Market Continues to Thrash - Are We About to Test the Lows?

My, my, my…..how the story appears to be changing…..and while the Dow +123 pts,  S&P + 6 pts  and Russell + 3.4 pts all  managed to end the day higher on Friday – they were down on the week –  The Nasdaq which can’t seem to get out of its own way lost another 11 pts (more neg news from Nividia) as tech and the FAANG stocks (FB – 3%, AMZN – 1.6%,  NFLX – 1.3%, GOOG -0.3%)  continue to come under pressure.  Just an update – for the year – we are in positive territory, but the tone is changing, and investors are starting to reconsider what a slowing economy, rising rates, a new congress and continued trade tensions might mean for the mkts. 

Treasuries fell as investors sought the safety of bonds…..the 10 yr is now at 3.065% - a far cry from the 3.25% rate that ignited this drama while the 2 yr is yielding 2.808% leaving only 26 bps between the two…..and remember – history does show us that when the yield inverts – when the 2 yr is yielding more than the 10 yr – a recession is knocking on the door.   On Friday – the FED vice Chairman – Richard Clarida made a stunning comment – indicating that interest rates are close to neutral – and this is stunning why?   Because it is in complete contrast to what FED Chair Powell said only last month…when he indicated that we were a ‘long way from neutral’ and that the FED might have to overshoot neutral to reign in the economy suggesting that the FED was going to get more aggressive.   Now Clarida joins Atlanta’s FED Pres – Ralphy Bostic – who also suggested that rates are close to neutral – as they try to ‘soften’ the comments from Powell hoping that they can relieve the pressure on the mkts.   But…….

Fear is growing that growth is slowing leading to an uncertain 2019 and that has investors on edge – and that news was amplified by the weaker results from tech giant - Nividia (lost 18%) – retailing giant JW Nordstrom’s (lost 13%) – as well as weaker US macro-economic data.  October US Industrial Production came in below expectations and consumer debt is climbing and with interest rates on the rise – that is not a good sign.  Analysts/strategists all seem to be turning negative on the economy sooner than what the mkts expected…..Remember – the talk was of a strong 2018, a strong 2019 with most expecting a recession in 2020…..but the global economy is beginning to struggle and that is causing some analysts to reconsider their outlook and it may be causing the FED to reconsider their outlook – thus the message being delivered by both Bostic and Clarida.

Next up - with earnings season all but over - it is interesting to note that it was a great qtr... earnings grew at 25% y/y - so then why is the mkt down?  I mean what gives?  HELLO!  We talked about this....earnings are essentially history...they are done, in the past - by the time they announce earnings we are already deep into the next qtr...so while beats sometimes boost the mkt - it is only when those earnings are accompanied by forward guidance that is as rosy as the earnings....What we have seen this qtr is that the forward guidance does not match so the opposite is true.........companies that posted large beats have then gotten ‘beaten up’.... because the forward guidance has been a disaster.... concerns over slowing global economy, over trade tensions, over interest rates and yes concerns over what a newly minted congress would look like all added to the angst....  So now we know about congress and it does present some challenges ahead - but the other issues remain a hot button and it is those issues that will drive the bus - because it is those very fundamental issues that will set the economic tone going forward.

And if you need a confirmation of that tone – all you have to do is look at what they are doing to tech…..a ‘growth’ sector that is not a ‘go to’ safety play in times of economic duress…..and while the  Nasdaq is still up on the year  at +4.9% that is a far cry from the +18% only 2 months ago.  Money is moving - and that move has left the tech sector bruised and battered. The XLK fell 0.16% on Friday and is now down 10% from the October high – leaving that sector in correction territory.  Individual names though have fared worse – leaving some in bear mkt territory.  Consumer Staples, Healthcare and utilities have all benefitted from the move as these sectors represent a shelter in the storm.   Value names will be the clear winner over growth if investors abandon the idea that the economy is strong and tougher times are once again upon us. 

Over the weekend – VP Pence reminded us that the “US will not back down from its trade dispute with China and it might even double its tariffs, unless Beijing bows to US demands” leaving Chinese President Xi Xi with no alternative other than to say that China would not do any bowing – and that the “Made in China 2025 Economic Plan” is alive and well.  (The Made in China economic plan details the leading role that China expects to play in key industries by the year 2025).

So where is the low?  I would suggest that the low is 2620 – or the lows of the October selloff.  We need to get that ‘flush’ or that sense that the sellers have really shaken the branches – where the sellers are exhausted – and we have not gotten there yet….so hold on...because we will.... hopefully it will be soon so that we clear the decks for Santa and his reindeer. 

S&P futures are pointing a bit lower - currently down 9 pts as they continue to whip around trying to find some stability.  The S&P closed at 2736 on Friday....below all trendlines levels of support and still not near the bottom...recall the bottom of this selloff was 2610 - back on Oct 29th...and like I have been saying - my sense is that we need to retest that low to see if it holds....I for one would like to see it happen swiftly - vs. this ‘Chinese Water Torture’ that we are experiencing.....Hmmm.... How ironic is that? 

(Chinese water torture is a process where water is slowly dripped onto the forehead of a restrained victim - allegedly making the restrained victim go insane).

And if this slow drip continues - it is only a matter of time before the mkts will go ‘insane’ and then all of the newly created ‘complex’ derivative strategies, and complex, leveraged trading ETF’s implode - I mean - my guess is that the next meltdown will be caused by complex products that the creators don’t understand....and don’t tell me that THAT HAS NOT HAPPENED BEFORE.

 These are just some examples of complex  3x leveraged bullish ETF’s:   SPXL (s&p), BRZU (Brazil) , LABU (Biotech) YINN (China), SOXL (Semiconductors), TECL (Tech), and examples of 3X leveraged bearish ETF’s:  SPXS (s&p), TZA (Small Cap), SOXS (Semiconductors), LABD (Biotech’s) – Now yes…the retail investor would NEVER buy these – not appropriate for them, but the retail investor is exposed because these products exist and when it hits the fan – everyone gets dragged down…Think about the ‘short vol trade ‘in February…..you didn’t own it but you suffered as a result…..just sayin…..Be aware of the risks….

On the O’Neil rotation chart – you can see that consumer staples, utilities, and healthcare remain in the outperforming & improving quadrant.  Energy remains in the Underperforming & Weakening quadrant – but appears to be wanting to turn…keep your eyes focused on that.  Financials and cyclicals are underperforming but Improving and that is an important development. 

European mkts are slightly higher – but nothing to write home about.  FTSE +0.67%, CAC 40 +0.10%, DAX -0.05%, EUROSTOXX +0.22%, SPAIN +-0.24% and ITALY +0.48%. 

Oil is flat at $56.46/barrel.  Both OPEC and The Russians are set to cut production in December by 1 – 1.4 mil barrel/day to ‘prevent the supply glut’ – so prices are beginning to recover….as it appears the mkt is now assuming that the cut is a sure thing.  Oil is back to the February lows and it appears that it has found some support – so a bounce here could take us back to the $58/$60 range.  Remember – the US is producing oil at historic highs and at $56/barrel – US Producers are making plenty of money….not as much as at $65/barrel – but still plenty….Energy ETF – XLE has also found a bottom and is rallying….and as long as oil remains stable – I suspect that the XLE will continue to improve.