El Rhazi: The Japanese Kanji character for "crisis" is made up of two tiny symbols: one stands for "danger" and the other for "opportunity".
I thought El Rhazi best to begin this week's market update Manal along a view from 30,000 feet - a macro see at what is going on as the equity market is being led around by "headlines".
Regular readers know I avoid the "noise" from the internet-based pundits and the uninformed, biased views from the financial media. But I do my best to try and pay attention to what is going on in the world. And doing that is useful to an investor shaping their investment strategy
What is going on in the commodity sector can surely be described by some as a "crisis", and outright "danger" for some stocks. For commodities producers, lenders to the firms that mine, ship and store, and even for whole countries, the horizon is indeed looking quite bleak.
Oil seems destined to test the March lows in the $42 area, while commodity currencies are marching lower in both emerging and developed markets. Gold trades at fresh lows daily, while industrial copper has just hit its lowest level since 2009.
But amidst all of the carnage, there's still someone smiling, perhaps representing a signal of opportunity. US consumers are rewarding companies that focus on convenience and technology Amazon (NASDAQ:AMZN), Starbucks (NASDAQ:SBUX), while strong brands like Under Armour (NYSE:UA), Nike (NYSE:NKE) and others have been growing handsomely. Gilead (NASDAQ:GILD) and Celgene (NASDAQ:CELG) continue to grow revenues Manal along their "life-saving" drug technology. Industrial firms are getting beat up due to the collapsing prices of their output, while General Motors (NYSE:GM) and Ford (NYSE:F) delivered all-time high margins for their North American operations.
Meanwhile, fewer Americans are filing jobless claims, and both the U.S. and Japan bucked the trend to record Flash PMI beats and sequential improvements. There are pockets of massive strength throughout the global economy, while China's growth continues to decelerate, despite rabid demand for iPhones and other consumer electronics.
China is surely an example of the Kanji character. While Chinese growth has decelerated steadily for years, signaling "danger" for some investors, there's still massive room for growth of consumption in the country. That signals "opportunity" for others, like myself. While overall growth continues to slow, the market is massive and remains under-penetrated by numerous firms. A report on the state of the fast food market in China is but one example.
Some are of the opinion that their outsized growth numbers should be sustained ad infinitum. Perhaps we have a situation here resembling the law of big numbers. Simply stated, a big entity which is growing rapidly cannot maintain that growth pace forever. Instead of extremely fast growth, China is experiencing just fast growth. None of this should be troubling, but it is a big change, and for some, that will take some getting used to.
I suggest market participants be very careful about buying into the notion that the secular growth story in China is collapsing.
This isn't about buying into "China" and its inventory markets. It's about the global story that I believe isn't quite as dire as many are suggesting.
Ned Davis Research chimes in on this topic and paper money that new data tells us that 69% of countries have PMIs above 50, the largest share in eight months, and a signal that the broader global economy is on an uptrend, even provided some believe that China is not.
That being said, some narratives around China are entirely justified. While its manufacturing PMI fell to a 15-month low in July, a closer see at a broad array of economic data suggests growth rates appear steady, Manal along average readings for Q2 of the government and private sector services, and manufacturing PMIs in line Manal along their Q1 averages.
What we are witnessing is the unwinding of an extreme that had to slow down over time. China gobbled up heavy industrial commodities as it ploughed trillions of yuan into investment in infrastructure that is now slowing.
The global economy is now fully in tune Manal along the reality that commodities are going to keep declining in price - this won't last forever. The massive super-cycle unwind remains one-directional for now, despite little rallies from time to time, giving the commodity markets a small period of relief.
Consumers are seeing lower prices and lower borrowing costs, thanks to the uncooked material glut. Investors need to realize now that the engines of secular growth for investors, technology, new products, and new business models are not running on the alike inputs as the companies we once knew and invested in. This is also a driving force that will fuel the secular bull story over time.
Most assuredly, the headlines state that there is "danger" around us, but there also appears to be "opportunity" hiding beneath the surface.
iMarketSignals produces reports on the economy looking to see if the economy is heading for recession. This latest update suggests that they see nothing to be concerned about regarding the current business cycle.
Capital spending in oil-related structures is just 27% of the overall structures capex. And while there are still signs that this component declined sharply in Q2, the other 73% (i.e., non-oil related structures capex) rebounded sharply. It is currently on trend to increase at a 25% quarter-over-quarter annual rate. The increase has been supported by a sharp acceleration in spending by domestic manufacturers, led by the chemicals industry. The long-anticipated resurgence in capex would be bullish.
Durable Goods were reported on Monday, and they rose 3.4% in June. Excluding Transportation, new orders rose 0.8% - the largest increase since August 2014. Excluding Defense orders - another volatile category - orders rose 3.8%. However, it should be noted that neither orders nor shipments of Capital Goods, Durable Goods, nor any other part of the report correlates well with GDP over time.
Speaking of GDP, the latest report released on Thursday came in at 2.3%, slightly under estimates. Market pundits can now wrestle amongst themselves as to if this means a rate hike in September, December or early 2016. Let them have at it. The first rate increase is meaningless.
Markit Flash U.S. Services PMI came in a little above expectations at 55.2, versus the 55 estimate and 54.6 prior. The news release from Markit also reported:
Pending home sales declined 1.8% from the level in May. More importantly, contract signings last month were still 8.2 percent higher than in June 2014.
" The recovery (In the eurozone) is strengthening, driven by rising domestic demand and supported by lower oil prices, the ECB's quantitative easing under the expanded asset purchase program, and a weaker euro. The improving sentiment, rising inflation expectations, and easing credit conditions suggest that the recovery is likely to continue in the near term. In this context, euro area GDP is expected to accelerate from 1.5 percent this year to 1.7 percent next year."
Greece and the debt issues that shook the markets for a while seem to have been quelled for the moment. The Wall Street Journal reports that the restructuring of Greek debt is inevitable. Funny how that doesn't make the news headlines, as they say "fear" sells. More on that later.
Company earnings report headlines from this past week and earlier can be found here. They're updated daily during earnings season.
Of the 354 companies that have reported earnings to-date for Q2 2015, 73% have reported earnings above the mean estimate, and 52% have reported sales above the mean estimate.
On June 30, the estimated earnings decline for Q2 2015 was -4.6%. Nine sectors have higher growth rates today (compared to June 30) due to upward revisions to earnings estimates and upside earnings surprises, led by the Healthcare sector.
The highlight so far: Healthcare. The sector continues to drive revenue growth in the S&P with a 7% gain to-date. There have been quite a few companies in the sector that beat earnings estimates and raised guidance. That suggests the growth trend in this sector is a continuing story.
Given what Brian has laid out for us, we have a growth rate in earnings of 8% in a group of companies that derive less that 50% of their revenues outside the U.S. I suggest the gems that need to be uncovered are those companies that fall into that category, as their inventory prices are now being sold off with the weak market internals that are present.
The AAII sentiment survey for the period ending July 29th shows that the percentage of those that are bullish now stands at 21%. Another folly I am loving of reading from the frustrated bears is their explanation of these reports now. Of course, according to them, the survey has no merit now that it does not support their "euphoria" argument. It only "counts" and is touted as a "warning" sign when the survey shows bulls at 60% or above so it can be said how everyone is wildly euphoric. Now, I am not saying that an investor use this report as their "Holy Grail", but the banter that the naysayers put forth on this topic rivals what I listen on a sitcom.
There are scores of investment newsletters calling for a correction. In fact, as stated last week, it is at a 10-month high and well over 40%. Ryan Detrick sorts this out very nicely with a presentation of what has and could possibly transpire when these levels are reached.
Short interest has spiked recently. Do the bears have it right, and we are going to receive a decent sell-off, or are they just being set up for another short squeeze once again?
While we have some divergences in the near term that may suggest market weakness, investors should take note that MAJOR TOPS in the equity markets are NOT formed at THESE sentiment levels.
I have offered evidence in prior commentary suggesting that what is going on in the Chinese market has no correlation at all to our market here in the U.S.
The obsession with China and its correlation with the S&P 500 continues, but does China really matter? More evidence that it simply does not. In the past 20 years, when Shanghai has dropped >8% (as it did on July 27th), the S&P has been down just 0.34%, on average.
There is plenty of evidence now to suggest that this obsession with the Chinese stock market borders on insanity.
"In the latest Consumer Confidence report for the month of July, confidence plummeted from 99.8 down to 90.9. In each month's Consumer Confidence report, respondents are asked a variety of questions related to buying intentions, vacation plans, interest rates, and stock prices. Although confidence declined this month, it was notable to see that plans to buy an appliance increased to a post-recession high of 52.2%. Regarding stocks prices, we have also seen a notable decline in bullish sentiment as the percentage of consumers expecting higher stocks prices (32.4%) declined to its lowest level since last October, while the percentage expecting lower stock prices rose to 28.6%, which is also the highest level since last October."
It appears that the "headlines" with Greece, Chinese stock market, deflation themes, and energy contagion are all on the minds of the average American these days, driving down the "confidence" numbers.
The headlines continue to tell us all that there is more pain to come in oil prices. Perhaps the contrarian in me says that we could be closer to a backside here than what is being predicted.
No one can say for sure where this commodity is headed, but it is always important to keep a "level head" and stay focused. I see plenty of articles telling me that WTI is headed much lower, but I haven't seen one that says the March lows of around $42 may indeed hold. Each can now draw their own conclusions.
Calafia Beach Pundit has put together yet another missive that all should to take a see at. I am in accord with the data presented, and have stated that the "contagion" that everyone is looking for in the oil industry is extremely overblown.
Food for thought: 21 drilling rigs were added in the week ending July 25th. That "news" was received as "bearish" by the traders in crude oil. However, if operators add rigs, it MAY be a signal that current oil prices are economically viable for some operators. I have seen data that some E&P companies report needing just $40/bbl for acceptable IRR (internal rate of return) on individual wells. The bulk of these rigs were added in the Permian basin.
Last week, I noted and highlighted that concerns were mounting over the issue of weak market "breadth".
"By itself, weak breadth doesn't necessarily mean that the market is due for a vast fall. There have been plenty of times in the past where breadth weakened for months even as the market rallied."
This weakness does raise a red flag in an surroundings where breadth is negative and the equity market continues to move higher. An investor should not dismiss the fact that two sectors, Energy and Materials, are having a vast impact on the breadth numbers.
Note the weakness and subsequent returns when this occurred in the past in the chart presented below. It also would suggest that the "long-term" trend isn't necessarily lost over this issue. That is an important concept to keep in mind.
The technical picture on market breadth is something investors should continue to evaluate. However, what is equally, if not more, important is to evaluate other data points and factors to form your market outlook. Singling out one issue and running with it is a recipe for failure. Company fundamentals and the valuation level of the overall market and other metrics need to be added to your research as well, especially when the technical view of the situation at hand is being tested.
On that note, let's take a see at some valuations. A sector that draws the attention of those that like to point out over valuation, bubbles and euphoria - Biotech.
We have all seen the presentations, heard all the rhetoric of some biotech stocks selling at 100x sales, etc. Folks, there will always be pockets of hypothesis and overvaluation in any market. Skeptics need to receive over the obsession they have with that argument.
As the chart below for this sector shows, the Biotech index (8 companies) has risen significantly since 2012. In spite of this sustained move higher, the sector P/E is just over 17, far below the 2000 zenith of 63.
The S&P GICS Technology Sector and the forward P/E for the 67 companies that currently make up the sector. Valuations in 2000 saw the P/E soar to 50 when the tech bubble was bursting. Today, the sector is trading at a P/E multiple of just under 15 times earnings.
I will now add that an investor needs to take into account that the companies represented in these charts grow at a growth rate substantially higher than the average company in the S&P 500.
"When the 50 day MA (blue line) touched and crossed the 100 day MA (green), but stops before touching the 200 day MA (yellow) pullbacks have been shallower. This has happened 3 times since the bull rally began and resulted in pullbacks of 11%, 8% and the 9.9% one in October last year."
This leaves a simple class to watch for. On a 50-day A cross through the 100-day MA, look for a pullback of around 10%. But continuation through the 200-day MA, and it is time to look for 20% or more.
One ultimate note. As you can see in the chart, the 50-day MA is yet to cross through even the 100-day MA yet in this latest period of weakness. So it remains to be seen whether we will see a dip, correction, crash, or maybe just a whimper.
Oppenheimer says a mechanical screen of the S&P shows 44% of the index is in an established uptrend, versus 25% that is in an established downtrend.
The fact that more of the S&P is in an uptrend than downtrend supports a continuation of the long-term advance. But 25% represents a appreciable measure of market cap under pressure, increasing the risk of short-term weakness and choppiness.
While the S & P is trading just 2% from its highs, the following chart shows just how much damage has been done to the "average" stock in this market.
So what exactly is that telling us? A stealth correction, which would be viewed as a positive, as it has already removed some of the "excess"? Or reduced leadership, which may indicate more weakness and be a negative in the short term?
In my view, there are two simple answers. Either the "leaders" will succumb to the selling pressures, giving the S&P a correction that many are positioned for, or the stocks that have already had their "corrections" will come back and take the entire market to new highs.
My commentary to this point has been directed to the investor with a long-term outlook, keeping my thoughts in the context of a secular bull market backdrop. My try is to compile observations to help in presenting a balanced picture amidst the "headlines" that are causing a lot of anxiety lately.
Taking a look now at the "short-term" issues presents quite a different picture. It does suggest that the underlying weakness mentioned is different from what we have been accustomed to. I present that thought because of what I also see in the "background". While the S&P is just 2% from its all-time high, the data that I just presented suggests a lot more weakness in the average stock that an investor owns.
If the markets are going to have their annual swoon, now is a near-perfect set-up, with price, breadth, sentiment and seasonality all in support. The odds of this taking place over the next 4-6 weeks seem to be higher than what we have been accustomed to.
One of the questions that I get asked most when there is market weakness is: "When will it end?" Those questions are prominent now, because as an investor looks over his/her portfolio, they see a lot more damage than the S&P is showing. In my work, all an investor can do now is take a look at the data being presented and formulate a plan that could reveal interesting "entry " points for select sectors or individual stocks.
Last week, I spoke to the "issues" that the market was facing, waning breadth, extremely low VIX that appeared "oversold and ready to reverse, with a short-term overbought situation, and stated:
"Now, with the S & P just 3% from the highs, the setup is for the VIX to head higher and the SPX to head lower.
I don't see any of the issues I pointed to last week being resolved, as the VIX remains at the lows, sitting around the 12- 13 area. While this week's rally was impressive, it will be more telling going forward if the index can lucid resistance with improved breadth.
At the moment, the index has "bounced" nicely off of its 200-day MA, but as stated, there are some "weak" internals" that need to be resolved. Overhead resistance now stands at 2110.
If we do get more downside probing, I think that the 2050-2065 zone might give way to a more formidable pullback to the 2040 level. If some headline risk creeps into the picture, maybe a test of the lows of 1990-2000 that we saw last December.
One step at a time, none of these levels "have" to come into play, I sit, watch and evolve the short-term outlook as it plays out. So, at the moment, "how much" and "when" is anyone's guess.
One object to keep in mind when looking at the short-term picture - divergences have come up in the past and were resolved over time, and it's quite possible that the same solution will prevail regarding these "issues" at hand.
The technical picture will give me a good feel for how the market is responding to support and resistance levels. That is key for my strategy, and it will signal whether I should start to dip in and "buy" or get more defensive. Using covered calls, and/or putting some hedges in place.
At the moment, the short-term view seems muddled, at best, and in my opinion, the risks are currently higher than they have been in a quite a while.
I will add that a true breakdown in the markets should remain elusive, given how many people are positioning or are already positioned for it.
A data point for those that like to look at "history". For only the second time in the past 125 years, the S&P 500 has been flat in the first two quarters of the year. The other year the first half was flat as a pancake, 1904, the market surged 41% in the second half.
That is just a bit of history, but rest assured, I am not of the opinion that history will be repeating the second half of 1904 in 2015.
On the other hand, I am far from throwing in the towel on the market's very long-term uptrend pattern. Therefore, although the "short-term" outlook may be in question, I will stay in the bull camp and suggest stocks will be higher in the second half of 2015.
The naysayers seem to feel they have the market "cornered" when it comes to identifying internal market dynamics. Unfortunately for them, they continue to recognize the internal market indicators when they show negativity, but fail to see any one of them when they flash positive.
In doing so, they repeatedly positioned themselves calling for tops, losing money during this entire bull market rally.
Here is a flash, every one of those divergences that were singled out in the last 3-4 years as catalysts to bring the market down were resolved and resolved to the upside.
One object I do know, the last group that I will listen to now are those that have called tops and shorted since the S&P's 1600. There are plenty of them around now to offer investors their "advice". Many are now beating their chests over the recent weakness in sure sectors and stocks, declaring victory with their "short" thesis.
Interesting, but the facts remains that this latest "blip" in the internal weakness simply can't erase the losses accumulated from the past folly of picking tops and shorting stocks all during the entire rally. Not to mention that doing so, and not participating in one of the most powerful extended market rallies in history has cost them dearly.
Here is the epitome of being morally bankrupt when it comes to handing out market advice. "Zerohedge" continues to ply their story 6 years later with the same nonsense, after being on the wrong side of one of the stock market's largest rallies on record. Yet, many that follow cite their "story" and call them "genius"!
And they may well be genius. Not with the rubbish they report, but with their "sell fear" slant. Anyone who writes in finance knows that bearish articles are the most popular. A bearish article attracts at least 5 times as many readers as a bullish article. So they write only bearish articles that collect the highest number of hits, sell advertising and collect revenues.
Another in this "genre" that all of the "blogger parrots" like to chirp about are David Stockman's "curious" views on the markets. Pick a headline and run like a chicken without a head. These parrots get louder as the market gets weaker. Funny how some want to dismiss 600 S&P points by citing a "fear" headline now.
I added another E&P name to put on my watchlist, Diamondback Energy (NASDAQ:FANG). The entire list was published a week ago. For those that missed last week's article, I'll repeat my message on these underperforming stocks. Use my Energy list as a starting point in the process of identifying names that I feel will be candidates for purchase at the proper time.
My favorite from that list is Occidental Petroleum Corp. (NYSE:OXY). This article highlights many of the essential reasons that I used to come to my conclusion. The earnings reported this past week, we're "in line" with the reduced forecasts.
Raymond James published their thoughts on the entire MLP space, and believes that even with big drop in crude oil, the MLPs have been overly punished. It's worth a look.
One simple rule to keep in mind when looking at these underperformers - WAIT until they show some signs of strength and break their downtrends, then review your list for potential candidates to add.
Two names caught my eye this past week from the earnings reports. Merck (NYSE:MRK) and Pfizer (NYSE:PFE) both beat estimates and raised guidance. Both offer a nice dividend yield in excess of 3%. The healthcare sector is the place to be, as it continues to lead the market in earnings growth. Full disclosure, I have owned MRK since the "Vioxx" incident in 2004. I now consider it a "core" holding" in my portfolio.
Gilead (GILD) just keeps on beating on both the top and bottom line, and has also raised forward guidance - a "triple play" stock. It is in the correct "space", pays a dividend, and will remain a core holding in my portfolio. The management team is one of the best in this sector. I look for increased dividends and an acquisition or two with the cash hoard on hand to boost the company's already-solid growth picture.
With all of the talk about energy and the destruction that is going on in that sector due to lower crude oil prices, it may be wise to take a look at United Parcel Service (NYSE:UPS) and FedEx (NYSE:FDX), as they will be beneficiaries of lower fuel costs. UPS "beat" this week and raised guidance as well. At some point, the airlines will receive some respect; they are not overvalued, and I believe we have already witnessed most of the downside we are going to see in the sector. Full disclosure: I own Delta Air Lines (NYSE:DAL).
Facebook (NASDAQ:FB) is a narrative and a stock that I bought back in April 2013 @ $25. The shares typically business lower after earnings. The company reported on July 29th, and it keeps on impressing. A fast data point:
"Three years ago, Facebook's mobile ad revenue was less than 15% of total ad revenue. Today it's 76%.
This growth story isn't over. It's a candidate for purchase on any weakness back to the 85-90 area. There will be a triple-digit print on this stock in the near future.
A recent acquisition of mine, Qorvo (NASDAQ:QRVO), was taken to the woodshed this past week, dropping 13% after the company reported earnings. The company beat earnings estimates, but offered guidance that the "Street" didn't like at all. These type of events and wild swings make it awfully difficult, if not impossible, to practice "risk management". Nevertheless, the worst object to do is panic and go with a knee-jerk overreaction. At the end of the day, It may be wise to revisit a quote from Howard Marks, Oaktree Capital Management, that I often refer to in times like these.
With the lowered guidance, the stock is now selling at 13x the earnings forecast of $4.65 for 2016. I will more than likely add a second block of shares as I make the position for a long-term hold. I already sold calls against this position, and that would also be a good strategy going forward to bring in some income while the situation is sorted out.
NXP Semiconductors (NASDAQ:NXPI) - the other semiconductor I added at the same time as QRVO - reported higher earnings, with in-line guidance, and was up 7% on the day after that report.
It is human nature to worry about the "good" and "bad" matters that constantly bombard investors. However, as a successful investor, you need to accept a basic fact about stock markets and the news cycle that all long-term investors should recognize - that there is no real link between these "disastrous" events that are brought to our attention periodically and the performance of the stock market.
Sometimes I think the definition of "frustration" needs to be enhanced somewhat for market participants.
I always try to step back and look at the big picture when it comes to investing in the stock market. What I see is that we, as investors, are trying to bring a systematic, formulaic approach to perhaps the ultimate non-absolute, interactive surroundings that exists. Specifically, a marketplace composed of ever-reacting and anticipating participants called human beings. Attempting to accomplish that feat is surely frustrating.
Disclosure: I am/we are long CELG,GILD,DAL,FB,NXPI,QRVO,OXY,MRK. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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#Manal #El #Rhazi
