range - $55.00 to $59.50. Point of Control $57.50. Support $57.00. Resistance at $59.
Energy was the top performing sector for the week, up 5.1% versus 2.2% for the S&P. The move was driven by slower production growth in the US and proposed cuts by Saudi Arabia, which lifted oil prices from $53 to $58 in five days. Oil Services and Equipment (OIH) jumped an impressive 20% in six sessions. Exploration & Production (IEO) was up almost 15% in the same period. Both were due for a pause.
The sector peaked Tuesday morning as crude rolled over and headed back to $54 on Thursday, the low end of its trading range. It seems like the fundamentals for oil keep deteriorating, making it difficult to beat the market for more than a few weeks at a time. If oil can level out around $55 for a few days, it might get interesting for a trade.
XLE $61 Range $56-$65. Point of Control $64. Support $59.00. Resistance $62.00.
As shown in the chart below, oil prices have consistently fallen since March, making lower lows on each successive cycle. Few experts expect materially higher prices anytime soon. That said, there have been several tradeable bounces for nimble traders.
Technology underperformed the S&P 500 in the last five days, up 1.8% compared to 2.2% for the S&P 500. The sector sold off sharply in the first week of August, initially on trade fears. Below the surface, big safe growth stocks like MSFT, V, and AMZN have barely participated since last Thursday since rates took off. Software and IT Services are still well below its July highs, in contrast to more economically sensitive industries. Is it possible that we are experiencing a changing of the guard?
Further confirmation can be found in the Cybersecurity and Cloud Computing groups, both facing challenges. Signs of a slowdown in data center growth do not sit well with momentum investors chasing the Cloud for revenue growth. A crowded competitive landscape is impacting security names. Both groups have high multiples, which are vulnerable to rate swings. It’s amazing how quickly things can turn around. Only the cyclical Semiconductor industry has kept Technology flirting with July highs.
XLK $82 Range $76-$83. Point of Control $79. Support $80.00. Resistance $83.00.
Communication Services may also be losing momentum. The sector is up 6% in the last three weeks, as it contains several of portfolio managers’ favorite large cap growth stocks – FB and TWTR. Both have been caught up in the growth stock selloff. Without the standout Q2 results from GOOG, the growth oriented Interactive Media group would be down instead of flat. In Entertainment, DIS has been held back by uncertainty surrounding Internet streaming services. Another interesting stock is SPOT, the streaming music service. The company has been billed as a winner in the streaming wars, and Apple’s announcement this week looks like it landed a blow.
XLC $51 Range $48-$52. Point of Control $49.50. Support is $49.50 Resistance at $52.00.
Diversified Telecommunication Services significantly outperformed the S&P 500 over the past week, as seen in the chart below. The group consists largely of T and VZ, which have both benefitted from the rush to safety during August. In addition, an activist investor has taken a large position in T and is angling for some changes to enhance shareholder value. This effort has pushed the stock close to $39, a price last seen in early 2018.
Consumer Discretionary has been one of the better performing sectors in the last three weeks, as it is widely considered a beneficiary of stimulus and an economic recovery. When rates were going down in August, Autos, Homebuilders, and Retailers got a lift. That has changed in the last few days, as rates have been ticking up. Momentum seemed to fade as the sector re-tested the highs from mid-July (well in advance of the S&P 500). Much of this underperformance reflects a poor showing from AMZN (25% of sector performance), which sold off on disappointing Q2 results.
XLY $123 Range $114-$124. Point of Control $119. Support $120.00. Resistance $124.00.
Hotels, Cruise Lines, and Leisure Products (PII and BC) represent other industries that rose on the stimulus talk and faded lately as interest rates tick up. Another interesting case is MCD in the Restaurant group. The stock went up in a straight line going all the way back to January, rising 29%. It was viewed as a safe growth stock during a period of economic uncertainty. After holding up through the August volatility box, the stock tumbled with other non-cyclical growth names earlier this week. COST also shows a similar pattern.
Health Care has been battling with proposed legislation and regulations that threaten to lower drug pricing. The WSJ even ran an article about proposed legislation to reduce drug prices. As a result, the sector has fallen more than the market since Spring and has been especially choppy for the last month. Exception for Equipment (Medical Devices), every group in the sector was down Thursday. Managed Care and Providers (i.e. Hospitals & Distributors) were both down over 1.0%. That is not good news for stocks like UNH and MCK.
XLV $90 Range $89-$94. Point of Control $89. Support $89. Resistance $92.
Consumer Staples underperformed the S&P 500 over the past week, as investors shifted focus to the Cyclicals. While the sector is down during this time, it snapped back quick in August and still sits close to recent highs. Key groups like Beverages and Food Products have been consistent performers since March. Interestingly, the beleaguered Agricultural industry has jumped over 10% on hoped Chinese buyers will return to the US farm products, such as soybeans and wheat.
Real Estate & Utilities are more tied together with Interest Rates than Staples. Both sectors outperformed the S&P 500 during August, as Defensive stocks provided an offset against a potential economic slowdown. Now that these fears have passed temporarily, investors have turned their nose. All three sectors were negative for the last week. REIT’s fell almost 4% since last Wednesday while Utilities dropped 1%. These groups could continue to underperform the SPX if the economy is expected to improve. As a result, we will watch them closely to identify any divergences.
Short Candidates
Source: Fidelity
