The Wheat from the Chaff

By January 11, 2019 Weekly TGIF

The Stock Market continued higher in the 2nd trading week of the year, notching its first 5-day winning streak since September. The S&P finished Wednesday on the best 10-day run dating back to 2009. This is an example of what oversold conditions can do. The bounces can be substantial.

The key is to distinguish the wheat from the chaff as the S&P has now retraced between 38.2% – 50% of the September 2940 highs to 2346 lows established the Day after Xmas.

Historically this has been the region where bounces begin to encounter heavy resistance. They tend to run out of steam. 2575-2640 is this congestion area right now.

Bad news has been largely ignored on this bounce, with many pundits using the statement “negative news is already priced in.”

We agree with part of that thinking, but not completely. Here’s how we see it:

The Pros:

  • Employment / Jobs Data
  • Less Hawkish Fed (Chairman Powell reiterated policy patience & flexibility)
  • Growing US-China trade deal optimism
  • “Lower” earnings season bar
  • Merger / Consolidations (signs of value buyers)

The Cons:

  • China Manufacturing (now contracting, 1st time since ’17)
  • France & Germany (i.e EU contracting and on verge of contracting)
  • US manufacturing “slowing,” but still in expansion mode
  • Extended Government Shutdown
  • Disappointing retail holiday sales (some retailers lowering guidance)
  • Airlines cutting guidance
  • Flattening and Flat Yield Curve remains

Microcosm of what we are dealing with in the Broader Market:

Next week the 4th Quarter earnings season ramps up with the Big Banks & Brokers reporting (JP Morgan, Wells Fargo, Bank of America, Goldman Sachs & the like). Financials were one of the worst performing sectors last year down over 13%. They have bounced higher in January, but that strength has not demonstrated signs of any leadership up off the lows.

It is an opportune time for Financials to start to signal the bar is now low enough and where they make compelling investments and the Value proposition is too great to pass up. Therefore, buyers begin to take notice and put capital to work again in the space.

Here is the rub and the example of the paradigm we are in for the broader market.

Being down double digit % last year presents the “value” if it was a sell scare on “slower growth” expectations and actual growth in fact comes in better or just not as bad as what is priced in…and Financials have a very nice upside.

The alternative is they remain cheap for a reason. And the growth scare and sell-off was the ‘beginning’ and valuations are not cheap enough yet, because growth will continue to disappoint and stocks still have substantial downside ahead.

2018 and Q4 ’18 went a long way to making stocks and the market much more reasonably valued if growth is delivered. In that scenario, the Stock Market can climb back and have a positive year. If the counter argument for financials plays out in the market, it means we are in for more recalibration of prices (lower) which have not entirely baked-in the continued slow-down potential.

We will continue to dynamically gather the facts as they come in and best position portfolios for both scenarios. We are prepared for whatever comes our way.

Have a nice weekend. We’ll be back, dark and early on Monday.

Mike Harris