Rising US-China, Brexit Deals Hope Spurs Stocks Higher
October 11, 2019

In this strategy briefing…

FSInsight Investment Views

Near Term View: Falling 10-yr, weakening USD, & higher odds of Sep. rate cut = very bullish. Stick with trades working in ‘19, especially asset-light stocks
YE Target: 3,125 (YE P/E 17x · 2020E EPS $184)
Style: Cyclical, US better than RoW

Your Weekly Roadmap

Vito J. Racanelli
Formerly a Senior Writer at Barron's, where he covered stocks, bonds, and financial markets.

Rising Hope on US-China Trade, Brexit Deals Spurs Stks Higher

Tweet, Rinse, Repeat.

At this point, almost three years into President Donald Trump’s term, if Twitter hadn’t been invented, you have to wonder how the stock market would get its “real” news. If Twitter’s (TWTR) stock was valued purely on the President’s tweets alone instead of profitability, no doubt it would be much higher.

Once again—and if you’re sick of this raise your hand but there’s little anyone can do for you—President Trump single-handedly pushed the stock market up, particularly Friday with a tweet about “Good things are happening” at the China talks, which reopened last week. “All would like to see something significant happen!” Well, duh.

The strength of the rally tells me the market smells a deal. Any deal, a deal that has a lot of hair on it, but a deal nonetheless. Even if Trump comes out with an agreement that isn’t very improved from the previous situation, I think the stock market will rally short term, if only because that particular tweeting worry will go away. It might even rally hard. For more on that see Tom Lee’s view on page 3.

Contrary to what Trump—who faces a reelection challenge soon—has maintained, he needs a deal much more than does a totalitarian government in China. My working assumption—always subject to new information—is that Trump ultimately caves in and the Chinese give him something to save face, a tactic at which it is quite good at.

Anyway, the early part of the week looked bleak for equities, as stocks dropped on news that the U.S. added 28 Chinese entities to an export blacklist, citing their role in the country’s suppression of Muslim minorities. Nevertheless, it was one of those turn-on-a-dime weeks often seen in markets and the dime was Wednesday.

While the Standard & Poor’s index gained 0.90% on the week, it rose 3% from Tuesday’s lows. Indeed, stocks were already in a better mood before Trump’s Friday tweet, as hopes were rising for some kind of deal or good news. Anything! Then too, the Brexit fiasco looked a little less chaotic. As stocks went up, investors shed safer assets like government bonds, the Japanese yen and gold. For more see page 8.

And for good measure, the Federal Reserve joined the party, saying Friday that it will begin buying Treasury bills on Tuesday–$60 billion initially—to boost its balance sheet and avoid a recurrence of the unexpected strains experienced in money markets last month. It will buy until the second quarter next year.

Why it had to say this Friday is any conspiracist’s guess. Maybe the Fed was worried about a failed trade deal? Perhaps not. But with a FOMC meeting coming in a few weeks, certainly the central bank could have waited. This move had been foreshadowed publicly more than once by Fed Chairman Jerome Powell and he explained that it wasn’t to be considered Quantitative Easing, but a technical reason to increase its balance sheet. Well, OK.

Says Mark Grant, chief global strategist for B.Riley FBR, in a report Friday: “This is the Fed’s first foray into buying bills and should change the shape of the yield curve and end the suggestion that the yield curve is signaling some sort of imminent recession.”

The market’s late week swagger was braced by data Friday showing U.S. consumer sentiment rose in early October, a counter to recent signs U.S. manufacturing is weak.

Next week, third quarter earnings reports will be added to the mix of influences on the market, as the reporting season kicks off in earnest. According to FactSet, for Q3 2019, the estimated earnings decline for the S&P 500 is -4.1%, which, if confirmed, would mark the first time the index has reported three straight quarters of year-over-year earnings declines since Q4 2015- Q2 2016. Additionally, the 3Q expectation was only -0.6% back on June 30, so EPS projections have been taken down.

In terms of sentiment, things look bullish and in keeping with a view that the market should begin to rally. Bespoke Investment Group notes that the most recent weekly sentiment survey from the American Association of Individual Investors (AAII) continued to give contrarian bullish signals. AAII’s reading on bullish sentiment continued to slide this week, dropping to 20.31%, taking out the lows from the Q4 2018 sell-off and the lowest level since 5/26/16. That places it in just the second percentile of all readings since 1987, Bespoke notes. Bullish sentiment is more than one standard deviation below its historical average. Bearish sentiment is also at an extreme relative to its historical average (one standard deviation above).

By the way, the market will soon be entering the November-April period, which throughout history has proven to be the better half of the year.

Quote of the Week: From Bloomberg: U.S., China Said to Reach Partial Deal, Could Set Up Trade Truce. Uh-huh.

Questions? Contact Vito J. Racanelli at or 212 293 7137. Or go to

signature of Vito J. Racanelli
Vito J. Racanelli, Managing Director, Senior Editor and Market Intelligence Analyst

Tom Lee's Equity Strategy

Tom Lee
Previously Chief Equity Strategist at J.P. Morgan from 2007 to 2014, top-ranked by Institutional Investor every year since 1998.

Investors Carry ‘08 Hammers’ Looking for ‘2008 Nails’

It is nearly a universally held—albeit logical—view that equity markets are currently carving out a top, that the ‘end’ is nigh. I find myself involved in recurring conversations with investors and businesspeople I encounter: the Standard & Poor’s 500 index is topping, they assert. Why?

Well, the market is facing too many risks from China/US trade war, Brexit, low rates, etc. It’s just a matter of time. They see little reason to think markets can rise since they have been going up for 11 years already. The logic there, admittedly, is faulty. This is consensus thinking, which is sometimes right but is often enough wrong. When that happens investors could make hay by going against it.

sp500 price history Investors Carry ‘08 Hammers’ Looking for ‘2008 Nails’
Source: FS Insight, Bloomberg

This consensus view strengthens my contrarian conviction that an upside market breakout is coming for S&P 500 index. It’s possible that this rise could be potentially significant, if history is any guide. As I have pointed out previously, since 1945 there have been six major tops, which were followed by a 30% or greater decline in equity prices. However, the major tops, highlighted in red, show an accelerating rise in the 20 months leading to the highs.

Instead, flat markets that are “going nowhere” were resolved with substantial upside moves. What we see in 2019, a flat market while hovering near all-time highs, is actually uncommon. Since 1945, this has happened only three times, which highlights the rarity. History suggests plateaus are a base before a strong up move.

Meanwhile, investors seem to carry 2008 hammers looking for 2008 nails, using the previous crash as a template for the next one. The current situation does not resemble 2008. However, burned by the financial crisis, investors remain largely too pessimistic, something chronic since 2009. What is notable is the conviction many have that 2019 is 2008 all over again, citing repo market weakness, inverted yield curves and high levels of debt. The maturity of the 2002-2008 expansion was evident by late-2005 (when the 3 measures above largely peaked). Similarly, post-internet bubble (2003), investors kept looking for the tech bubble to burst again.

Skepticism about the health of the business cycle is rising. Of course, there are understandable factors: China/US trade war, resulting visible weakening of global purchasing managers indexes; inversions of yield curve; underperformance of cycle leaders (FANG), and the poor performance of recent IPOs. This combination could naturally feel late-cycle, but, again, a surprising number of our clients see parallels to the events in 2008.

That said, the US still looks more mid-cycle than late. Economic expansions end when incremental returns on invested capital turn negative, due to one of multiple factors: (i) exhaustion of labor pool; (ii) overinvestment (capacity utilization or investment as a percentage of GDP) and (iii) excessive debt service crowds out spending.

Yet, in the US currently, the employed as a percentage of the population is 61% vs 63%- 65% in prior peaks, implying a 6 million to 10 million jobs growth before peak. Meanwhile, private investment/GDP is 24% vs 28% peaks, which suggests $800 billion further, and finally debt service for government, corporates and households is well below typical peaks. See chart.

us economic maturity Investors Carry ‘08 Hammers’ Looking for ‘2008 Nails’

Basically, it comes down to these observations: (i) there remains plenty of labor slack. Our work still argues the U.S. “unemployment rate” overstates the strength in the labor market. (ii) investment spend is too low. Two measures of private investment spending maturity, capacity utilization and private investment to GDP ratio shown in charts, are still well below what is typically seen at expansion peaks. (iii) US debt service, much more important because this is what ultimately crowds out private spending, is the lowest compared to prior cycles due to our low interest rate environment.

Despite a surge in federal debt as percentage of GDP, debt service requirements remain at record low levels. In other words, by a comprehensive set of measures, the US still has plenty of room to grow.

My 2H19 thesis remains “flat markets going nowhere” resolve to the upside, which will surprise most investors. Equities have gone nowhere for 20 months, yet hover near alltime highs. This has been seen three times since 1945 and all three were resolved by a significant upside breakout—average gain 51%. I see a rebound in the next few months, coinciding with a bottoming of Purchase Managers Indexes. An end to the GM strike also strengthens this case.

What could go wrong? Investor confidence is weak due to impeachment, trade uncertainty, market volatility. And this could result in a self-fulfilling contraction.

Bottom line: I still look for a year-end rally and overweight cyclicals, on the premise of a bottoming of PMIs. Interesting tickers are KSS, LEN, PHM, EXPE, LMT, CAT, EMR, ROK, CSCO, QCOM, XLNX, MSFT, EMN, CF, NUE, TTWO, VIAB, DISCK, ATVI, GOOGL and FB.

oil fed whitehouse earnings brexit tradewar Investors Carry ‘08 Hammers’ Looking for ‘2008 Nails’
Figure: Comparative matrix of risk/reward drivers in 2019
Per FS Insight
execution of strategy Investors Carry ‘08 Hammers’ Looking for ‘2008 Nails’
Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
signature of Tom Lee
Tom Lee, Head of Research

Fed Watch

Will Fed Oct. 31 Meeting Be Trick or Treat? Likely the Latter

When it comes to when and how much the Federal Reserve will change the Fed funds rate, who ya gonna believe, the Fed or the CME’s Fed fund futures trading?

After watching the Fed futures activity for years, I can say with confidence that markets have so far had a better handle on rates than even the Fed “dot plots” from the knowledgeable members of the Federal Open Market Committee. Over the past five years, time and time again, the futures turned out to be more accurate than the Fed itself, often times signally up to a year in advance that the Fed would eventually turn weak-kneed and cut, despite no-cut rhetoric often emanating from policymakers.

Currently, the CME futures say the probability is 68% that the Fed will cut another 25 basis points from the Fed funds rate at the end of the month, bringing the target band down to 1.50%-1.75%. That’s down from 80% the week before, but still up from 45% the week before that. This suggests that investors are having some second thoughts, but still look for a cut.

Moreover, investors should beware that there is some cognitive dissonance on the subject. You will see some Fed officials quoted as being against the cut or that it’s not a done deal. For example, let’s look at the Fed’s monthly minutes, released last week, from its Sept. 17-18 meeting, when the central bank approved a quarter-point rate cut to 1.75%-2.00%. They show that “a few participants” said prices in futures markets “were currently suggesting greater provision of accommodation at coming meetings than they saw as appropriate.”

Further, “it might become necessary for the Committee to seek a better alignment of market expectations regarding the policy rate path with policymakers’ own expectations for that path,” the minutes said. My bet is that markets aren’t ready for such a statement and, further, that the Fed probably won’t make it. Every Fed chairman is baptized in the warm waters of FedSpeak: try to guide markets, but never ever give away what you are actually going to do.

History has been on the side of the fed futures, and it shouldn’t really be a surprise to anyone who knows how markets work. The Fed futures trading represents the sum total of knowledge of many investors around the world. Collectively they “know” more than the savants, however eminent, that are members of the Fed or the FOMC.

An October rate cut seems likely but investors could be disappointed by a Fed that doesn’t give any more sign of accommodation. If some definitive end to easing were broached, I suspect it would be a painful day on Oct. 31, when the next FOMC meeting ends. The caveat to that is if a U.S.-China trade deal is struck by then.

The NY Fed continued to add tens of billions to the financial system through repo operations and 14-day loans. For more on this see last week’s newsletter.

The U.S. Treasury 10-yr note yield ended Friday around 1.75% versus 1.52% the previous week.

Upcoming: 10/30-31 – FOMC meeting.

Recommended Stock Ideas

Focus Insight Stock List - Week 41

Below we’ve highlighted the FocuS stocks that we recommend across at least two of our investment strategies for 2019.

Figure: Focus Insight Stock List
As of 10/10/19, source: FS Insight, Factset

20191012 focus Focus Insight Stock List   Week 41

Technical Strategy

Robert Sluymer
Former Managing Director leading RBC’s U.S. Technical Research team with over 26 years of expertise in investment research and technical analysis.

Stress Testing Says Equity Rebound Poised to Take Hold

US equity markets are stress testing important technical support levels just above the summer lows heading into what I view is a binary trade-tariff backdrop. Short-term momentum indicators, tracking 2-4 week swings, are oversold and beginning to bottom as equity indices attempt to stabilize at support. That suggests a rebound is poised to take hold.

What I find particularly interesting is the behavior of markets outside of equities, notably bonds, gold and few risk-on currencies. For example, as equities flip-flopped through the past week US 10- and 30-year Treasury yields diverged climbing to new weekly highs as did the risk-on euro-yen currency pair. In addition, gold broke its relative uptrend to copper, something that had been in place since April.

I encourage readers to take a look at the daily chart of the TLT, which is the largest long bond ETF. It is early to conclude a major trend shift is developing but lower highs are in place, and the TLT (142.20) broke below its shorter-term uptrend defined by the 50dma (142.97) on Thursday.

While no one has an edge on how the trade talks will conclude, capital markets are at a technical inflection point that should support an upside reaction favoring growth and cyclical equities. In the Noteworthy section on the next page, I discuss the pending rotations potentially developing back toward technology along with cyclicals and away from defensive sectors.

This week’s chart reviews the IGV Software ETF as one of the catalysts likely to help fuel an acceleration in the technology sector. As usual, let’s break down the technical story and note the similarities between the current technical setup and what developed during the last cycle in Q4 2016.

Software Index IGV ETF – First signs of bottoming at its 200-day sma

20191012 FSinsight Newsletter Technical 2 Stress Testing Says Equity Rebound Poised to Take Hold

Software Index IGV ETF – First signs of bottoming at its 200-day sma In the top panel, the weekly momentum indicators are suitably oversold to be looking for a bottom and upturn to develop, which is happening as price, in the second panel, is beginning to bounce from widely watched support at 40-week (200-day) moving average.

In addition, relative performance versus the S&P 500 is in the early stages of turning up at a higher low from the cycle lows that developed in late 2018. Lastly, in the fourth panel, relative performance versus the S&P 500 tech sector is retesting the cycle lows and showing early signs of bottoming. Bear in mind, it’s early to conclude an upside reacceleration is already underway but this is where the IGV should bottom and it is showing early evidence of doing so. I’m looking for further upside through Q4 well into 2020.

fs201910121 Stress Testing Says Equity Rebound Poised to Take Hold
fs201910122 Stress Testing Says Equity Rebound Poised to Take Hold
signature of Robert Sluymer
Robert Sluymer, Managing Director and Technical Strategist

US Policy

L . Thomas Block
Formerly Global Head of Government Relations at J.P. Morgan for 21 years, and previously served as Legislative Assistant and Chief of Staff in the House, and Legislative Staff Director in the Senate.

It's All Impeachment, US-China Trade All the Time

Unless you were sitting under a rock somewhere, you know that the potential impeachment of President Donald Trump dominated the news last week, kind of like the New England Patriots and football. That’s likely to continue for a while. Anyway, while the House of Representatives might indeed approve articles of impeachment against him, investors need to focus on the fact that there remains little support among Senate Republicans to convict him.

For those of you who don’t remember your high school civics class, the effect of impeachment alone is limited. An impeachment is equivalent to an indictment in criminal law, and only the statement of charges against an official. While a House vote to impeach only requires a majority, which the Democrats have, a conviction in the Senate requires a 2/3rds majority, which the Democrats don’t. It’s far out of reach today.

As noted in the piece by my colleague Tom Lee on page 3, investors need to look more deeply into situations the market is evaluating. And ironically, impeachment may actually help the President next year, as the political conversation ahead of 2020 Federal elections moves from issues such as health insurance, prescription drugs, and climate change to talks between two leaders and whether or not the President may have violated campaign finance rules during the conversation. Remember, the Democrats captured control of the House because of the issues that impact voters, not campaign finance issues.

More fallout from this also hits former Vice President Joseph Biden, who’s been hurt by the talks of the role he played with respect to his son’s activities both in Ukraine and China. The talk of Biden in this negative light could help Senator Elizabeth Warren as she continues to climb in the early polls. And here’s another thing: President Trump has shown he is street brawler who will fight hard to be re-elected.

Trade took second place last week in the market’s sights. For more on this see page 1. China and the U.S. have announced a new round of trade talks in Washington, D.C. to occur October 10-11. The Chinese seemingly have shown goodwill by permitting the purchase of soybeans and pork from the U.S. ahead of the talks. While a big comprehensive deal isn’t in the cards, a smaller agreement could be reached in the coming months. An agreement would likely have Chinese agricultural purchases and the US permitting export licenses to be given to American companies that supply Huawei.

The Congress avoided a federal government shutdown next week by approving a Continuing Resolution postponing spending decisions to Nov. 19. Kick the can down the road.

Figure: Top Trump Tweets

Rising US-China, Brexit Deals Hope Spurs Stocks Higher
signature of L . Thomas Block
L . Thomas Block, Washington Policy Strategist
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