Ben Graham, the legendary mentor to the legendary Warren Buffett, reportedly said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

Last week’s stock minor sell off was a pretty good example of voting not weighing, and, more importantly, it gives investors a way to buy into the market at a pause before, as I believe, it will go higher.

Market Overreacts to Weak ISM PMI; Pullback Buy Opportunity

The hiccough began last Friday but intensified Monday on a couple of things. First was an overreaction to weak U.S. Purchasing Manager Indexes, and then to—surprise surprise—another tweet from President Donald Trump that seemed to put a damper on whether a trade deal will be struck before the December 15th deadline for new U.S. tariffs on Chinese products.

Equity markets sold off most of last week, down nearly 3% at one point. While the cumulative decline isn’t significant in the grand scheme of things, the sharpness of the reversal is notable and the abrupt change in character from much of November stands out.

Selling intensified Monday with the downside reading of US ISM Manufacturing report, (48.1 vs 49.2 expected). I would be a buyer of this pullback. My base case remains that the 2020 economy will be stronger than 2019’s, setting the stage for a “revival of animal spirits” (investor perception) and thus contributing to a potential move towards 3,185 (my target) on the Standard & Poor’s 500 index before year-end.

Mind you, equities have already come back some, and the market is not much below the all-time highs set on Nov. 27, but you can still hear the bears calling out, “This is the big one.” I don’t believe that. And one data point is just that.

For example, the Markit PMI shows improvement even as the ISM missed estimates. The November Markit US PMI (reported 12/2) rose to 52.6 from 51.3 and the best readings since April, 2019. This is in contrast to the US ISM showing flat 48.1 vs 48.3 the previous month.

The average investor might not know that discrepancy between ISM and Markit reflect some important differences in methodology. Markit weighs forward looking indicators, while the ISM is a simple average of five components, and Markit itself has indicated that it believes ISM tends to weight larger companies (https://ihsmarkit.com/researchanalysis/ explaining-us-manufacturing-pmi-surveydivergences-Oct19.html).

Market Overreacts to Weak ISM PMI; Pullback Buy Opportunity

Thus, I think the Markit divergence, an improvement in this case vs ISM weakness mitigates the “miss” value of the ISM reading.

Moreover, the broad data shows that global PMIs are generally improving, and think back to when investors were fretting the “global economic slowdown.” The JPMorgan Markit Global PMI rose to 50.3 vs 49.8 (Oct.), moving above 50 for the first time in 7 months. (Above 50 indicates expansion, below 50 contraction.)

I think this further buttresses the idea that in 2020, the economy will be better and should revive animal spirits. Only Germany remains languishing, but this isn’t surprising given the linkage to China.

Another way to think about the market’s risk/reward is to look at the relative strength index (RSI). On the 4-hour chart (nearby), we can see that the RSI is severely oversold. For most of 2019, when fundamentals are improving, these oversold readings of RSI are bullish.

And again, as we’ve noted previously several times, central bank easing plus easing financial conditions equals GDP upside. This will build a meaningful tailwind for the stock market, and should add an estimated 0.5% to US. GDP growth in 2020, according to a recent report from Goldman Sachs, as well as upside to S&P 500 corporate EPS growth.

Bottom line: I believe there are more funds that “need performance” than those “playing with house money” and as a consequence, it seems likely that pullback will be bought, particularly by underperforming fund managers who don’t want to be left out.
And, unlike the bears, we do not think this is a repeat of December 2018.

Figure: Comparative matrix of risk/reward drivers in 2019
Per FS Insight

Market Overreacts to Weak ISM PMI; Pullback Buy Opportunity

Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019

Market Overreacts to Weak ISM PMI; Pullback Buy Opportunity

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