- Pado’s Perceptions
- Sector Analysis
- VAW – Vanguard Materials
- VCR – Vanguard Consumer Discretionary
- VDC – Vanguard Consumer Staples
- VDE – Vanguard Energy
- VFH – Vanguard Financials
- VGT – Vanguard Information Technology
- VHT – Vanguard Health Care
- VIS – Vanguard Industrials
- VOX – Vanguard Telecom Services
- VPU – Vanguard Utilities
March 22, 2017
Damned If You Do, Damned If You Don't
Republicans face their first real test in the House. While a "repeal" would have been easy, a "replace" reveals a chasm within the Republican party. The Tea Party Republicans took hold in 2010 on a promise to unwind the Affordable Care Act and to de-emphasize government involvement. That is directly at odds with any plan to replace the health care law with a new law that still provides any government subsidy. Then there are the Republicans from more religious states, where it is the emphasis on Christianity and family values that drives the narrative. However, many of these areas are poor, and health care does matter to them and their congressional leaders. To offer enticements to one side offends the other, and therefore cannot gain traction of the absolute majority.
This is a case of dominoes. First, the health care proposal ends certain taxes on Wall Street that were imposed to help pay for the bill. Wall Street liked that. The budget proposal relies on the drop in healthcare spending or it doesn't even come close to meeting deficit objectives. No budget means no chance for an infrastructure spending package. No way to fake a potential for 4% GDP growth, then no way to pass a tax cut on individuals and corporations. A President's political capital is highest in the first 100 days. That is why we watch it so closely. If Trump fails to win this vote, he is probably not seeing a budget in 2017.
If you are a Republican House member, you are up for re-election in 2018. Voting against or for a health care repeal could help or hurt you locally. Now you have to add the unknown, how the whole Russia connection might mire Trump's reputation. If you are with him, and things go south for Trump, it will be hard to distance yourself before elections. If you are against him, regardless of how things go for Trump, he will push for the party to be against you in the elections. So how do you vote?
Thursday, the House is "supposed" to vote, but that doesn't mean that they "must". There in lies the rub. If they don't have the votes, it will be delayed. A delay will be viewed as a sign of weakness and failure. The market will fear the dominoes falling, unwinding much of the benefits of the Trump Rally we have seen on Wall Street. This does not mean we go back to the November levels, for two reasons. 1) Wall Street was bracing for a Hillary win, and possible repercussions against bank and Wall Street brokers. That relief bump won't go away. 2) The economy was improving, despite the "disaster" comments by Trump. This is an economy on solid footing with employment improving, housing strong, and rates still low. 3) Earnings season starts in just a few weeks, and earnings tend to support the bulls. For these reasons, we would have been positive with a 19,500 level on the Dow without all the Trump promises.
The pullback anticipated throughout February and March is being weighed late. The market peak on March 1 was the high, and it's been in a slow slide since. The drift has turned into a pullback. "Pullbacks" are considered 3% to 5%, or Dow 20,500 down to 20,050. A bad day tomorrow and we could be there.
This is one of those moments where one needs to plan to ride out the storm or get out of the way before it hits, not decide in the middle that it was worse than anticipated. The indicators have rolled over. One should not bank on a positive outcome. If the vote goes in favor of Trump, there will be time to get back in on a bullish trade. This is not "yes" or "no". The "hold off" category could be as high as 50%, meaning the odds are against a "yes" vote. Be prepared.
February 4, 2017
Institutional investors always like it when the Financials lead. The implication is that Financials do well when expectations that the economy is about to improve. This was the case off of the Trump bump, but was given additional life on Trump's comments to the economic advisory council. Trump plans to cut "a lot out off Dodd-Frank". In addition to repealing the financial advising rule, that allow's brokers to sell 70 year old widows much needed naked option writing capability, removing the consumer financial protection bureau, and lifting restrictions on leverage. Dodd-Frank was an overreaction to the economic crisis that lead to 2008-2010 recession. It placed a significant regulatory burden on banks, especially smaller regional banks. It want's all bad and unnecessary. It was always assumed that banks would never allow practices that might undermine and destroy their own institution. They were wrong. There are regulations that need to be levied on banks, but many believe that Dodd-Frank went too far. Trump's desire to unwind the law will free up capital restrictions and expand lending, no doubt. What's good for Finanicals is good for the economy.
Last week we said to watch how stocks and the sectors responded to earnings. Apple had good earnings and held onto its gains. Amazon disappointed on some measures and was punished. Facebook did well, but after a good start, ended down. Bear moves end when stocks go up on bad news. Bull moves end when stocks go down on good news. We weren't quite there yet. Facebook did go down on what was generally considered decent news, so we are seeing cracks in the rally's underpinning. I still advocate tightening stops so that we don't miss the start of a typical, seasonal correction of 5% to 7%.
On the economic front, last week saw much good news. The Fed left rates steady, as anticipated. The nonfarm payrolls were up 227,000, better than expected. ISM manufacturing was strong. Consumer confidence, home prices, consumer spending, and factory orders were all solid positive numbers. In general, the economy is on solid footing and earnings are decent.
Our caution stems from the market seeing all the positive steps that should lead to better economic growth. An infrastructure spending plan should also be viewed as a significant boost. Civil discourse doesn't immediately play into economic expectations. T-shirt and hat sales are way up, as is poster-board sales. We don't see the market reacting to that news. However, "expectations vs. reality" is where we should become concerned. It's not that Congress isn't going to pass Trump's plans, it just might take longer than is currently being discounted. When overbought, time can become an enemy.
Technically, new highs are great, but there is no way that they are getting a confirming tick in the momentum indicators. This will eventually set up an negative divergence that traders will look back at and say "that was obvious". It doesn't mean that the bull market ends, but it does mean that one should be prepared to position for the 5% to 7% pullback at the first sign of a breakdown. The economic calendar next week is very light. There are still significant earnings releases next week. We should anticipate more volatility. However, volume is starting to temper, and that means news can have an impact at the start of each day. A better opportunity to enter the market should happen by March.
Expectations Driven Market
The "Trump Bump" into December was followed by mostly sideways action, as investors digested earnings and the potential benefits of a Trump administration. At the heart of the action has been the anticipation that the administration will cut Dodd-Frank to bare bones. This will free up lending practices and will cut costs. What you need is the other side of the equation... demand. With Republicans in charge of all three houses, there is a very likely outcome of a significant infrastructure stimulus package. After 6 years of Republican obstruction to an expanded budget without offsetting cuts to programs, the question will be, will congress now pass a stimulus plan that is unfunded, now that it is a Republican president? The answer, although there will be objections, will be "yes".
However, today's pop in Financials, which has let the major averages to new highs, is more likely due to Trump's meetings with two key financial and trading allies, Japan and Canada. Having pushed through these meetings without causing controversy, the market is relieved and our key trading partners were not pushed too hard on Trump's pledge to back out of TPP (Trans Pacific Partnership). Calamity avoided... market trades higher.
Fed Chairman Janet Yellen will speak before Congress this week. Expectations are that she will lay the groundwork for rate hikes this year, possibly as soon as March. A steeper yield curve is good for financial institutions, as there is a broader spread between the borrowing rate for banks and the lending rate to consumers.
In summary, the supply side is set to improve with looser capital requirements and less regulations. The demand side is likely to improve as government spending on infrastructure spurs economic growth. The profit side improves as rates edge higher. As goes the financials, so goes the market. That is what we've seen today and what we need to keep a close eye on this week and the weeks to come. If Financials falter, it will be hard for these new highs in the averages to be sustained.
The Thick Of ItIt's earnings season, and the generally positive mood about forward-looking earnings potential is keeping the averages afloat after the significant post-election run. As of the last day of January, the Dow Jones Industrials have gained 8.35% since election day, November 8th. The S & P rose 6.5%, the Nasdaq gained 8.13%, and the Russell 2000 soared 13.97%! The so-called “Trump Rally” had ridden the wave of expectations. I would say the market was unprepared for a Republican sweep, and therefore investors were in the wrong sectors. As the wave of portfolio adjustments gave rise to new leadership in Financials and Energy, money was chasing the same rabbit.
Look at January. “As go January, so goes the year.” That old adage may prove to be true. If you reduce regulations, healthcare requirements, and pollution controls, then companies will make more money. The market reflects earnings, not societal concerns. January might serve as a bit of a short-term warning. We are seeing divergences. January was up. The Dow barely held onto positive ground, up 0.52%. The S & P was up a modest 1.79%. Tech stocks helped lift the NASDAQ in the last week to gain 4.31%. But the Russell squeaked by with a gain of 0.37%. The rationale behind January’s adage is that portfolio managers position themselves with core holdings looking at the up-coming year, as a whole. If the outlook is positive, January is up. If Trump can push through deregulation and pass an infrastructure spending plan, 2017 should be bullish for stocks. On the flip side, 8% GDP growth to pay for his plans are a pipe dream, especially if the Republicans can push through tax cuts. Sorry. Higher debt, higher rates, and inevitable inflation could have us talking about the bear in 2018 or 2019, but for now everything is coming up roses. Another warning sign comes in earnings season. Early reports have “coattails” to their industry group. A good report will give a boost to all in the same field. The second wave is that company reports need to be as good as the revised expectations to gain any more ground. Finally, when companies beat earnings, but go down anyway, it’s a sign that the market has priced in all the good news for now. Apple reported after the bell. The stock is doing well (+3%) in after-hours trading. Watch it closely Wednesday to see if it can hold, and help hold the overall market steady. If it fails, it is a yellow flag warning that we are near the end of this rally phase. We don’t have big technical divergences. The Dow Jones Transports made a new high, as have the big three indices. However, the strong leadership in the Russell has faded and we did not confirm. Let’s just say that is a cautionary flag. Since early December’s peak, we can look at the last 7 weeks as a “distribution”. There is support below, which is solid. However, February is typically the worst month of the year, as profit-taking follows the historic November-December-January rally. We look to have the make-up of such a pattern. Momentum indicators, such as the MACD, have diverged for all but the NASDAQ. Again, a modest warning sign. Markets tend to have a few 5% pullbacks in a calendar year. It is unusual to have more than one 10% plus pullback if we are still in a bull market. The current expectation should be for a 5% to 7% pullback. Those levels equate to Dow 19,095 to 18,693, assuming we don’t make a higher high in the next week. For the S & P, that would target 2183 to 2137, a 5% to 7% decline. The NASDAQ has a higher beta, so let’s say 7% at 5264. Put your political feelings aside. Don’t act on emotion. Yesterday’s recovery off of a very negative open is an indication of what the market can do after it shakes off the emotional reactions seen in early trading. If you like stops, tighten them up a bit. We may squeak out another week of rally, but we can feel the wind in our face. Marc
August 26, 2016 Yellen In Focus The divergence between price and the momentum indicator, MACD, continues to suggest a pullback is likely. Add this to the seasonal tendency for markets to correct in September, and it is logical to remain cautious for the near future. Throwing a little logic on the technical flame, Friday's appearance by Fed Chairman Janet Yellen at the Jackson Hole retreat has had investors a tad worried and on the sidelines this past week. Several Fed Presidents have been more hawkish over several weeks, laying the groundwork for Chairman Yellen to set expectations for a September rate hike. While a 25 basis point move isn't likely to move the needle much, because expectations have been in place for some time, investors remain cautious about a market reaction to the news. We've long pushed the concept of watching the Dollar Index, currently at 95, as a proxy for how the world perceives the move. The Dollar Index dove to 91.92 when the Fed backed off of any plans to raise rates back in May. As employment levels fell and expectations that the Fed still needs to hike this year, we've seen the index back up to 97.50. We currently sit mid-range. The question is, will the Dollar strengthen on a rate hike? My expectation is that it might, but not by much, and temporarily. The damage to the Euro seems played. A move to 110 should be met with support. The implication is that a rate hike will bolster the Dollar, and hurt the trade deficit, has likely been discounted. Therefore, we need to get beyond the event to eliminate the uncertainty. i.e. the Fed should raise rates by 25 basis points already. Technical resistance short-term runs along the rising tops line just above 2200 and support along its parallel at 2160. Major support starts at 2120 growing more substantial approaching 2080. We remain very optimistic about year-end new highs across the board. The short-term is cautious.
August 17, 2016 Unwinding The Negatives The last two weeks of July managed to extend the run into record territory, despite oil falling from $45 to $40, but when oil broke $40, it ignited concerns and projections for sub-$30 oil. That fear was quickly reversed after the Saudis asked for an off-schedule meeting of OPEC to consider production freezes. That was quickly welcome news for crude, which has rebounded to $46.50, and to the Energy sector, the Vanguard Energy (VDE), which held its 200-day moving average, aiding in the bounce. Looking at the S & P 500, driven down by that break in oil, also recovered over the past week-and-a-half. However, we are seeing a divergence emerge from this pop to new highs. This is not an indication of a major signal, but more a warning of a possible pullback. This would be completely within the seasonal context of seeing weakness from mid-August through September. There a many reasons why we see such seasonal patterns that tend to drive markets to October lows. However, we would point out that the typical “fund selling” that occurs in September is often made worse when stocks are already headed lower. This is not the case this year. There is also no “top of consequence”. In fact, we would look at the significant areal of support below 2120 to 2050 as strong technical support for any pullback that might occur. Timing-wise, given that the market does not like uncertainty, there are two events that has the investors’ attentions, the US election and the FOMC meeting. Despite the strong lead that Hilary Clinton may enjoy at the moment, people are fickle. Don’t underestimate the fact that the tide of support could turn quickly on bad news for Clinton, and the world is fearful of what a Trump presidency might mean. I say this only in the context that he is “unproven”, and not as a political opinion. If Clinton wins, the market pretty much knows what to expect, whether they like it or not. No so with Trump. Perhaps more important will be the fate of the Senate. If the Senate goes Democratic, it is still unlikely that the House will turn. Therefore, big things like $15/hour minimum wage won’t pass, but the potential for a more liberal Supreme Court will have repercussions for decades. The other point we are making about the uncertainty in September is the FOMC meeting. The market gets nervous when it doesn’t know what to expect from the next meeting, and that should become more and more the case as time pushes forward. We believe the economy and the market can endure a rate increase, but it will have some negative undertones initially. Also coming up in the fall will be a shift in focus to Consumer Discretionary. The Vanguard Consumer Discretionary VCR sector has been driven by the likes of Amazon AMZN and Home Depot HD, as well as Comcast CMCSA and Time Warner TWX. Today’s earnings disappointment came from Lowe’s Cos. LOW, which is off nearly 6% today. As Lowe’s approaches its 200-day moving average and falls into an area of technical support, it may become an interesting opportunity. It is early, and we would want to see a bounce and then a test, but it should be on the radar for a move back up over 78 to fill that gap from 80.81. While it didn’t match the results from Home Depot, the fact that significant storm damage in the south that has destroyed 40,000 homes will require significant “home repair”, it is a positive for HD and LOW. This is a sector to watch.
The Vanguard Consumer Discretionary Sector (6/5/15) Short-term (Neutral) : Intermediate Term (Neutral) : Long-term (Positive) The Consumer Discretionary group is holding up extremely well here, but we have to be a bit cautious short term because it is flirting with support at 123.50 right here. The rising short-term trend offers support at 122.20. While the MACD remains above the zero line, realize that a breakdown in price will be confirmed by a breakdown in some of the technical indicators as well. This group has led and has come a long way. Long-term, it all remains positive. This is a sector to watch. A strong move would force us to get more positive above 125.50. We are still in the "squeeze" we previously mentioned, looking for a break down or break out to establish a new trend. This is why we are at Neutral until a move is made.
August 2, 2016 Pullback Time On July 29th, we were willing to “let profits run” with a tight stop on the S & P 500 at 2159. We are breaking that today. Note the definitive break in the high, tight consolidation pattern. I’m sure this is no surprise to anyone, short term. Our short-term objective was a pullback to the top of this very long-term and significant base. The 50-day moving average has ticked up slightly to the 2112 level, adding some support to the very top of this base. This would be the immediate risk, but then we would expect to see buyers between 2100 and 2110. Technology provided the catalyst for the S & P and major averages breaking out to new bull market highs. While this sector is participating in the profit-taking pullback, the catalyst stems from weakness in Oil. Crude has slipped back below $40 per barrel, to the lowest level since a brief dip back in April. It has been since February that we were consistently below that $40 mark, and it has raised some concerns for the broader market. Looking at the Vanguard Energy (VDE) sector, we can see that the past several weeks had failed to confirm strength in the broader market. This has led to a pullback in the sector to its lowest level since May. We are approaching some key short-term support at the 200-day moving average. Breaking 88.30 should project down to that lower base at 80, about a 9% drop. The weakness is also reflected in the breakdown of the MACD into negative territory. Using Energy as a proxy for global economic strength, this is a disappointing chart and, for good reason, is weighing on the S & P. Exxon Mobil (XOM) and Chevron (CVX) are two of the funds highest weighted components, and both are falling more aggressively toward their 200-day moving averages. They are 84.17 and 94.39 respectively. These two have been leading the weakness. One that has been trying to resist the downside has been Schlumberger (SLB). It’s 50-day is at 78.32, which the stock trading slightly below. If we see more of a breakdown in Schlumberger, its 200-day at 74.60 could come into play as a target and would lean on an already weak sector.
July 29, 2016 End of Month Odds of one or two Federal Reserve rate hikes by the end of the year may have experienced a bit of a setback on Friday, as July draws to a close. GDP rose at an annual rate of just 1.2%, much slower than the 2.6% forecast. Q1 was revised down to growth at an annual rate of 0.8% versus its original forecast of 1.1%. This was enough of a disappointment to push some interest rate forecasts to one or no Fed moves this year. Once again, despite the major averages being short-term overbought on this run off the the "Brexit" low, new record highs were seen in the S & P 500 and the NASDAQ, led by Alphabet (GOOG). The 10 year Treasury yield slipped to 1.48%. Technically, we are in a testing phase of the 1.32% low that followed the "world is ending because Brexit, which is going to cause a financial collapse" ow. After a technical bounce to 1.60%, we are seeing a pullback in rates. Positive quarterly earnings surprises and some fairly substantial pops by big name stocks gave the major averages new record highs to end the month. It's not surprising to see some "window dressing" come in over the past week, especially chasing names that surprised with better-than-expected earnings. However, the timing and reason for the pop should give us some pause heading into August. Overall, our view remains bullish. There is strong leadership from Technology. While we could hope for more aggressive upside from Industrial and Financial, given the circumstance of a slow growth, low interest rate environment, these sectors are acting quiet well. Because of the low interest rate environment, Telecomm and Utilities continue to do well, and those "defensive" sectors are often used as a source of capital when perceptions shift to a higher expectation for economic growth. Therefore, we are lacking some of the fuel that could drive stocks significantly higher in the very near term. Stocks don't like uncertainty, and the political front is creating a bit of angst among investors. It's just a fact of life. Polarizing views lead to unease for investors, depending on which way the pendulum swings. With both conventions out of the way, the mudslinging usually picks up steam, if you can believe there is more. Earnings season drawing to a close, end of the month buying adding some temporary support, an extended short-term technical situation and contentious political rhetoric all adds up to expectations for a pullback. The base below 2110 on the S & P is substantial. We haven't broken any support as of yet, and for those that like to let profits run, the best method is to stick with the trend until we see some type of a break. For the S & P, we've managed to hold slightly higher intra-day lows throughout this past month. If we break 2159 intra-day, we should see a pullback to 2110. That isn't all that much of a decline from a longer-term perspective, but the "how" and "why" will help us decide the next opportunity to get aggressive again.