Weekly Update: If you're stressed about the correction, visit New York City

10-26-2018

I realize I said this a few weeks ago about Wisconsin, which was a sea of calm. In New York City, it was the opposite, with massive traffic jams, sirens all day and night, and a cop car/truck smash-up on our way to LaGuardia. News about pipe bombs around the city saw office buildings evacuated. Taken with a matter-of-fact attitude, this wasn’t discussed at dinner with my beloved niece and her handsome N.Y.-native boyfriend in a crowded, youthful restaurant with laughter in the background. Advisors at my meeting were taking the market’s correction in resilient stride. New Yorkers are to die for! So when will the downdraft end? It’s too early to say. Interim lows historically are accompanied by indiscriminate selling and unmistakable evidence of fear among investors, neither of which has been evident save perhaps Wednesday afternoon, when put volume finally elevated, with the last 90 minutes of the day having a “sell what you can” tone to it. But Thursday’s rally was unconvincing—breadth was fair, not spectacular. It reminded Strategas Research of the weakness seen in 2015/16 and 2011, particularly given the market shift toward more defensive leadership. In both prior instances, stocks forged an interim low, rallied, and then ultimately retested/undercut before establishing “the low.” Earlier in the week, I spoke at a large annual meeting of West Virginia lawyers/CPAs/advisors and the only question was whether the opioid crisis threatens the longevity of the massive millennial generation. If this correction can’t end without end-investor panic and capitulation, there’s more to go.

Midweek saw big retail flows into the behemoth S&P 500 ETF, with CNBC commentators suggesting these investors may be smarter than the institutions which have been moving toward defense for numerous weeks. Witness the large strides made by high quality dividend stocks versus the market just in the month of October. There is much talk in the media of an earnings slowdown in the U.S. and a global economic soft patch. The market knows this, so it’s doubtful this is what is being priced. Nearly 90% of S&P companies that have reported beat earnings-per-share (EPS) estimates; EPS growth is up 23% year-over-year (y/y) so far and surprising positively by 5%. Some have blamed the Fed and rate increases, but if that were the case, one would expect 10-year Treasury yields to rise and high-yield performance to fall in line with stocks and plunge. Neither has happened. True, guidance hasn’t been great—widely held tech giants Amazon and Google disappointed on that front, and others have complained about a slowing China (more below) and costs going up with the tariffs. But none of this is really new. President Trump and China President Xi Jinping will meet in early December, by which time both should be highly motivated to get something done. The Institutional Strategist (TIS) thinks the difficulty for the market is that it’s trying to price what it cannot measure, with mini-deleveraging (margin calls), derivative losses and the structure of some markets adding to the instability. This combination, as well as huge index-tied passive investing flows, tend to exacerbate price moves, presenting a risk that can spiral pretty quickly and making the next 12 days up to the midterms especially worrisome. With volume technicals breaking February lows, Dudack Research expects potential further downside within a market that remains in a longer bull cycle, a view we share at Federated. Renaissance Macro also sees the potential for the market to get worse before it gets better, with a turning point possibly coming post-election, a view we also share at Federated.

For China, the concern is that its slowing growth could get a lot worse. TIS, which has been visiting China and Asia, says America’s threat of a 25% tariff on Chinese goods starting Jan. 1 has led to pre-ordering by Chinese companies, similar to what happened in Japan years ago when the consumption tax was about to be raised. The Japanese beat that increase by buying before prices went up, and the same pattern appears to be happening now among Chinese companies. The result might be a significant drop in orders starting in December as inventories are run off instead. This would be difficult for Chinese manufacturing and all of Southeast Asia, and TIS thinks it could accelerate the deep sell-off in Chinese stocks as a massive amount of listed shares appear to be close to becoming victims of margin calls. It notes both the Shanghai and Shenzhen indexes certainly acted like the margin clerks were in charge last week, as each bourse suffered cascading losses until the government stepped in. Beijing has encouraged responsible parties to take steps to deal with this problem, adding risk to the equity market and by extension to the economy, more so because of the leverage which has been employed. I finished the week at a client event in Greenwich, Conn., one of the wealthiest cities in America. Lots of thoughtful questions, but the group was in a fine mood and laughed when I complained of my Gucci heels killing my feet. Afterward, a lady suggested, “You can’t stop wearing those heels, or we will surely fall into recession.” Resilience! If the market has your stomach churning, you might schedule a visit up North.

Positives

  • Consumers OK Consumer spending rose more than expected, pushing the government’s initial take on annualized Q3 GDP growth to an above-consensus 3.5%. The final take on October Michigan sentiment also was solid, though it did pull back a tad from September. The GDP report reflected trade’s continued drag as also evidenced by September’s further widening in the trade deficit.
  • Manufacturing OK Led by increasing new orders, Markit’s first take on October activity accelerated, with the manufacturing PMI hitting a 5-month high. September’s durable goods orders also rose strongly on surging defense, although the core rate (ex-defense and aircraft) slipped on softening computer shipments.
  • Finally, some positive housing news September pending sales rose for the first time in three months, indicating existing sales should follow suit in the months ahead. Ned Davis Research reiterated that it is still bullish long-term on housing on favorable demographics led by a rise in millennial buyers.

Negatives

  • But even more bad housing news New home sales fell a fourth straight month in September to their slowest annual pace since December 2016, causing y/y sales to plunge by the most since 2011. New home sales now stand 22% below their November 2017 expansionary peak, even as available supply has expanded 13% over the same period and stands at an 8-year high relative to sales.
  • More signs of global weakening October’s initial eurozone composite PMI fell to a 2-year low, with 1-year manufacturing business expectations hitting a 6-year low on concerns over Brexit, growing protectionism and geopolitics. In China, GDP growth slumped to 6.5%, the weakest rate of growth since the global financial crisis, highlighting the negative impact U.S. tariffs are having on its export-driven economy.
  • Is that inflation I see? Price pressures are showing up across a broad range of manufacturing and service firms, Markit reported, driven by higher fuel, material and borrowing costs, and tariffs. In the Fed’s Richmond district, companies blamed rising wages and prices on difficulties in recruiting and retaining workers. The Fed said skilled worker shortages are broadening across districts.

What else

A ‘Red Wave?’ A review of early voting already underway in several states shows that in six of seven where there are relatively tight races, Republican early voters are casting ballots well in excess of Democrat early voters. The exception is Nevada, where a Republican senator is in a dead heat with his opponent.  Otherwise, from Tennessee to Texas to Florida, these very early returns point to a possible “Red Wave” in six key states, although a lot can happen in two weeks in a normal political year, much less a midterm election year that’s far from normal.

Alexa would be LOL in my fridge Silo, a voice-controlled food-storage system that seeks to minimize waste, launched a Kickstarter campaign this past week to raise funds to produce models that would go on sale a year from now. The system uses containers that have a smart technology at the bottom that not only vacuums and seals food, but also incorporates Alexa to alert when produce is about to go bad—saving money and reducing waste.

Trick-or-treaters will get chocolate at my house The $35 billion candy industry is experiencing its “hardest time” in at least 20 years, Tom Schoenwaelder, a principal at Deloitte, tells Ad Age. The two biggest headwinds: the rise of online shopping and interest in better eating.

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