0e2796d9-8ba9-47d9-827d-e6c1aad73712_Market-Update-December-3rd-2019.pdf
Market Update: December 3rd
The S&P 500 is currently on pace to have one of its best years since 2013 with a return north of 25%. The question on investors’ minds is – will the good times continue, or are we trading at the top? While many are hoping for a melt up or Santa Claus rally, we also saw the market approaching a bottom this time last year with fears of an economic slowdown.
The purpose of this update is to look at both sides of the argument on a deeper level and to provide indicators that we think are notable. First, we’ll explore the bear case, outlining the data points from both the economy and sentiment, which should be factored into any investor’s current game plan. Then we’ll look at the bull case, and finish up with a position update.
SECTION 1: Macro Outlook: Economic Inflection Point
Since the current business cycle began in 2009, we’ve currently had the longest expansion in U.S. history. However, within this expansion, we have had 3 mini-cycles that lasted between three to four years.
There are a number of ways to show these mini-cycles; however, the PMI over the prior 10 years provides a great visual.
United States ISM Purchasing Managers Index (PMI)
Chart Source: Trading Economics
The first cycle started in 2009, was derailed by the European Debt Crisis, and bottomed in 2013. The second cycle began in 2013, was stopped by the crude oil collapse and Brexit, and it bottomed in 2016. The current cycle began in late 2016 and was halted by the trade war, and the Fed’s tightening cycle.
The market is assuming a rebound in economic activity. Equities are always a leading indicator to economic activity, and the market’s answer to the above question is a resounding affirmation for a new mini cycle. The below chart shows the divergence between the ISM Manufacturing Index and the S&P 500.
Chart Source: Knox Ridley
SECTION 2: Earnings Slowdown
According to FactSet, 75% of the S&P 500 have reported a positive EPS surprise, which is above the five-year average. Total number of companies with sales above estimates is at 60% and is also above the five-year average. This can be misleading as the blended earnings decline is negative 2.3% and is the first time the index has reported three straight quarters of yearover-year declines since Q4 2015 through Q2 2016. It also marks the largest year-over-year decline in earnings since Q2 2016 at negative 3.2%.
FactSet also states that analysts are expecting a decline in earnings in the fourth quarter followed by 5-6% earnings growth for Q1 2020 and Q2 2020. The forward 12-month P/E ratio is 17.5, which is above the five-year average and above the 10 year average.
SECTION 3: CEO Confidence vs Consumer Confidence
Source: Lance Roberts
The above graph is important to consider. The orange line represents a collective of CEO confidence about the state and future prospects of the economy. The purple line represents how the average consumer feels about the state of the economy and its future. The grey line is the return of the S&P 500. The shaded gray bars represent recessions.
What’s notable is that the orange line consistently diverges downward long before the consumer realizes what is happening. Meanwhile, CEOs are paid very large salaries to forecast business revenue. CEOs are also experts in their sector of the economy, so it would make sense that CEO sentiment would precede economic slowdowns rather than consumer sentiment (which would react). They are our best insiders to the health of financials.
It’s also worth noting that consumer confidence peaks just before a recession, indicating exuberance for the economy before it reverses sharply. Today, there is a sharp divergence between CEO and consumer confidence. This divergence has historically taken years to unwind, but it’s worth monitoring that consumer confidence is at a cyclical high while CEO confidence is at a cyclical low.
SECTION 4: Technical Warnings – breadth signals
Over the last couple of weeks, we’ve had an unusual number of breadth warnings, which basically monitor the number of stocks participating in the rally.
There are 2 popular signals that have been good harbingers of, at minimum, a large correction in the past – the Hindenburg Omen and Titanic Syndrome. We have seen a cluster of such signals trigger ranging over the NYSE and NASDAQ. In fact, we had an extremely rare occurrence where seven Hindenburg Omens triggered in a row on the NASDAQ recently.
The below chart was comprised by Jason Goepfert of Sentiment Trader, and it shows the instances going back 30 years where we had a combined 10 signals over 7 sessions between the NYSE and NASDAQ. The red dots show when these occurrences happened.
Chart Source: Sentiment Trader
SECTION 5: Divergence in Semis
Chart Source: Knox Ridley
The above chart is showing the Philadelphia Semiconductor Index (SOXX) compared to the South Korean Kospi Index. South Korea is an economy that is fueled by some of the world’s largest semi-conductor companies, as well as many mid-level players. Companies such as Samsung, and SK Hynix supplied over 60% of the components used in memory chips sold globally in 2018. So, the KOSPI can provide more information about the global health of semiconductors.
As you can see, these indexes are typically correlated. Today, we are seeing the widest divergence between the U.S. semiconductor index and the Kospi. This suggests that one of these indexes will need to correct, and a divergence like this amongst highly correlated stocks rarely lasts.
SECTION 6: Macro Outlook: Risk-on Assets are Breaking Out
Chart Source: Knox Ridley
On a more positive note, looking back through the most recent market rebound starting in late December of 2018, there has been a number of divergences between risk on assets and the market. In other words, we saw classic risk off assets like gold and treasuries going up with the market.
Also, transportation stocks, small caps and financials were not participating in the recovery. This is important because these sectors indicate a growing economy, which is necessary for a continued market breakout.
Recently, small caps and financial broke out to all new highs. This is important, because it’s showing that economically sensitive segments of the economy are beginning to participate. Transportation stocks are still lagging, trending up and are not far from new highs.
SECTION 7: Housing
On another positive note, due to lower rates and easy money, housing has rebounded and doing quite well. We simply do not typically see housing report numbers like we are seeing today when a recession is on the horizon.
For example, New Home Sales are up +733,000 – best since 2007. Existing Home Sales Prices are up 6.2%. Building permits are up 5%, which is the best we’ve seen in 12 years. The Case-Shiller tracks 20 cities, and only San Francisco saw a year-overyear decline.
SECTION 8: Federal Reserve Policy
On October 8th, the Fed indeed announced they would begin expanding their balance sheet by buying $60 billion in treasury bills per month starting on October 15th and extending until at least mid-2020. They have injected hundreds of billions of excess capital into the system through a new on-going operation that they insist is not QE, but looks exactly like it. The reason for the actions is not as important as the results, which are higher asset prices for the time being.
This marks the end of the balance sheet shrinking. Over the past several weeks, the balance sheet increased by $324 billion, now exceeds $4 trillion and growing, which is four times higher than pre-crisis levels. At this pace, by mid-2020, we will likely be at new highs for the balance sheet.
SECTION 9: Record Outflows in Equity Mutual
Funds/ETFs
We are currently seeing record outflows from equity mutual funds and ETFs. This may seem counterintuitive with prices at all-time highs; however, this chart isn’t showing an exit from equities, just the mutual fund and ETF flows, which are predominantly the results of average investors and historically reflects the herd sentiment.
Furthermore, we are seeing very high short ratios in the NASDAQ (QQQ), which is also playing out across other major indexes.
Chart Source: Fintel.IO
The above chart shows that last week, between 12%-18% of all shares traded in the QQQ ETF, which tracks the NASDAQ, were short positions. This is an unusually high level of short interest, and this trend can be seen across the NYSE and S&P500 as well. The graph further shows that this trend has continued for most of 2019.
It may seem counterintuitive that high levels of short interest can be a bullish sign, but if the index fails to breakdown, this will cause the shorts to cover their positions, in turn, pushing the index up. Short covering can move stocks and an index in meaningful ways.
When we see a high level of short positions being taken across major indexes coupled with record level outflows in mutual funds and ETFs, it’s a contrarian indicator that stocks may have more upside in the near future.
In conclusion, these data points show that the case for the bulls and bears is equally strong today. Be careful of confirmation bias. If the market continues to move up, we will look to participate with tighter stops than we would normally do in a market with fewer warning signs.
SECTION 10: PORTFOLIO UPDATES
You can access the PDFs for these stocks that cover the fundamentals in-depth by clicking on the headlines below.
Zoom Video Communications (ZM) Zoom Video Communications (ZM)
Zoom retraced to its initial IPO price. It held and is now in an uptrend. The uptrend is overlapping, so it’s hard to get excited just yet. Also, it broke its new trend line to the downside on both price and RSI, confirming that the recent uptrend was corrective. I’m expecting more downside from ZM, will look to add in the mid to low $60s with a stop just below $59.90.
Zoom is also below its VWAPS, anchored at the all-time high and low, indicating that the bears are still in control. If ZM can break above the 50% retrace and its VWAPS, it’s a strong indication that ZM could see new highs. If you do want to play the long side today, I’d hold a stop just below its all-time low around $59.90.
Please keep in mind, Beth likes the fundamentals of Zoom as it’s growing 78% year-over-year from $330 million in annual revenue to an estimated $587 million-$590 million with gross profit margins in the 70-80% range. The company is profitable, which is rare among its SaaS peers. The business model has a viral mechanism, which helps drive adoption and retention. The valuation is high, as Zoom has the highest enterprise value to sales of any company over $500 million, and this is the company’s primary weakness.
Microsoft
MSFT was stuck in a multi-month consolidation range, while its cloud counterparts saw drawdowns. The RSI exhibited a coiling pattern while price elevated, indicating that it was preparing to make the next leg up. We then had a clear break out with both price and the RSI. It has commenced on the next leg up, trading above its 10-day EMA. A breakout like we see above is usually an indication of more upside.
We’re seeing a retest of prior support levels, which are currently holding. My current stop for this position is at $128.50.
As Beth has covered extensively, the market is underestimating the importance of hybrid cloud, which is where Microsoft concentrated their efforts and why the company won the Pentagon contract. These distinctions are important as cloud infrastructure is expected to grow from $73 billion in 2019 to $166 billion in 2024.
Roku Roku
The $162-$165 region has been problematic for Roku in the past, and we saw evidence of this again this week. My primary count still has Roku seeing more downside, but I will scrap that for the alt count if Roku can push above the current region. If it can break above this region with heavy volume, my next target is in the $220 region. Roku is a classic momentum play until we have a larger market correction, so tight stops that move up with the gains will be crucial.
Buying Roku between $120 to $162 has proven to be a gamble, and something we cautioned against in previous analysis. Buy-and-holds should look under $120 with the $100 mark being a steal.
Workday Workday
After hitting our stop, Workday then hit the upper mid our target zone for Wave 4, and the structure off the bottom is promising. It’s approaching heavy resistance, with fading volume and momentum. I favor more downside, before a breakout and have started layering in some longs. I will look to add on the next pullback, or if it breaks out, signaling a renewed uptrend.
Fundamental snapshot: Workday has beaten analyst estimates for twelve quarters in a row, and did again today. The company has not missed sales expectations since early 2014, according to FactSet. After adjusting for stock-based compensation, the company reported earnings of 53 cents per share, up from 31 cents per share in the same-quarter last year. Analysts had expected 37 cents per share on sales of $921 million, according to FactSet.
Alibaba Alibaba
Alibaba finally broke out of its year-long triangle pattern that we outlined twice over the months. The RSI broke into new bullish levels as Alibaba closed above $200. This is what we were hoping for when we wrote our analysis on the stock.
Today we are seeing a retest of the upper wedge range with a close above the support. I will be adding to my position in any market weakness. For the new shares that were added, hold a stop just under $160 or close out for 13-15% gains.
Nvidia Nvidia
Nvidia has been in a strong uptrend ever since breaking the $190-$200 resistance region we outlined in the prior report. It has broken through $200 with heavy volume, which favors the bullish scenario outlined.
The above chart shows Fibonacci price regions that will act as resistance for Nvidia to break. The $222 region has been important for Nvidia in the past, and it appears to have failed just under this level with a sharp reversal that broke through the base of its Bollinger Band. It found support at $200, with heavy volume coming into support this price. In short, we are range bound until one of these levels breaks. Below $197 and we could see a retest of the 200-day. My current stop for new positions is at $160. Anything close to this region should be considered a buy for long term investors.
Uber Uber
Uber is currently at major resistance and struggling to break out. The blue lines indicate a price cluster of Fibonacci relationships, which also coincides with the red trend line. If Uber does break above this region, we will take the final gains in our current short, and look to re-enter at one of the above blue zones on the chart.
Bitcoin Bitcoin
Bitcoin had a strong bounce from our primary target in the high $7,000 range, breaking above $9,000 and then giving us a head fake. My updated structure is above, and it appears that BTC may have one more leg down before a bottom. There were heavy sellers at the $8150 range and heavy buyers at the $6500 range. I would hold a hard stop at $4300 for any longterm longs.