- Signal from Noise
There appears to be a lot of angst, at least if you go by the headlines in major news organizations and Wall Street bank comments, about the increasing concentration of the stock market rise. Bloomberg The FAANG+ stocks, defined roughly by Facebook (FB), Amazon (AMZN), Alphabet (GOOGL), Apple (APLN), Netflix (NFLX) and Microsoft (MSFT), plus Tesla (TSLA) and Nvidia (NVDA) were about $8 trillion in market cap as of July 10, or 24% of all US stocks market cap and 29% of the Standard & Poor’s 500 index (SPX). Wow. Here’s a sample of some of the scarier headlines: 1 Goldman Sees Imminent Momentum Crash As All S&P Gains Come From Just 5 Stocks; 2 This Is Nuts… Again. Reducing Risk As Tech Goes 1999; 3 Tech titans’ market heft could signal broader stocks worry; 4 The stock market is looking like the Dot Com Bubble again, with market cap super concentrated in five companies. But this time it’s worse; 5 Only a Handful of Stocks Are Helping the Market Rally. Why That’s a Bad Sign; 6 Top heavy returns showed 3 stocks — Amazon, Netflix and Microsoft — alone make up more than 70% of the gains in the S&P 500 and Nasdaq 100 indexes. Forgive me, but I’ve tricked you. Just No. 2 is recent. The rest of the headlines date anywhere from several months back to two years ago (No. 6). The comparisons to 1999 keep coming: One well known trading site noted that Monday the Nasdaq 100 rallied more than 2% intraday to set an all-time high, then reversed to close down by more than 1%. The only other time that happened was March 7, 2000. Cue the scary music. Don’t ignore a narrow rise, but alone it doesn’t tell you much about whether the market is going higher or lower. It might be that the stocks involved are overbought and will drop, and that might or might not lead to other stocks falling. Or it might be that they are expected to produce very strong earnings compared to the rest of the market. In the case of Tesla (TSLA) in particular, there is apparently a large retail contingent jumping into the stock through Robinhood trading platform. That’s another story. I’m not trying to be facetious. Yes, narrow breadth is something many investors might consider worrisome. But my point today is that market concentration is a regularly recurring issue in bull markets. I’m not trying to disparage any particular source of information above. What I am saying is step back, look at what is happening, look at the future earnings possibilities post-coronavirus (COVID-19) and look at the history. Let’s look at history courtesy of Advisors Capital Management, a money manager which published an interesting report Monday. “The equal-weight S&P 500 (not market cap weighted) is down -10.6% year-to-date, while tech-heavy NASDAQ is up +19.0%. Obviously, performance in 2020 has been concentrated among the mega cap stocks. We are hearing a lot of angst-ridden commentary and handwringing among investors regarding this top-heavy risk, but is this necessarily a cause for alarm?” ACM Wealth “In a word, no. This concentration is not unprecedented. (My italics.) The chart on the left shows the long-term concentration in the US stock market for three groups: the single largest company, the top five, and the top ten. Clearly, when looking at recent history, we are at a high in concentration at the top. Looking longer, though, it becomes clear that most of the market’s history has been highly concentrated. By itself, this level of concentration is not a concern.” That’s the key: “by itself.” So what can we say about this market concentration? Let’s examine the NASDAQ 100 phenomena Monday from that well-known trading website. The sample size of that scary statistic is now 2 data points. I’m not sure how much one can glean from such a tiny data sample. It’s interesting but is it indicative? Can’t say. Robert Sluymer, our head of technical research, says given reacceleration in growth stocks since June 8, a short-term correction is likely underway. But it’s too early to tell if that action defined a long-term peak for them. He expects leadership to ebb and flow between growth and cyclicals through 2H20, and that a rotation away from growth toward value/cyclicals is likely developing. The Nasdaq 100 (NDX) established an outside reversal day on Monday, which probably marked a short-term peak for growth stocks following the surge since June 8. In general, Sluymer doesn’t recommend chasing those mega-cap growth stocks right now and says that there could be lower entry points later in this quarter. After such a run, the megacap FAANG+ stocks look like a crowded trade. In contrast, cyclicals have been correcting since June 8 and are showing early signs of bottoming at key support near 50-day moving averages heading into earnings season. His contrarian ideas include unpopular cyclicals such as Citigroup (C); Bank of America (BAC); Goldman Sachs (GS); Morgan Stanley (MS); Wynn Resorts (WYNN); Las Vegas Sands (LVS); Caterpillar (CAT); Deere (DE), and AGCO (AGCO), as examples of bottoming patterns following six-week corrections back to support at 50 DMA’s. You can find additional “Epicenter” recommended stocks on our website. Sluymer expects the SPX will hold key support near its 50- and 200-day moving average on near-term weakness and is more likely to consolidate in Q3 than break to lower lows. A break below the 50-dma by the Russell 2000 and most cyclicals in general would be needed to change our bullish view. In other words, just because Tesla seems overvalued, it doesn’t mean the market is. Indeed, given how lackluster all those stocks outside the FAANG+ have done, we view the Epicenter stocks as those with EPS leverage next year, as my colleague Tom Lee has written about extensively. Where I could be wrong: While we believe that the US economy is slowly recovering, a huge collapse in FAANG+ stocks could undermine market confidence in general. Bottom Line: Market concentration might or might not be a bad sign, but it occurs more often than most investors think. Prior “Signals” DateTopicSubject / TickerThe Signal7/8/20StockSEC FilingsOther Voices: Why Reading 10K Filings Is Crucial; Part 17/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest6/17/20StockNordic Semiconductor (Nod. NO)Continued IoT Growth Good News for Nordic Semiconductor6/10/20StockHelmerich & Payne (HP)Helmerich & Payne Stock Could Energize Your Portfolio6/3/20OptionsVan Hulzen Asset ManagementFor Income Seekers, Why Covered Calls Top Junk Bond ETFs5/27/20StockJP Morgan Chase (JPM)Why JPMorgan Chase Belongs in Portfolios Post-COVID-195/20/20StockHorizon (HZNP)Horizon Therapeutics Is Inexpensive; 2 Drugs Show Promise5/13/20StockBank OZK (OZK)‘Plain Vanilla’ Bank OZK Could Be Long Term Opportunity5/6/20StockGraham Holdings (GHC)Post COVID-19, Graham Holdings Could Return to Growth4/29/20StockPacira (PCRX)Pacira To Benefit from Surgery Trend Away from Opioids4/22/20StockAvalara (AVLR)Avalara Stock Could Benefit from Catalysts Boosting Amazon4/15/20StockFirst Republic (FRC)First Republic Stock Looks Cheap in Post COVID-19 World4/8/20StockGalapagos (GLPG)If Galapagos Arthritis Drug Is Approved, Stock Looks Cheap4/1/20StockDaVita (DVA)In Uncertain Markets, DaVita’s Stable Rev/EPS Look Attractive3/25/20Q&AInsiderInsightsIn Roiled Market, Insider Activity Could Offer Directional Clues3/18/20MarketUS Stock MarketMarket Discounts Recession; GDP, EPS Growth Worries Mount
- Your Weekly Roadmap
Bears Fight Back and Stocks fall 5%; Rally Trend Unbroken
Nothing like a nice 5% selloff to get your attention, eh? Gets the juices flowing, makes you think. Or is it worry? Just when you thought the bear had raised the white flag and slunk back into his dark cave, there he was again bearing sharp teeth and slashing at investors last Thursday. Yes, the stock market fell sharply last week, about 5% by Friday’s end, and the drop was even deeper at its nadir, down almost 7% from a high of 3233 Monday. Oh, for the happier days of just—well a few days ago. I, and my colleagues Tom Lee, Brian Rauscher and Rob Sluymer as you’ll see in following pages—don’t view this as the beginning of the end of the rally since March 23. We look at the data, whether the coronavirus (COVID-19) stats, or corporate earnings estimate revisions, or technical analysis, and it doesn’t look like a bear market rally. It looks like a bonafide rally. A few factors seemed to have depressed the formerly more enthusiastic investor sentiments. First, the fear of coronavirus (COVID-19) returning is ever present and just below the market’s surface. The rally’s been big but sentiment remains fragile. There were some media headlines about some states experience increasing cases. However, as Tom Lee points out, beginning page 3, the headlines and the facts aren’t the same. There is no strong evidence so far of a serious “second wave” as states reopen. And secondly the Fed’s FOMC meeting finished Wednesday and its outlook was less than thrilling. The idea that the Fed will keep rates low through 2022 might seem good for stocks, but the corollary to that is, “Wait a minute, the Fed thinks the economy will need rates to stay low that low.” Cue the despair and the bear roar. For more on this, see page 12. Last week, the Standard & Poor’s 500 index finished around 3041, giving back the gains of the previous week. The market is up 4% from 12 months ago. Then of course the market had gone a long way in a few weeks; it was ripe for any excuse in my opinion. Last Thursday, the S&P 500 saw its largest single-day downside shift in the percentage of overbought stocks since at least 1990, according to Bespoke Investment Group. On Monday, the net percentage of overbought stocks (overbought minus oversold) reached as high as 89%, but that fell to 6% after Thursday’s rout. But BIG also notes that one, three, and six months later, the S&P 500 traded higher all four times. In the one-year time window, the median gain was 16% with positive returns three out of four times, ranging from a decline of 1.36% after the 2007 occurrence to a gain of 21.5% after the 1997 occurrence. I find that comforting. While we’re on the subject of technical things, you can get your fill from Rob Sluymer on the website today, where there’s a special look at some hard-hit cyclical stocks. Moreover, I will note that the market saw 90% up volume days on the previous Friday and last Monday, similar to the first rally days in March. That’s strong stuff. As Wellington Shields put it in a recent report, you just can’t expect that kind of momentum to persist three months in. The numbers are long term bullish, even if short term the market is stretched and a little frothy. This is the kind of pullback we’ve been saying to buy, if you missed the initial 40% from March 23. As Tom Lee has pointed out again and again, there remains a lot of dry powder sitting on the sidelines in the form of cash. There’s simply too much of it for this to be the sustainable return of the bear. The reopening of the US economy isn’t going to be smooth but it is going to happen. Moreover, even if there is a second wave, I doubt there will be a second shutdown, but a more balance approach of masks, hand washing and distancing. On Thursday, Labor Department data showed 1.5 million Americans applied for unemployment benefits in the week through June 6, extending a drop from a recent peak of nearly 7 million applicants in the week through March 28. The Cboe Volatility Index, or VIX (dubbed the market’s “fear gauge”) jumped to about 40 from 25 during the week with Thursday its biggest one-day increase in more than two years. Quote of the Week: From WSJ: The net worth of U.S. households saw a record decline in the first three months of this year as the coronavirus pandemic sent shock waves through the economy and caused equity prices to plummet. Household net worth fell 5.6% in the first quarter from the previous three months to a seasonally adjusted $110.79 trillion, the Federal Reserve said Thursday. That was the largest single-quarter drop in records going back to the early 1950s. Gross domestic product contracted at an annualized rate of 5% in the January-to-March period. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to
- Alpha City
Despite Pullback, Earnings Revisions Support Rally Continuing
Given last week’s pullback, I remind investors to keep your eyes on the bigger target, the horizon six, 12, and 18 months away. Our work tells us that equity markets will be higher in the future. Additionally, from a positioning standpoint our proprietary sector single stock quantitative stock models still strongly suggest that offensive, like tech and cyclicals, areas will lead at the expense of cash and traditional defense sectors. I continue to recommend a barbell approach of Growth/FAANG and Value/Cyclicals. The bears claim the rally since March 23 is non-sensical, a bubble, disconnected from the economy, and only rising because of Fed policy. The impressive equity market bounce that began after our preferred tactical indicators flashed a buy signal on 3/20 has not only made sense, but also has the underpinnings for more gains. Our research is supported by the following: Extreme oversold condition that occurred on 3/20 and positive inflections in all our preferred tactical indicators; earnings revisions that have clearly turned less bad; investors valuing the S&P 500 and its constituents on some type of forward normalized earnings, NOT trough profits; and valuation expansion that is based on historical factor analysis of what drives multiples. Additionally, unprecedented monetary and fiscal policy has rained on the economy, with more likely. Finally, continued skepticism by investors, which is a contrarian positive, and helps equites climb the proverbial Wall of Worry. Earnings revisions are clearly getting less bad. This is VERY important. This alone strongly backs the rally and makes a case against the market being illogical or only being fueled by Fed Policy. The historical precedent for this is powerful with no exceptions for major market bottoms since 1990. Markets don’t wait for profit growth to return to absolute positive before beginning to rally. The key driver has always been positive inflections and signs of less bad. The number of companies with absolute revisions positive and improving has risen once again. I generally expect all these figures to continue to trend higher for the next 4-8 weeks. I will be on the lookout in coming months for more names are shifting from “earnings revisions still absolute negative but less bad” to “absolute revisions positive and improving,” or double plus. Our research suggests that valuing the equity market or specific stocks on the current depressed profits levels from the self-inflicted corona virus lockdowns is misleading and not reflecting the true earnings power of Corporate America. Normalized earnings stream provides a better gauge. Investors should use at least 2021 and or 2022 EPS estimates, preliminarily a range of $180-200. I take exception to comparing forward P/Es absolutely with historic readings. Without considering other factors, including interest rates, inflation one is really comparing apples and oranges. At the 2000 S&P 500 price and valuation peak, the fed funds rate was above 5.5% while today’s level is near zero. In our view, this alone clearly argues for a higher level of valuation for equities. I could make a case based on historical valuation analysis that P/Es should not only be at the north end of their long-term ranges but should also trade at all-time peak levels. If the current low level of interest rates stays in place and inflation remains quiescent, the forward P/E could reach 20-22x the normalized OEPS level for 2022, which may prove to be conservative. Thus, we see a range of 3600 (20 x $180) to 4400 (22 x $200) as achievable over time.
- Your Weekly Roadmap
Market Tide Appears to Be Turning; Will You Be High and Dry?
After six straight weeks of a rising U. S. stock market, if you haven’t already then you should ask yourself if this is a trend? The house view here has been and continues to be an emphatic yes. Indeed, my colleague Tom Lee does a great job of explaining why there is more juice, beginning on page 3. Here I’ll limit myself to what’s going on right now. The Standard & Poor’s 500 index rose almost 1% to finish around 3120.46 last Friday, a new all-time record high and up over 5% since early October, which marks the longest winning streak in two years. What seems solid about the rise is that it is driven by a multitude of factors, which lends some sustainability to these gains. Sentiment appears to have switched firmly to risk on from risk off, something you can see in the bond market too, where bond yields have risen over the past few weeks. That suggests the bogeyman of a near-term recession is back in the closet. All to the good. Secondly, the U.S.-China trade spat, though it can always derail, looks like the parties might reach some sort of Phase 1 deal in the near term. I’m beginning to think, too, that the market has been inoculated against bad news on this score anyway. The economic data is decent to good, again reinforcing confidence. For example, the Commerce Department said Friday that U.S. October retail sales increased 0.3% from the previous month, thanks mainly to car sales and higher gas prices. That’s better than expectations of sales gaining 0.2% in October, according to Reuters. Want more? October U.S. consumer prices rose a seasonally adjusted 0.4% from the previous month, the Labor Department said. Economists surveyed by The Wall Street Journal had forecast a 0.3% rise. Simultaneously, Federal Reserve chairman Jerome Powell was giving the high sign to the economy during his two visits to Congress to testify. For more on this see page 6. And as I have noted in these pages most of this year, the dire warnings about the “earnings recession” have turned to be overdone. And as Tom Lee points out later in this report, S&P 500 earnings could surprise to the upside next year. According to the latest from FactSet, to date, 92% of the companies in the S&P 500 have reported actual results for Q3 2019. The blended (combining actual and estimated results from companies yet to report) 3Q earnings decline is -2.3%, down from -2.5% last week and nearly -5% at the beginning of the quarter. If -2.3% is the final number, it will mark the first time the index has reported three straight quarters of year-over-year declines in earnings since Q4 2015 through Q2 2016. If my math is right, the market is up big time since then, almost 50%. Looking ahead, analysts see a decline in earnings in the fourth quarter followed by 5% to 6% earnings growth for Q1 2020 and Q2 2020. “What if that’s too low?” is the question that current improving economic data should bring to mind. Additionally, FactSet notes that the number of S&P 500 companies discussing tariffs on Q3 2019 earnings calls is 13% and 25% below the number through the same point in time in the second and year ago quarters, respectively. And last but not least, the technical long-term picture supports the bull, too. For more on this, see page 9. While trading volumes were low last week, the NYSE Advance/Decline line has remained strong for many weeks but has weakened in the last few days. However, that appears to be mainly due to rotation out of defensives and into cyclicals. That, in itself, is a fair indicator of sentiment. For a little bit of levity, I bring up the chatter last week of the “Hindenburg Omen” and “Titanic Syndrome,” both technical signs that occurred together last week among Nasdaq stocks, an unusual event that sometimes precedes a selloff, according to SentimenTrader. It would take too much space to explain both, but suffice it to say the concept to both is that strong market strength could be hiding divergences under the hood. The trouble is these scary sounding indications have had some noteworthy failures, as well as successes. Quote of the Week: Democratic presidential candidate Elizabeth Warren has unveiled sweeping tax proposals that would push federal tax rates on some billionaires and multimillionaires above 100%: WSJ. Uh-huh. Good luck with that. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to
- Tom Lee's Equity Strategy
Don't Be Swayed By Risk Off Fears: Rally Looks Intact
It feels bad, doesn’t it? Even though the market slipped only a little this past week, the bears are rejoicing like it was 1999. The first five months of this year have been one of those rare market moments that harken back to the mid-90s, when equities relentlessly rallied. Now comes a little cold water. Since May 3, at one point the S&P 500 was down about ~5%, or ~125 points, the deepest such pullback since the awful days of December. Naturally, investors are asking themselves has this pullback done sufficient damage to signal a major top? I’m of the opinion that May 3’s level of 2945 isn’t the high for the year, as stocks seem to have pulled back more severely than investment grade and high-yield bonds. To me, the fact that credit activity is more muted suggests the trade tensions/tariffs are having transitory impacts. More specifically, risk off has raised equity premia but not severely raised the risk of default. This can be seen quite clearly within the investment grade credit default swaps arena. Technology, industrial and financial stocks have been among the hardest hit, thanks, in part, to exposure to the China-U.S. trade and tariff tiff, but corresponding credits are not reacting as badly. Nevertheless, deeper technical damage has been done to markets than the pullbacks seen earlier in 2019. Consequently, time will be needed to heal these wounds. The next few months of trading might see some “choppy” action, as markets and investors attempt to fully price in tariffs and the risks of escalation against the probability of a resolution of these issues. This doesn’t change my expectation for the S&P 500 to reach 3,100 by yearend 2019. Another interesting indicator is that sentiment is also arguably bottoming. The American Association of Individual Investors AAII reading of the percentage of bulls less the percentage of bears was -9% in the past week. (See chart on the right.) That’s the worst level in all of 2019 and one surpassed only during by the dark weeks around the Federal Reserve meeting in November and resulting market collapse. In my view, the AAII is one of the most reliable measure of investor sentiment. This reading suggests that the bad news seems baked in. What could go wrong? There remains a risk that a major top was put into the equity market this month and that the trade war leads to a recession. However, such a risk is low and more than offset by the higher probability of a massive risk-on rally. Perhaps we’ll see FOMO again. I continue to believe that upside this year will be driven by both an expansion in the market price/earnings (P/E) ratio and by earnings per share (EPS) revisions. Bottom line: During this period of choppy action, investors should stick with FS Insight’s Granny Shots, which are culled from portfolios constructed with FS Insight long term themes applied to company fundamentals and other factors. (For more on how Granny Shots are chosen and these themes, please see the May 11 edition.) They represent the “best of the best,” so to speak. Granny Shots have outperformed the S&P 500 index by 4.3% so far this year since January 10. The tickers are : GOOG, AAPL, TSLA, BKNG, XLNX, PM, AMGN, FB, GRMN, NKE, LOW, AMZN, EBAY, ROK, CSCO, PYPL, KLAC, NVDA, QCOM, PSX, AMP, AXP, BF/B, MNST, MO, VAR and DIS. Figure: Comparative matrix of risk/reward drivers in 2019 Per FS insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500 ** Performance is calculated since strategy introduction, 1/10/2019