Tis the season!

Tis the season!  Last week was an appetizer for the earnings season that begins in earnest this week. Following on a positive week for markets, in which all equity indices managed to make positive technical gains on “no trade news”, traders will hopefully shift their attention to the underlying health and strength of their equity holdings.  Let’s start with charts.  The large cap S&P 500 posted a very positive week trading above and maintaining a Fibonacci support line.  The index managed to close above resistance and slightly above 2800, which has been serving as a ceiling both intraday and on a daily basis (see chart 4). The Dow Jones Industrial index also closed out last week with a very positive close above 25000 but still has some work to do in its quest to re-trend.  While the Dow displays slightly positive mid term momentum, its momentum trend remains flat indicating that the large cap industrials which make up the Dow continue to be neutralized by trade fears.  The mid term momentum is the orange line on the bottom panel with its trend displayed in blue (see chart 6).  Momentum is one of only two indicators that have been quantitatively proven to be able to give some insight into a market’s future value, albeit not perfectly. The small cap Russell 2000 bounced off its all-time high last week and was unable to regain the strength to re-attain its highs (see chart 7).  There appears to be a correlation between trade fears and the strength of the small cap index as traders moved capital from small cap to large (more on this below). The NASDAQ 100 index behaved more like the NASA 100 index as it rocketed to new highs with the speculative FANGS leading the charge (see chart 8).  All major indices continue to be constructive except for the Dow Jones which remains neutral.

The dichotomy between the major indices tells the story of a market that has high hopes for the future but worries about the road ahead in the near term.  To start, it helps to recall the difference between a growth stock and a value stock.  Growth stocks are generally shares in companies that do not pay dividends and may not even be profitable.  The primary value in these stocks is the potential for future growth beyond the horizon and are typically technology-oriented companies or ones with disruptive business models. Value stocks are shares in companies that typically pay a dividend and are valued by their ongoing ability to grow earnings and have sufficient cash flow to maintain dividend growth.  Because a value stock is assessed by its ability to make and grow earnings, their values are highly susceptible to changes in the economic situation.  Therefore trade fears and any potential for economic slowdown would serve to lower investor appetite in value stocks.  Growth stocks on the other hand get a bit of a pass when it comes to earnings but must continue to demonstrate growth, but usually on more non-traditional metrics such as subscriber growth or new product launches.  This provides growth stocks with some insulation to changing economic conditions such as trade wars and economic slow-downs.  Because their valuations are not rooted completely in earnings, there is much room for speculation about future growth which makes growth stocks more speculative and volatile.  Because they are more volatile than typical stocks there is a greater ability to make and lose money on those investments.  SO… when things heat up with the trade war or bad economic numbers are released value stocks take the brunt of the pain while investors move their money into growth stocks.  Larger cap growth stocks such as Apple or Google do earn money despite the superlative described above making them also susceptible to trade issues, so when investors fear for them they move their money into smaller cap companies that are not yet affected by international trade, currency vagrancy, and even domestic economic slowdown.  All of these factors are affecting markets heavily in recent months as they attempt to digest the cocktail of trade wars, earnings growth, economic health, a mature bull market, and rising interest rates.  The result of this digestion is the rapid rotation of assets being cycled between investment styles and asset classes. Speaking of rotation and interest rates…

Starting tomorrow, Fed Chairman Jay Powell will deliver the semi-annual Humphrey-Hawkins monetary policy report to the Senate Banking Committee in which he will give his opinions on the health of the economy as well as his own views on where the economy and rates will be in the future.  Elected officials will grill the Chairman and attempt to send indirect messages to the President and his party on recent trade developments, which will serve as additional fodder for Fed watchers and traders in what is sure to be a volatile week of trading in equities.  Powell will most likely continue to toe the official line of: Economy looks great, inflation is just where we want it, we need to keep raising rates carefully as planned, the flattening yield curve is not a problem, and trade “may” affect future economic growth but the jury is still out.  This means… nothing really but a market starved for information will look for something to trade on and the testimony will provide some catalysts.  Fixed income markets, which have been stuck in a very tight range in recent weeks will have an opportunity to put in its vote on future economic health and its verdict is one that should be more carefully followed.  In addition to the testimony, we have a number of economic releases this week (see attached economic release calendar) and quite a few earnings releases in finance, retail, and mining (see attached earnings release calendar).  Many investors will be interested in early signs of a slowdown related to trade (though it is not likely to appear yet) and corporate management will be grilled on how last year’s tax relief was actualized along with how long the sugar high might last.  Expect volatility this week as the main course begins to be served while the political entertainment is sure to please.  Please call me if you have any questions.

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daily chartbook 2018-07-16