Carl’s Corner – 2018

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Carl Perthel, CMT

Disclaimer: The views expressed are those of Carl Perthel, CMT. These views are subject to change at any time and The American Asset Management Group, Inc. (AAMG) disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for AAMG are based on many factors, may not be relied upon as an indication of trading intent on behalf of AAMG.

 

*** Carl’s Corner for February 2018 ***

I would characterize the U.S. stock market’s price action in January 2018 to a new bartender, unfamiliar with how to serve Guinness Stout on tap; too much foam and not enough beer. The last few days of the stock market selling off in January is akin to “blowing off the foam” in the aforementioned, poorly filled glass. Giddy emotions, and therefore, rising prices beyond the norm are now “reverting to the mean.” A well-deserved “pullback;” blowing off the froth, is a healthy sign for further stability if prices are to move higher. Let’s get back to the beer.

Each year, the February through April time frame is historically the second best quarter on the stock market calendar. But beware; February is typically the weakest month in the strongest consecutive six month period, running from November through April. February’s historical return over the past 15 years in the SP-500 is a 0.6% return, on average, according to the 2018 edition of the Stock Trader’s Almanac (Wiley 2017). Therefore, after a strong run-up in stock prices in January, this coming month may dictate more volatility and less upward thrust in stock prices. Again, a welcoming turn of events, so the market may digest the January gains.

Price is a discounting mechanism. Therefore, what might the rising “technical action” be signaling regarding the “fundamentals?” The fundamental news is positive: (a) low “absolute” interest rates for now, (b) tax legislation favorable to companies and stock holders, (c) plans for infrastructure spending that may likely create jobs and spur industrial output, (d) a strong earnings season, just beginning, (e) an improving U.S. economy, (f) overseas growth, compliments of continued quantitative easing from foreign central banks and (g) a newly elected “moderate” U.S. Federal Reserve Bank (Fed) Chairman.

Jerome Powell, the newly elected Fed Chair, starting February 3, served for 5 years under Janet Yellen, supporting many of her decisions regarding interest rates. He will likely steer the Fed to raising interest rates in a deliberate manner. “Deliberate” action creates certainty (more of the same policy) and stability for the financial markets.

With over 25% of the SP-500 companies reporting earnings results for Q4, 2017, earnings are up and so is revenue growth. Almost 70% of reporting companies have provided some sort of upside earnings surprises. When evaluating company earnings for a “bullish” outlook, key in on three determinates; (1) earnings “beat,” a (2) revenue “beat,” and (3) most importantly, look for “rising” guidance from the company regarding its outlook, going forward. Simultaneous “beats” in these three areas typically portend a favorable quarter ahead and are indicative of companies executing sound business practices.

After 2 consecutive quarters of GDP growth above 3%, Q4, 2017 fell short of consensus expectations. The positive takeaway is that the consumer showed strong demand, while companies increased their capital investments. Perhaps the newly passed tax legislation will further spur companies to increase capital expenditures, while promoting research and development?

As I write this on the eve of the State of the Union, here is one recommendation; a way to put “America First,” would be to implement an infrastructure plan to (literally) rebuild our country. Much like President John Kennedy asking America to put a man on the moon, let’s put safety and security back into America with stronger bridges, safer sewers and pipes, better roads for a future with “driverless” cars, and stabilize our utility grid. Let’s gather architects, engineers, laborers, public and private sector individuals, and make this happen. My solution to pay for these proposals is to raise the tax on gasoline and put that money to work in accomplishing these goals. No one is going to miss a nickel or a dime on the price of a gallon of gas, given the benefits of an infrastructure buildout.

The weaker U.S. dollar and the negative concerns around the fallout last month in cryptocurrency have gold up in January. In addition, other commodities like oil and agricultural issues are showing well since the beginning of 2018. In a typical economic cycle, a move higher in these issues point to stronger economies, here in the U.S. and abroad. Commodities, like oil, which are priced in U.S. dollars, are in a favorable position given the weakness in the U.S. greenback. Keep an eye on the commodity patch which may have further gains ahead, since these global inputs may be purchased with cheaper U.S. dollars.

It bears repeating that February is historically the weakest performing month in the six consecutive months that make up the “favorable” season. Look for possible volatility.

Carl Perthel, CMT

 

*** Carl’s Corner for January 2018 ***

My son, an engineering graduate, with a minor in physics, likes to remind me that I majored in business and economics. I told him, had I’d known back then what I know now, I would have majored in psychology; given that my days examining Wall Street price action is an exercise in the study of human emotion. Price is a proxy for people’s emotions, and for many of us, it’s difficult to keep our emotions in check while watching our investments gain and lose value.

And speaking of physics, Newton’s laws are to physics, as the laws of price action are to Wall Street and the stock market. The more I contemplate price movement, the more I am convinced that Newton’s First Law in physics is just as applicable to price movement; reflecting supply and demand. Newton’s First Law states that “every object in a uniform state of motion tends to remain in that state of motion unless an external force is applied to it.” 2017 price action in the SP-500 reflected this Law, and the SP-500’s price action is likely to continue rising until an “external force” derails its upward “state of motion.”

The “external force” may be the frequency of rising U.S. interest rates. At some point, interest rates will rise to a level where the yields on fixed income instruments will be attractive enough to lure investors away from the stock market and back into bonds and other fixed income instruments.

In mid-December, the U.S. Federal Reserve (Fed) increased short-term interest rates by 0.25% (from 1.25% to 1.50%), not enough to upset the stock market’s upward “state of motion.” The Fed expects to raise rates three times in 2018, but Fed funds futures are pricing in only two rate increases, presently. Yields across the fixed income spectrum are not high enough to induce investors (en masse) out of equities at this time.

As we witnessed in 2017, fundamentally, sustainable earnings growth should keep investors interested in the stock market. The rising cost of money may eventually “bite into” earnings. It’s at this point where the investor should start focusing on the rate of change in earnings, from quarter to quarter, and not just on the quarterly earnings number alone.

The Consumer Discretionary sector finished in the #1 position among U.S. sectors for Q4, 2017. This sector is a proxy for consumer spending. About 70% of U.S. economic growth is attributable to the consumer. A strong move this past quarter points to more discretionary income being put into the consumer market place for groceries, Amazon packages, restaurants, home improvement and furnishings, lodging and entertainment; likely, a result of the consumer feeling better about their individual economic situation.

It may come as a surprise…Q4, 2017 witnessed the SP-500 outperforming the internationally developed markets outside of the U.S. and Canada (those markets represented by the EAFE). Nevertheless, with global central banks continuing their brand of quantitative easing (QE), the overseas markets still represent an attractive area to invest money. QE overseas will keep interest rates down, making foreign equities attractive to most investors seeking yield, in tandem with capital appreciation.

The point of foreign QE is to bolster their economies. A strong U.S. consumer, with a desire to purchase foreign goods, should assist overseas economies, support foreign currencies, and help grow U.S. multi-national balance sheets. Should export demand jump in foreign countries, as a result of a confident American and global consumer, their currencies should strengthen, likely leading to a weaker U.S. Dollar. At year-end 2017, international and emerging market “equities” are outperforming their international “debt” counterparts on a relative basis.

At first blush, it looks like corporate America will get a raise with the new tax bill coming out of Washington, DC. Let’s hope that the tax savings by corporations will be invested into research, development and other projects, like infrastructure. That’s the point of the tax cut, isn’t it? Otherwise, what’s the point?

At these price levels in the U.S. stock market, I would be remiss not to mention that the likelihood of volatility may be greater in 2018 than it was in 2017. As mentioned in bullet point one, please consider putting your emotions “in check” before making decisions regarding your equity portfolios. Have a plan and try to stick to it.

Carl Perthel, CMT