Bad Woosh!

I update each Saturday with my view of the stock market for the next few weeks.  The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a crash, and buy back in for most of the next bull market.  You can always scroll down a few weeks and find the latest “Long Term” update.

If you lose your bookmark to the blog, google “Rich Investing” and it should show up on the first page or so.  The more often you google it and hit the link, the higher it will show in your results.

Economy:

New-home sales ran at a seasonally adjusted annual rate of 553,000 in September, the Commerce Department said Wednesday, swooning to the lowest since December 2016.  September’s selling pace of 553,000 was 5.5% lower than in August, and 13.2% lower than a year ago while the median price dropped 3.5% to $320K.  Initial jobless claims rose by 5,000 to 215,000 in the week that ended Oct. 20, still near a 50 year low (initial jobless claims is a “trailing indicator”, the economy goes bad, then employers lay off workers).  Durable goods orders increased 0.8% in September, the third gain in the last four months, but excluding defense spending they fell .6%.  Gross domestic product (GDP) decelerated a bit to a 3.5% annual pace in the third quarter, a drop from last quarter’s 4.2%, but still the fastest six month gain in 4 years.  Below the headline number, there is a slowdown in business investment.  Businesses hate uncertainty such as the trade war with China, and in the face of uncertainty they stop committing capital to new projects until the situation stabilizes.  The final reading of the University of Michigan’s consumer-sentiment index in October was 98.6, marginally below September’s level of 100.1.

Things look generally good, but housing is a definite concern.  One might think that the slight uptick in mortgage rates to 5% on a 30 year fixed is not too bad, we have seen rates that high before (my second house in 1978 the mortgage was 8.25%, but a nice 2400 sq. foot new house only cost $75K).  But due to housing inflation greatly exceeding the general inflation rate, we have not seen these higher rates when the median selling price is $320K.  Housing is a huge important sector of the economy and when it slows, it backs up into the rest of the economy.

With the drop in the stock market, the trade war with China, the Fed raising interest rates, a slowdown in housing and the slight drop in consumer sentiment, the headwinds are building for the economy.

Geo-Political:

Let’s take a look over at Europe as Mario Draghi just gave an update on economic activity on Thurday.

“Oct. 25, 2018 – Rising interest rates. Brexit. Trade tensions. The danger that Italian banks could become victims of their government’s war of words with the European Commission.

All these risks have helped roil stock markets in recent days, Mario Draghi, the president of the European Central Bank, acknowledged on Thursday.

But none of those hazards were enough to budge Mr. Draghi or the bank’s Governing Council from their conviction that the eurozone economy is fundamentally solid.

That message — that the eurozone economy is growing less briskly, but is not on the verge of recession — was perhaps the main point of Mr. Draghi’s news conference in Frankfurt after a meeting of the bank’s Governing Council.

The council left its benchmark interest rate unchanged at zero and made no changes to its timetable for slowly withdrawing economic stimulus.”

https://www.nytimes.com/2018/10/25/business/european-economy.html

That generally sounds good.  BUT….

Growth is slowing in Europe, do not miss that message, and they are still on schedule to end their QE bond buying program by December.  That will suck up private capital and reduce liquidity to buy the bonds that the ECB formerly bought.

Growth is slowing in Europe, growth is slowing in China.  Growth slowed in the US from 4.2% GDP in Q2 to 3.5% in Q3.  The US has launched a trade skirmish with Europe and a trade war with China.  Guess what, that is not good for business, and what is not good for business is not good for the stock market.

The real debate for the US economy is what will be the long term impact of the Trump tax cut?  The republicans tell us that growth will be accelerated from 2% to 3% on a long term basis and that change will allow us to grow out of the awful $800 billion budget deficit that CBO projects will be $900 billion for 2019 and $1 trillion in 2020.  Many economists argue that the CBO is right, that the tax cuts will produce a temporary “sugar high” in the economy where corporations and individuals see a difference in their cash balance and spend some of that, boosting the economy.  But after that initial surge in spending, it will become life as normal and no longer boost economic activity higher than the level initially reached, so after a year, no higher growth.  From corporations, most of the money is going to buying back their own stock, which they do to cover up the looting of the companies through stock dilution by top management in their excessive stock option programs (issuing new shares that primarily go to top management).  We won’t know the answer to that question for two more years, we’ll just have to watch the GDP numbers.

Technical Analysis:

The week just ended was rough, down 3.6% on the S&P.  Clearly there is a correction going on, or did a bear market just start?  We don’t know right now but this late in the expansion it is prudent to ask that question and be prepared to deal with it if that is what is going on.

A bear market starts when the last stock market cycle high is hit, not necessarily when the recession starts (when GDP goes negative for 2 consecutive quarters is the standard definition of a recession).  Leading up to the financial crisis, the market peaked in Dec. 2007, but the recession did not start until the spring of 2008, since Q1 of 2008 had positive GDP.  The stock market is a forecasting mechanism, looking ahead about six months usually.  The pros have access to tons of data and they watch for small changes in key indicators that they believe forecast what is to come, but is not yet apparent to those that just watch the larger “headline” numbers.

Technically, the market is in a precarious position.  The market is down 9% from its recent high, and closed the week near its closing low for the week.  We have not found stability.  Relative strength (the RSI index at the top of the chart) is at 30 which is oversold.  In a bull market buying in at oversold areas usually turns out well, see the occurrences this year in Feb. and March.  The question is, are we still in a bull market?  No new base has formed and with the concerns discussed in the previous section (Geo Political), it is too early to make a bet on a turnaround in the market.  Momentum measured by MACD at the bottom of the chart is very negative and there is no bottoming in sight.  Price action is very negative, having violated support at 2700 at the early July low.  The next support is back at the early April low of 2580, another 80 S&P points down, roughly another 3%.  I don’t know if we’ll go down and test it, and if we do, whether that support will hold.  We’ve broken down on every other traditional support level, the 50 day moving average, the 200 day moving average (a very important one), and the bottom of two uptrend channels.  It is an ugly picture right now and there is no motivation to invest right now.

2018 10 27

Click THIS LINK to open the chart in a separate window.

I sold out of the market midweek according to the observation I made last week.  I took a hit like everyone else who is in the market.  I hate to sell in a correction panic, but this late in the expansion and with the headwinds we’ve discussed on rising interest rates, trade wars, housing weakness, the irresponsible expansion of the US budget deficit, slowing growth in Europe and China, the risk of a recession in 2019 or 2020 comes into possibility.  Will it happen, I certainly don’t know.

I bought a 1 year brokered CD at Fidelity at 2.7% interest with some funds (it pays monthly).  The money market is paying 1.7%, so that gets me a 1% premium.  The Fed has said it will raise rates in Dec. and 3 times next year, so this CD will outperform the MM all year, and it’s fully FDIC insured.  If a recession hits, I only want to be in top quality bonds, Treasuries or FDIC insured CD’s.  Rates are finally getting to the point that they provide an alternative to stocks.  It’s not a great alternative, but its light years ahead of 0% we got in the MM the last 5 years.

FDIC insurance is up to $250,000 per bank on brokered CD’s, so if you invest more than that, use multiple banks.  At your local bank, FDIC insurance can be higher than $250K if you properly register the holders of the CD, so one held in joint names such as “John and Sally Smith” is eligible for $500,000 insurance.  One “badged” as “John and Sally Smith, pay on death to Rover Smith” is eligible for more.

From the FDIC website, and talk to your local bank:

Q: Can I have more than $250,000 of deposit insurance coverage at one FDIC-insured bank?

A: Yes. The FDIC insures deposits according to the ownership category in which the funds are insured and how the accounts are titled. The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category. Deposits held in different ownership categories are separately insured, up to at least $250,000, even if held at the same bank. For example, a revocable trust account (including living trusts and informal revocable trusts commonly referred to as payable on death (POD) accounts) with one owner naming three unique beneficiaries can be insured up to $750,000.

https://www.fdic.gov/deposit/deposits/faq.html

I saw a speaker on CNBC talking about stock market returns and he pointed out that the average annual return on stocks since 2000 has been 3.5% a year, but with a lot of volatility.  It makes that 2.7% safe return look not so bad.  We all need to reconsider how much we should have in fixed income now that the return is somewhat reasonable.  I do not like bond funds in a rising rate environment.  I prefer an individual bond or CD, relatively short term where I pick the maturing date.  I will allow the Fed to make its projected rate hikes, then reinvest at the higher rate later.  By the way, there is no guarantee that the Fed will raise 4 times in the next 15 months because if weakness persists the Fed would probably stop the hikes.

Regarding the CNBC speakers comment about the low return in the stock market from 2000 to today, it could be said that he cherry picked the start to be the top of the “dot com” bubble, a period of the highest stock market overvaluation in history.  Of course the average annual return off an all-time high valuation will be low, especially if you throw in a “financial crisis” in 2008.  If he picked 1990 as the start date, the average annual return would be much higher.  This is a true comment.  It is also true that for many people, they were fully invested in 2000, they were told to “buy and hold for the long term”, and they did in fact experience the 3.5% average annual return since 2000.

The question I have raised before is: Can the govt. respond to the financial crisis of 2008 by carrying the economy by issuing debt through bonds from the Treasury bought by the govt. at the Fed, to the tune of $10 trillion (4 trillion at the Fed plus 6 trillion to the rest of the world), and have no major negative repercussions?  The short answer is nobody knows because we’ve never done it before.  My gut tells me that there will be a long term negative repercussion we will have to deal with, and that is why I’m cautious late in the current expansion.  I don’t know what will happen in the next recession, but we may have fired all our heavy artillery at the last “great recession”.

If you enjoy these updates, please tell your friends and family who are interested in the stock market about this blog.

Your comments and questions are always appreciated, so feel free to comment using the “Leave a Comment” feature just under the title of the post, or send me an email, my address is on the “About” page at the top of the blog.

You can use the hyperlink below the chart of the S&P that will open a larger picture of the chart in a separate window.  The reader who suggested this wants to look at the chart side-by-side with the blog text so he can look at the chart while reading the text.  To do this in Firefox you can open a “private window” from the browser menu and have two instances of Firefox up, then size each window to about half of your monitor size.  If you bookmark the link you can look at it each day of the week to see how the market is progressing to certain milestones.

Rich Comeau, Rich Investing

Flat Week

I update each Saturday with my view of the stock market for the next few weeks.  The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a crash, and buy back in for most of the next bull market.  You can always scroll down a few weeks and find the latest “Long Term” update.

If you lose your bookmark to the blog, google “Rich Investing” and it should show up on the first page or so.  The more often you google it and hit the link, the higher it will show in your results.

The monthly long term update for October was posted on Wed., so just scroll down after reading this update.

Economy:

Retail sales for Sept. rose just 0.1% for the second month in a row, the government said Monday, where Wall Street had expected a 0.6% increase, according to Econoday (impacted by Hurricane Florence in N. Carolina).  Initial jobless claims, one measure of layoffs, dropped by 5,000 to 210,000 in the seven days ended Oct. 13 (near a 50 year low).  The index of leading economic indicators rose 0.5% in September after 0.4% and 0.7% gains in the prior two months, a good number indicating growth ahead.

Existing-home sales ran at a seasonally adjusted annual rate of 5.15 million in September, the National Association of Realtors said Friday, a 3.4% decline for the month, the 4th decline in the last 5 months, and the lowest pace of sales since November 2015.  Homeowners are just not putting their homes up for sale because mortgage rates are rising, homes are so expensive, and they are not willing to bite off the additional expense, plus buyers in market may be priced out by the higher rates.

The Federal budget deficit came in at $779 billion for the govt. fiscal year that ended Sept. 30, an increase of $113 billion over the prior fiscal year.  This is due to the tax cuts and spending increases passed by congress and everyone knew the deficit would rise substantially.  The republicans said the deficit would rise for a couple of years, and then growth from the tax cuts would increase revenue and start to bring the deficit back down.  That plan failed in the 1980’s under Reagan (caused Bush 41 to raise taxes breaking his campaign pleadge “no new taxes” in order to deal with the deficit), and it failed in 2001 and 2003 when Bush 43 cut taxes twice and the deficit only grew (well there was the Iraq war and the housing crisis that hurt also).  The “growth will save the deficit” appears set to fail again as the congressional budget office predicts the deficit will grow to over $900 billion in the current fiscal year and surpass $1 trillion in the 2020 fiscal year.  That is unconscionable deep in a multi-year expansion to run deficits that high.  Deficit spending is needed to pull economies out of recession, not to juice up well performing economies.  Now the republicans say that in order to deal with the deficit they created with the tax cuts, we need to cut entitlement spending on social security, medicare and medicaid.  If you are retired, or plan to retire someday, read up on this.  There is more information at this link: https://www.marketwatch.com/story/us-budget-deficit-jumps-to-779-billion-2018-10-15

Do the government deficits affect the economy?  You betcha.  Now that we have exited QE and the Fed is no longer buying bonds, corporations and individuals will have to buy them.  With more supply and fewer buyers of bonds, the yield will have to go up to get them sold, and existing bonds will fall in value.  Rising yields will hurt business, it may be a drag on the stock market as fixed income finally provides a viable alternative to stocks, and it will help savers, especially those looking for more predictability of their return.

Geo-Political:

I don’t see any military hot spots at the moment, although fighting continues in Syria and Yemen.

European markets have been roiled over difficulty with Britain reaching a sane exit deal with the EU nations.  That is probably negotiating tactics and will be resolved at the 11th hour (just a guess on my part, but I seldom see these negotiations concluded before the 11th hour, the rest is negotiating tactics).

The Chinese economy slowed a little in the latest report, but not dramatically so.  The govt. is taking steps to stimulate the economy, such as lowering taxes and lowering reserve requirements to banks to give them more money to lend.

“China’s GDP growth eased to 6.5 percent year-on-year in the third quarter, the lowest in nearly 10 years, but the fundamentals remain stable, as the country has taken a series of measures, such as tax cuts, to revitalize the economy and increase people’s income.”

http://www.chinadaily.com.cn/a/201810/20/WS5bca6582a310eff3032837c6.html

The key question with US – China policy remains, is this as Trump SAYS, a dispute over trade issues such as forced technology transfer to do business in China (theft of US intellectual property) and free access to Chinese markets without the need of local Chinese govt. mandated joint ventures, or is it really about the battle for global economic dominance between the two largest economies in the world, the US and China?  In the former case, this dispute would tend to be shorter, and in the latter case the dispute would drag on while the US says it is just a trade dispute (but it isn’t).

Trade talks with China were cancelled in Sept. and right now it looks like it is dragging on rather than moving toward a resolution.  The latest round of tariffs against China were instituted at 10% but are scheduled to jump up to 25% in the first quarter next year.  Right now it is still hard to tell is this is a trade dispute or economic attack.

For US business it is a quandary.  Some US businesses are being hurt, namely those that moved their supply chain to China.  It takes 2 years to rebuild an international supply chain and if this is resolved quickly, companies will eat the higher costs for a while.  If it will go on a long time, they need to move their supply chain.  That indecision will cost US companies in the short run.

It is certainly costing Chinese companies.  The US has sought to build the Chinese economy for at least 3 decades, thinking that the path to world peace is by having all the nations succeed economically and be able to employ their people with adequate wages so they can consume the products of industry.  That has been the model and it has worked since WW II.  Now the concern may be that China is becoming “too successful”, and in fact a rival to the US.  There are hard liners in the administration that may think cutting China back a bit is “winning”.  A little pressure on China may yield positive results without too much pain domestically for the US.  The danger is if the situation escalates and we put a lot of pressure on China, things could get so bad that they pursue extremist policies in response, the way the German people did in the is the aftermath of the WW I peace treaty, that led to them turning to a madman because he promised to restore Germany to prosperity.  A few years later, things got really bad.  Is something very bad going to happen?  I don’t know, but history shows that when high pressure means are used, the results are not predictable, and some of the unpredictable results can be very negative.  All I can say is that risk factors are rising as long as this doesn’t get resolved.

This is a minor point but I will throw it out.  Regarding forced transfer of technology, there really is no such thing.  Every CEO is charged with protecting the company’s key competitive advantages, whether they be intellectual property or physical, or human.  If I was CEO and had a key intellectual property, an algorithm or patent, or manufacturing technique, and I was told that to do business in China I had to give that information to a local Chinese partner, I would just say “NO”.  You cannot give away your competitive advantage, to anyone in any place.  Any CEO that would is crazy and should be fired.  Govt. intervention should not be needed to solve the problem.  Now the US could label that as an unfair trade practice and we could limit Chinese business in the US until the policy was changed, and that would not be as inflationary as putting tariffs on imports that will eventually show up as higher prices to US consumers.  But at the end of the day, I think it is a CEO problem.  Now if the Chinese govt. is helping their companies hack into our companies and STEAL key intellectual property, that is a government situation to deal with, and it should be dealt with through sanctions, and our other trading partners would probably help us with the issue.

Technical Analysis:

The S&P 500 was almost flat this week after the prior week’s gain.

Technically the market is still weak with RSI at the top of the chart moving up to 36 but still closer to oversold than neutral.  Momentum looks like it is trying to bottom and we can see the MACD lines at the bottom of the chart start to flatten a bit, and this histograms are shrinking which is a good sign if they are below the zero level.  The price action is very interesting.  I guess gone are the days of “V shaped recoveries”.  We could be moving down for a retest of the recent low around 2730.  If we stop short of that and move up, it could be over.  If we break below 2730, the correction continues.  All of this is contingent on the belief we are in a bull market, and from this week’s monthly Long Term update, it appears we are still in a bull market, and that is what I believe.

Now for a word about bear markets.  They start when it is the farthest thing from anyone’s mind, when absolutely nobody in the world thinks that once could start now.  So, I could be wrong about the bull market continuing.  It is wise to question everyone else’s opinion, and YOUR OWN.

So, what might tip the market into a bear market?  Housing is weakening due to higher costs of imported goods due to the tariffs and higher interest rates are eliminating some buyers from the market as they would no longer be able to meet a monthly note at higher interest rates.  Car sales are slowing.  Those are two pervasive and big ticket items in the economy and as they slow, that could back into the rest of the economy down the road.  Higher interest rates loom as an issue, and with all of the debt the world has piled up, as some of it is refinanced at higher rates, it is going to pull liquidity out of the system, money that will go to debt service rather than more productive projects like infrastructure building. There are possible unanticipated consequences of the trade war with China.  The rapidly expanding US budget deficit will suck up private capital to finance the deficit since the Fed is no longer buying bonds as QE has ended, and that can push interest rates up higher than anyone expects.  The state of the economy is changing from early expansion to late expansion, and coupled with changing government policies, the risks to the economy are rising.

2018 10 20

Click THIS LINK to open the chart in a separate window.

The question is, what do we do about it?

I didn’t do much last week.  If the market breaks decisively below 2730 or the 200 day moving average (red line middle of chart), I may take my 5% loss and bail.  It is far better to lose 5% from the high, than take a 20% or greater loss.  If we rally back near the all-time highs, I would sell into the rally in 3 or 4 sales.  I am still beating the S&P 500 year to date, but I have taken far less risk in getting here.  You might say “if you time the market so well, why aren’t you beating the index handily”.  That is a good question.  When I move out and in the market, I usually do it in 3 or 4 chunks.  So, sometime the market is going up, but I am not all in yet.  The same applies in reverse from market tops, I sell in 3 or 4 chunks so I eat some of the loss, but not all.  I approximate a market return, but I avoid the big risks.  For a retiree, I think it is a good strategy for me.

One thing to think about is owning bonds or CD’s at this point in the cycle.  I have not owned any since 2010 as the return was too meager.  But the Fed has raised rates to the point that depending on the duration of the bond, you can at least stay up with inflation or break out a little ahead, while the stock market appears to be more volatile and new risks are emerging.  I don’t recommend bond funds in a rising rate environment as they have no maturity date.  I will try to buy a treasury bond or CD where I pick the maturity date and know exactly what I will get back, and when.  The Fed says they think there will be 4 more one-quarter of a percent rate hikes in the next fifteen months, so there is no incentive to go farther out than 1 year.  Then buy a new CD in a year and lock in all of that rate hike, and then you may go farther out, like 3 years or even 5 depending on what the Fed says about the future.  How much to allocate to fixed maturity bonds?  I’ll start at 10% and if volatility remains high and the Fed keeps raising rates, probably increase that component of my funds.  I am retired, and that influences my thinking, but I still don’t think I am that far outside the mainstream.

This report is longer than I would like and for that I apologize.  However, there is a lot going on and changing which I have tried to cover and explain my thinking.  I hope you found the read worth your time!

If you enjoy these updates, please tell your friends and family who are interested in the stock market about this blog.

Your comments and questions are always appreciated, so feel free to comment using the “Leave a Comment” feature just under the title of the post, or send me an email, my address is on the “About” page at the top of the blog.

You can use the hyperlink below the chart of the S&P that will open a larger picture of the chart in a separate window.  The reader who suggested this wants to look at the chart side-by-side with the blog text so he can look at the chart while reading the text.  To do this in Firefox you can open a “private window” from the browser menu and have two instances of Firefox up, then size each window to about half of your monitor size.  If you bookmark the link you can look at it each day of the week to see how the market is progressing to certain milestones.

Rich Comeau, Rich Investing

Long Term – October 2018

Once a month, on the Wednesday following the 15th of the month, I will put up a long term view of the market.  This is provided for investors who don’t want to trade secondary swings in the market, but would like to exit the stock market relatively soon after a bear market begins, or enter the market after a new bull market begins (change in the primary trend).  In the blog, they will always have a title called “Long Term (month) (year)”, so you can use your browser “Find” function and easily find them.

Economics:

GDP – Second quarter GDP remained at +4.2% for the final (third) estimate in late September.  Economists expected the economy to quicken a bit in 2018 following the tax cuts last December, so this was not a surprise.  The question is, “is it sustainable”?  Most economists think it is not sustainable, that a tax cut is a temporary stimulus, and I agree with that view.  The greatest expected impact from the tax cut is in the first year when everyone realizes they have a few extra bucks in their pocket, and the impact is less in year 2 and gone by year 3.

The Atlanta Fed GDPNow forecast for Q3 is 4.0% on Oct. 15.  This forecast is unreliable in the months before Q3 ends, but when Q3 has ended like now and we are into Oct., I have found it pretty close, so let’s go with “around 4%”.  That’s a good number if that is what we get.

Annual GDP growth has been stable for a few years at a 2% annual rate and moved up a bit in 2017 to 2.6%.  This GDP number supports the assertion that the bull market continues. 

Year Quarter GDP %
2018 Q2 4.2
2018 Q1 2.0
2017 Year 2.6
2017 Q4 2.9
2017 Q3 3.2
2017 Q2 3.1
2017 Q1 1.2
2016 Year 2.0
2016 Q4 2.1
2016 Q3 3.5
2016 Q2 1.4
2016 Q1 .8

 

Fed interest rates –  The Fed raised the Fed Funds Rate .25% to the range of 2.0 – 2.25% on Sept. 26, as expected.  The Fed is still expected to make a 1/4% hike in the Fed Funds Rate at the December meeting.

Interest rates tell us a lot about the economy and that is why it is so important to watch interest rates for a hint on future stock market activity.

For now, rates still support the long term bull market. 

 

Date Fed Funds Rate 5 Year Treasury 10 Year Treasury 30 Year Treasury
Oct 17, 2018 2.1 3.0 3.2 3.3
Sep 19, 2018 1.9 3.0 3.1 3.3
Aug 15, 2018 1.9 2.7 2.9 3.0
Jul 18, 2018 1.9 2.8 2.9 3.0
Jun 20, 2018 1.9 2.8 2.9 3.1
May 15, 2018 1.6 2.9 3.1 3.2
Apr 18, 2018 1.6 2.7 2.8 3.0
Mar 21, 2018 1.6 2.7 2.9 3.1
Feb 21, 2018 1.4 2.7 2.9 3.2
Jan 17, 2018 1.4 2.4 2.5 2.8
Dec 19, 2017 1.4 2.2 2.5 2.8
Nov 15, 2017 1.1 2.1 2.4 2.8
Oct 18, 2017 1.1 2.0 2.4 2.9
Sep 20, 2017 1.1 1.8 2.2 2.8
Aug 16, 2017 1.1 1.8 2.3 2.9
July 18, 2017 1.1 1.8 2.3 2.9
June 20, 2017 1.1 1.8 2.2 2.8
May 17, 2017 .9 1.8 2.3 2.9
Apr 18, 2017 .9 1.7 2.2 2.8
Mar 15, 2017 .9 2.1 2.6 3.2
Feb 15, 2017 .6 2.0 2.5 3.1
Jan 18, 2017 .6 1.9 2.4 3.0
Dec 21, 2016 .6 2.0 2.6 3.1
Nov 15, 2016 .4 1.6 2.2 3.0

Valuation:

PE on S&P 500 – The current 12 month trailing GAAP PE on the S&P 500 is 22.2, down from 23.7 last month.  I used 4 quarters of earnings with the most recent being Q2 2018 (100% of companies have reported).

This metric is slightly overvalued relative to my trimmed 30 year average of 19, with the recent decline in the market dropping it down a bit.

This valuation is based on the 10/12 market price, after its recent significant drop.  The market is not overheating in this late stage of the expansion, which is good.  On the other hand, one might reasonably ask why the market is not doing better this year with the strong economic performance.  I think we are OK, but I remain cautious.

In a bull market, stocks can remain overvalued for years, so this is not a sell indicator, but it is a cautionary sign.

S&P earnings – The earnings projection for Q3 from Factset as of Oct. 12 sits at 19% increase vs. the prior year.  The corporate tax cut is projected to keep earnings increases near the 20% level for all of 2018.  This is very positive for 2018, as corporate profits primarily power the stock market.

This indicator is supportive of the bull market.

Age of primary move, bull or bear market – The bull market is 9.6 years old, which is a long bull market by historical standards.  In and of itself, this is meaningless.  It does provide some perspective that one should keep in mind.

Geo-Political:

The N Korea situation risk has receded a little following the Trump/KJU summit, but N Korea is up to its old tricks and failing to make progress in the negotiations to denuclearize (July 2018).  Tension between Saudi Arabia (Sunni center) and Iran (Shiite center) has reached a level that bears watching, centered in the Yemen conflict (noted Dec. 2017).

The US has withdrawn from the Iran Nuclear Deal, which has the potential to destabilize the Middle East further, as well as create some sanction tensions with our traditional allies France, Germany, and England, a dispute over secondary sanctions against our allies if they were to trade with Iran (May 2018).  The US withdrawal from the Iran deal was not seen as a possibility in the past as new presidents honored prior agreements.  This will change the future negotiating stance of our allies, being more careful not to box themselves into situations they do not want to be in if the US changes its mind.

In the US, we are approaching the point in the investigation into Russian meddling in the 2016 US presidential election where we will find out whether charges will be filed against the president’s closest advisors.  At that point a constitutional crisis could emerge.  A constitutional crisis is not a given, but if it occurs, I would expect the stock market to retreat for a while. (noted January 2018)

The trade issue with Mexico and Canada appears resolved, probably with limited impact on any of the trading partners, but it is good to get this behind us.  Trade wars are in effect with China and the EU.  I think some of the objectives Trump pursues are valid, but I am not confidant the method being used is the best.  This is causing serious pain to some segments of the economy, notably anyone that uses steel to make their products, and for farmers trying to sell their products.  This is already a small negative for the economy, and has the prospect of getting worse.

Global geo-politics is supportive of the bull market, currently.  However, the list of concerns that could tip the market is growing.

Technical:

The market had a significant correction in early October, down 7% at the low point.  Press reports indicated the correction was caused by a quick rise in interest rates, particularly on the long end of the yield curve in 10, 20 and 30 year Treasury bonds.

RSI at the top of the chart has fallen from 78 to 67, where 70 is overbought.  The market is oversold on a short term basis and near overbought on a long term basis.  Momentum measure by MACD at the bottom of the chart has slowed to flat, but at a high level.  Price action has fallen to the middle of the range it has been in for the last 7 years, so there is room to rise or fall without affecting the overall long term trend.

2018 10 17 Long Term

The market’s price action supports the thesis that the long term bull market remains in force. 

Conclusion:

The stock market remains in a long term bull market technically, and there is nothing in the general economy, in Fed policy, or in the global geo-political realm to overturn that conclusion.

 

Long Term Issues to Keep in Mind:

Federal Deficit:  (Negative – Noted Jan. 2018)  It will go up despite the republicans saying that if the tax cut bill is “dynamically scored” using “possible” increases in economic activity, it will hold down the deficit by increasing tax receipts.  This has not been shown to work in the past.  With the Fed no longer buying the US government debt that is currently running at $650 billion per year, and will likely expand to $750 billion per year, who is going to buy that debt, and what interest rate will they demand before committing their capital to that investment?  If that causes interest rates to rise unexpectedly fast and high, that would pose a significant risk to the US economy.

With the ECB ending their QE bond buying by the end of 2018, and probably beginning to raise rates in 2019, this may divert some buyers of US treasury bonds to Euro bonds, and that would put upward pressure on US interest rates (noted June 2018).

The total national debt exceeds $20 Trillion, and as interest rates rise, the component of the annual budget allocated to “interest on the debt” will increase, putting pressure on existing programs, or increasing the deficit.  If the deficit is allowed to rise too much in good economic times, the value of the dollar will fall and that is inflationary which is usually bad.

Rich Comeau, Rich Investing

Mini Crash

I update each Saturday with my view of the stock market for the next few weeks.  The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a crash, and buy back in for most of the next bull market.  You can always scroll down a few weeks and find the latest “Long Term” update.

If you lose your bookmark to the blog, google “Rich Investing and it should show up on the first page or so.  The more often you google it and hit the link, the higher it will show in your results.

The monthly “Long Term” update will be posted on Wed. the 17th.

Economy:

Initial jobless claims, a rough way to measure layoffs, climbed 7,000 to a seasonally adjusted 214,000 in the seven days ended Oct. 6, however this remains in historically low territory.  The consumer price index (CPI) rose 0.1% in September to mark the sixth increase in a row, while economists had predicted a 0.2% advance, and the annual rate came in at 2.3%.

The economy continues to look good, with the only significant concern in home sales.

Geo-Political:

The bond market, the bond market, the bond market!  Much of the turmoil in the stock market was driven by the recent rapid increase in interest rates on the longer end of the yield curve, out in the 10 year, 20 year and 30 year bonds.  This caused home mortgage rates to rise to 5% and home sales are stalling.  Last week we looked at Lennar Homes stock tanking.  Higher rates cause business costs to go up, profits to go down, and some projects that are marginal to be cancelled.  This eventually has a slowing effect on the overall economy.

The 10 year treasury jumped to 3.25% this week while the 30 year jumped to 3.4%, yields not seen since 2011’ish.

Why?

As I mentioned last week,

  1. GDP is strong as last quarter had 4.2% growth.
  2. Inflation is at the Fed target of 2% and they don’t want it to go above that.
  3. The deficit is booming due to the tax cuts and spending increases in the last budget deal (remember the $1.3 trillion increase over 10 years).
  4. The Fed is trying to normalize its balance sheet and is selling some of the bonds it bought during the recovery (the opposite of QE, which is Quantitative Tightening, never done before).
  5. THIS IS A NEW ONE. The Chinese are not showing up at the Treasury bond auctions currently.  They historically have bought $10 billion per month of treasury bonds, but they have quit.  The US attacks China with tariffs, China cannot fully retaliate with tariffs, so they retaliate in different ways.  But, somebody new has to buy these bonds, and they may DEMAND a reasonable return.  I know I’m not buying any long term bonds until yields are well north of 5%, and then just a 10 year bond.

Some of this goes back to the financial crisis (the size of the Fed balance sheet).  Some of this belongs to Trump policy, such as the booming deficit and the trade war with China and their retaliatory measures.

That, in as small a nutshell as I can manage, is what I think is going on with rates.

Below is an excerpt from the “Geo-Political” section of my Oct. 7, 2017 report, and I recommend that you go to that in the archive and re-read the whole section.  I called this one a year ago.  Many times it is apparent WHAT should happen, but it is very difficult to say WHEN it will happen.

“Here is the big potential RISK to the economy.  It is one thing for the Fed to buy a 30 year bond that yielded 2.2% interest annually for the next 30 years.  They don’t have a family to feed and if it turns out to be a bad investment, they can always just print some more money.  That is not true in the private market where corporations and individuals buy bonds.  We look at the investment value of the bond, its ability to generate a yield that is attractive to all the other investment options we have, at a risk profile we are comfortable with.  But, we all know that when interest rates rise, the value of bonds issued at lower yield levels will fall.  That is investment risk.

If we know that interest rate increases are coming and the value of the underlying bonds will fall, why would I go out and buy a longer term bond?  The answer is that I would not; I would wait until the yields had risen. 

That is the RISK to the economy, a sudden rise in interest rates when consumers realize what is happening.  A sudden rise in interest rates is bad for many reasons.  It increases borrowing costs for business which will reduce their profitability which drives their stock prices.  It would discourage plant expansion or equipment modernization, slowing the economy.  It would make it harder for individuals to buy goods, particularly large expensive purchases like cars and homes.  The value of the dollar would spike as international investors flock to our bond market to lock in attractive yields, which would make our goods more expensive in international markets, at least until the stock market began to crumble due to flagging profits.

So, is that scenario going to happen?  I don’t know.  The Fed will try mightily to not let it happen.  While the Fed has a lot of power, at the end of the day, the rest of the world has more power.  The Fed is moving very slowly with these quarter point rate hikes 3 times per year.  Can they hold all the water behind the dam and not have the dam break?  We’ll see.

What should you do?  I have not bought a bond since 2009 as the yields were simply too low for me.  I have not recommended bonds, especially bond funds (even short term bond funds), nor even balanced funds that hold a mix of stocks and bonds.  A little bit of gold is a safety hedge, although the government bought gold from private hands during the great depression. https://en.wikipedia.org/wiki/Gold_Reserve_Act

The main thing you can do is be aware that we suffered a financial system crash in 2008, the Fed and Congress both played a long term game and manipulated markets to prevent a depression, and that risks remain as the Fed ends the manipulation of the financial markets, directly in the bond market and indirectly in the stock market.  The Fed is just beginning to normalize their $4 trillion balance sheet, and we’ve never done this before!”

One final statement on this topic, the scenario I describe above is a MAJOR market event, a crisis like 2008, and given all the debt the US has already generated and continues to generate, a WORSE crisis than 2008!  What we just saw is a miniature version of what could be out there, if the above scenario happens.  But today you can see the elements are in existence that could cause it to happen in the future.  In California, they call the worst case earthquake scenario, a large adjustment of the San Andreas Fault, “the big one”.  In California, “the big one” has not occurred yet.  I’ll call my “interest rate spike” scenario “the big one” for our economy.  “The big one” has not happened in the economy either, yet.

Technical Analysis:

That’s gonna leave a mark!

I started raising cash last Thur., sold some more on Friday last week, and sold more on Monday.  I don’t like to move all funds at one time in case I miss the call.  But, when the market hits an air-pocket collapse, it’s painful.  I feel your pain!

Wed. and Thur. this week, the selling looked like a panic, and it is usually a mistake to sell at the bottom of such a hard panic.  So I enjoyed a little bounce on this Friday, I even bought a little.  JPM and Wells Fargo reported good earnings and that seemed to stabilize things, and the administration had folks out telling the TV people how good the economy is and “it will be alright”.

But the bottom line is that while I believe the bull market continues, risks are also rising.  A good old fashioned one year CD may be a good place to park some money.  Do not put your money in ANY bond funds as they don’t have a maturity date, and in a rising rate environment, you MUST have a definite maturity date (pretty near in, like 6 months to 2 years, I like 1 year right now) when you will get your money back so you can reinvest it at a higher rate.  The Fed is on schedule for 4 more quarter point rate hikes by the end of 2019, and then a pause.

If we get a stock market bounce, the question will be what do you do when that bounce plays out.  Much will depend on how high the market gets.  If you look at the late January selloff on the chart below, we got a “lower high”, which signaled continuing corrective action.  I suspect something like that again.  In that case, I will sell into that rally or “fade the rally”.

Technically, the market is fully oversold with RSI at the top of the chart down at 30, normally a buying opportunity once the market has stabilized and presuming the long term bull market remains in effect.  Momentum is straight down, shown by MACD at the bottom of the chart.  Price action is in the danger zone still, as all the natural supports have been broken, including the last one, the 200 day moving average (a red line).  For the market to rally, we need to see a definite rebound above the 200 day moving average.

I think we’ll get a bounce, then some corrective action like last Feb.  The market does not usually just shrug off panic selling like we had this week.

I looked at the long term S&P chart today, and the price action is still in the long term channel it has been in for several years, so far me, the long term bull market continues.

2018 10 12

Click THIS LINK to open the chart in a separate window.

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Rich Comeau, Rich Investing

Interest Rate Correction

Today I want to do something a bit different and mostly look at charts in different areas of the markets and talk a little about each.

Bonds made a significant move up in rates this week and that has upset the stock market, as business costs will go up to borrow and bonds may eventually provide competition for our investment dollars relative to stocks, so perhaps stocks should come down a little. With the Fed raising short term rates to 2.25%, finally the long end of bond market is rising, witness the yield on the 30 year bond moving up to 3.4% recently.

2018 10 05 1 30 yr treasury

Why are rates going up?

  1. Strong economy, GDP was +4.2% last quarter
  2. The Fed is raising short term rates
  3. The Fed is selling Treasuries from its balance sheet that it bought in the years following the financial crisis (it was called Quantitative Easing or QE). Now the Fed is selling the bonds at about $50 billion a month, we have Quantitative Tightening, which I don’t think we’ve ever done before.
  4. Globally, rates are rising due to improved economies.

What is the impact of rising rates?

  1. The value of existing bonds will fall relative to newly issued bonds that have higher yields and are therefore more desirable.
  2. Long term bonds will fall more than short term bonds.

Let’s look at the value of TLT, a long term bond ETF:

2018 10 05 2 tlt

You can see that as the interest rate rises in the first chart, the value of the bond ETF falls significantly.

I particularly dislike the “target date funds” these days, particularly for retirees or those approaching retirement. Those funds set asset allocation of bonds vs. stocks by your age, one of the dumbest ways possible (except for tossing bones on a bear hide and trying to read the future that way!). Bonds have been in a 35 year bull market, but it appears bonds have entered a bear market period, so now is not the time to be loading up with long term bonds, yet that is what “close in” to retirement target date funds are doing.

Let’s look at the asset allocation of TIAA-CREF Lifecycle 2010 fund sold through Nuveen:

https://www.nuveen.com/mutual-funds/CL10

2018 10 05 3 nuveen target 2010

Long term bonds will fall more than short term bonds.

We see the heaviest allocation to longer dated bonds (Fixed Income) and much less to Short-term Fixed Income, the opposite of what it should be entering a bear market in bonds. In fact, why would you want most of your assets in bonds in a bond bear market anyway? I don’t think that will end well. The target date funds have done well for years because for the most part, both stocks and bonds have been in bull markets for most of the last 40 years. But if you load up on bonds, particularly long duration bonds, as they enter a bear market, the result will not be nearly the same, it will be much worse. We can see this clearly starting in the chart above of TLT.

The target date funds may be ok for young investors, as they will allocate much more of the fund to stocks instead of bonds. That is the right thing to do as bonds enter a bear market, but deciding to do it based on an investors age is simply stupid. You are supposed to make a decision to invest in an asset based on the investment VALUE OF THE ASSET, not the investors age. They will just luck up and do the right thing for the young investors while they do the wrong thing for retirees.

Current stock market technical analysis:

The stock market hit an air pocket on Thur. and Friday, and analysts attribute it to the sharp rise in bond yields across the board.

Technically it is not a pretty picture. RSI is heading down to low neutral at 44 (top of chart), while momentum has turned down shown by MACD at the bottom of the chart. Price action has ended the brief narrow up-channel shown by the two black lines on the upper right of the screen, a decisive violation of the bottom of the range. We are right on the 50-day moving average, which is the thin blue line through the data and rising to the right. In a brief correction many times the 50-day moving average provides support, so we’ll have to see Monday what happens. If the market wants to correct more, downside targets include the bottom of the long term range, the lower blue line of the channel, down at 2800, or the 200 day moving average (thin red line below the data points that is rising to the right) down at 2760.

2018 10 05 4 spy

So far we are only down 2% from the all-time high of a month ago. The numbers sound large because the Dow has grown so high, but the only thing that really counts is the percent gain or loss, and so far that is minimal. Earnings season starts in a week, and that should be good.

I sold a few winners into the decline to lock in profits, but held my major position in SPY. It’s not too early to start thinking about a buy list. I don’t think this is the start of a bear market for stocks.

All stock markets in recovery, and more specifically in solid expansion, face a time when rates rise. When that happens, investors go crazy for a bit. Eventually they realize the bull market did not end, rates went up because the expansion is going so well.  But, volatility will probably increase, and the easy money has been made in this market.

We must always consider the possibility that I am wrong this time, and that this correction will be serious, in duration and depth (possibly as much as a 10% correction). If we break below the 200 day moving average convincingly, I would have to change my opinion. Much will come to light when earnings season season starts next Friday, Oct. 12, with JPM reporting.

Some other charts:

The home builders are sucking wind right now, victims of higher rates and rising costs due to the tariffs.

Lennar Homes is breaking down due to the double whammy, tariffs hitting their costs and higher rates eliminating some buyers from qualifying for a loan. Also, go to stockcharts.com and check out KB Homes, symbol KB.

2018 10 05 5 Lennar Homes

We also see that the tariff on imported steel has helped US Steel (symbol X) as its stock price is higher than a year ago (check it out at stockcharts). But both Ford and GM are down from a year ago, saying the increase in steel prices is hurting their bottom line. Of course higher rates and hitting their consumers ability to buy a new car also.

2018 10 05 6 Ford

If you want to follow the daily changes to the SPY chart, just get the link on last week’s report, scroll down a bit.

I thought enough big things are changing that I wanted to look at some charts in different areas of the market and hopefully you find that informative.  Next week I’ll return to the usual format.