stocks

• Tom Lee's Equity Strategy

Aug 9, 2019

Writing about what might happen in the market’s future isn’t without risk. Nobody gives you a magical crystal ball when you become a strategist. But here’s the thing. There are signals—based on empirical data—that, when interpreted properly, give investors a useable roadmap to what the future will likely hold for stocks, for example. We’re all about the data. I’m going to give you five of them here which together point to a gain of about 12% over the next six months for equities. I believe investors should be more aggressive buyers right now and here’s why, followed by some 15 “asset light” stock ideas. The S&P 500 index fell a breathtaking 7% in the 4 days following the July 31 FOMC meeting and the plunge in the US 10-year note yield to below 1.70%. Indeed, it triggered a global market sell-off (panic?). For more on this, see page 6. As they always do after such big moves down, the doom prophets emerged from their bear caves, some pointing to 2019 as approaching its own “Lehman moment.” The plunge in US bond rates is certainly not welcome (sign of disinflation, and even credibility issues for Fed); the 10-yr was 1.32% in 2016 after the surprise Brexit vote, so this is not ‘new ground.’ However, investors ignore at their own peril the following five bullish signs that were generated in the past week. These signals have dependably generated an average gain of 12% in the following six months, 3.3 times above the 3.6% average gain over 90 years seen in the rolling average of any six months. Source: FS Insight, Bloomberg Here’s why I’m bullish: 1. Fed made its first rate cut in July, and since 1971 such a move, when leading indicators are positive, as they are now, resulted in an average 14.4% gain; (See chart.) 2. The VIX term structure (1 month-4 months) inverted. The last five of seven times was the bottom, followed by a mean six months gain of 8.9%; 3. A 3% one-day drop is sign of panic. Since 2009, there followed a mean 15.3% gain in the next six months; 4. The daily relative strength index (RSI) fell below 30. Six of the last six instances saw the market gain sharply, with average six months gain of 11.1%; 5. The American Association of Individual Investors (AAII) measure of the percentage of bulls less bears is about -26. Since 1987, when it has been that negative, the market followed up with a mean 9.3% gain in the next six months. So maybe this is our crystal ball. Source: FS Insight, Bloomberg We are not ignoring the negative signal of a plunge in interest rates, nor saying that a full-blown trade war is negative for the world. But we believe the trifecta of strong US corporates; a positive White House (towards business) and a dovish Fed are major supports for U.S. equities. Moreover, whether investors are convinced of it or not, 2019 is tracking 2009 closely (something I’ve been saying since the start of this year). My view remains that 2009 is the best analog for 2019 and that equities are seeing their best year since before 2006. The larger question remains: why does the Street seem to view every 5% pullback as the start of Armageddon? This old bull market has endured multiple 5%-10% drawdowns and managed new highs—yet, investors seem to believe this expansion’s structure is built on straw (though, actually, it makes sense if one sees this as purely central bank driven). What could go wrong? There are so many things that could go wrong. Deflation. A badly managed Brexit. Trump and China go to threat level 10. The Democrats surge in the polls. Russia interferes in the next election. North Korea. Deutsche Bank. Too many. Bottom line: I believe that investors need to stick with the four winning strategies I have pointed out: (i) US over RoW; (ii) “asset light” over “asset heavy”; (iii) Large-cap over small, (iv) and cyclicals. The following 15 stocks tickers represent the top decile of “asset light” + Doctor Quant Model ranked 1, and 11 underweights which are “asset heavy” and DQM ranked 5. OW tickers are: ROK, VRSN, LRCX, MXIM, QCOM, XLNX, MSFT, CL, MNST, MO, PM, AMGN, BIIB, GILD, BMY UW tickers are: WAB, CRM, WDC, ICE, CB, L, STI, HCP, WELL, NI, AP 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

• Your Weekly Roadmap

Jul 19, 2019

I regret to inform you that the market only made one new high last week, Monday, and then actually slid slowly and quietly down from there. How so you might ask? Well, it’s been a very good June and first half of July, and, frankly, everyone needs a break from all the festivities. Volumes were low as many market participants are presumably on break, probably somewhere less suffocating than New York City. Investors moved to a modified “risk off” stance last week after hitting another all- time high on Monday While a quiet week until the very end, it was punctuated with some minor excitement caused not by earnings nor by macroeconomic data. No, it was a reaction to comments Thursday from a policymaker of the Federal Reserve Board. OK. No surprise. The culprit this time was New York Fed President John Williams, who said central banks must take swift action when faced with adverse economic conditions. That was immediately and happily interpreted by markets as meaning a 0.5% rate cut is coming at the end of July from the Fed instead of a 0.25%. (For more on this see page 6.) The market slips from highs for a few days and just like that the cavalry, I mean the Federal Reserve Board, comes to the rescue. However, the central bank later walked that back and said Williams didn’t intend to signal any specific policy changes. I think this underpins the growing difficulty the Fed has created for itself in terms of communications. In the long run, I’m not sure how salutary it is for markets to hang on the word of every single Fed policymaker. I think maybe I should just retitle this newsletter to the “Vito’s Central Bank Watch.” The Standard & Poor’s 500 index fell 1.2% last week to finish at 2976.80. Monday did see a new all-time high close of 3014.30. The market is now up about 20% on the year, with tech stocks leading. Stocks skidded sharply in the last two hours of trading Friday on news of Iran reportedly seizing a British-flagged tanker in the Persian Gulf. Among stocks, video-screaming company FANG stock Netflix got its wings clipped, after widely missing paid-subscriber growth projections in the second quarter. The stock fell 13%. Indeed, the second quarter earnings report season kicked off in earnest last week, with roughly 56 companies in the S&P 500 index reporting. According to FactSet, some 15% of companies in the index reported results, and EPS is tracking currently at negative 2.1% compared to the same period of 2018. A few weeks ago, the projection was for minus 2.7%, so improvement is evident. I know quarterly earnings are important, but don’t overdo it. That is, the constant headlines warning about an “earnings recession” (two consecutive quarters of negative EPS growth) should be taken with a couple of grains of salt. As a recovering journalist, I can vouch for the fact that bad news sells, and the worse the news seems the more papers get sold. Second, remember that the second quarter is in the rearview mirror already. The market discounts the future, not the past, and right now 2020 EPS growth, about 11% expected, is probably more important than the 2Q EPS. For more on this, see our July 17 Signal from Noise story, “The ‘Earnings Recession’ is Here! Look Through It.” In short, the report notes that over the past five years actual EPS growth for S&P 500 index companies has tended to be better than analysts’ expectations. I don’t see anything different in this latest quarter. Focus on 2020. As I noted above, there was some sentiment midweek that perhaps the Fed would cut the Fed futures rate by 50 basis points instead of 25 bps. I think 50 bps is unlikely. Historically, and short of dire data, the Fed has been a gradualist in terms of changes, particularly when there is some uncertainty about the economy’s growth—as now. Second, a 50 bps cut could shock some investors and immediately bring up the idea that perhaps the Fed knows something the rest of us don’t, as in, what if the economy is much worse off than thought? And actually the U.S. economy isn’t bad at all. For more on this see page 3 and page 6. Bottom Line: I wouldn’t be surprised by near term softness, but the bull trend seems intact. Quote of the Week: In a CNBC interview BlackRock Inc.’s founder Larry Fink said “people are under-invested in equities” now and said that investors shouldn’t pump the brakes on stock buying even as the market trades in record territory. Fink noted the Fed’s change in tone that corporate earnings are coming in “pretty well,” which underpin recent gains. “At these levels, markets are going to trend higher,” he said. That’s what we’ve been saying. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to /.

• Your Weekly Roadmap

Jun 28, 2019

Well, we might as well have kept the stock market closed this week. Traders had their hands in their pockets, as investors were keyed up about the upcoming talks at the G-20 meeting in Japan. Not much happened amid low trading volumes. Last week, stocks were down slightly, as the Standard & Poor’s 500 index gave up 0.3% to 2942. Obviously, Monday’s market open could be significantly impacted by the weekend US/China talks—or lack thereof. If there’s some sort of deal, any deal, it will be interesting to see if stocks react well in the short term, or if such a denouement is already discounted. A poor showing by the trade negotiators will likely lead to a deterioration in sentiment and lower stock prices. But as I’ve said before, in the longer term I find it difficult to believe that we won’t have a deal at some point before the presidential election in November 2020. Set that aside, and investors have to celebrate at the half year mark. So far, the Standard & Poor’s 500 index is up 17% this year and 25% since the ugly day of Dec. 24, 2018. For the month, stocks are up 7%, which would be the best June since 1955, and 4% for the second quarter. What’s not to like? Nevertheless, for all this good news, when you step back from the market we aren’t too far above the highs of September 2018. Things feel better, but only in comparison to December’s swoon. In reality, the new highs of June were just a tad over the old high of September, so we’ve been running in place for all intents and purposes. I don’t see any traditional euphoria in the stock market, which is the typical precursor to a bear. Still, there are plenty of high spirits in pockets of the market: crypto currencies, marijuana stocks and certain IPOs, like Beyond Meat (BYND). Still, I think we could have a breakout in the second half. For more on this see Tom Lee’s article on page 3. Past performance doesn’t guarantee future returns, but looking at history often supplies some useful context. According to Bespoke Investment Research, since 1945, when the S&P 500 Index has been up in the first half of the year, as it is now, the index has averaged a gain of 1.3% in Q3. When the S&P has been down in the first half of the year, the index has averaged a decline of 1.3% in Q3. After a gain of more than 10% in the first half, stocks tacked on an additional 7.5% on average in the second half, but it was relatively flat when the index fell more than 10% in the first half, according to BIG. Tom Lee makes a persuasive case for a higher market by the end of the year, but investors still need to keep an eye on things. As we come to the end of the first half of 2019, what should we be watching in the second half of the year? Well, at 120 months, the U.S. economy just completed year 10 of this economic expansion, now officially tied for the longest business cycle expansion in the post-war period, according to FactSet in a recent report. While most economists will tell you that expansions don’t die of old age, the odds of fatal missteps increase the older they get, says FactSet. Keep an eye on the yield curve, where the spread between the 3-months bill and 10-year note has turned negative at minus 12 basis points recently from 100 bps positive last October. I’ve said the latter isn’t a particularly good signal but watch the 30 year-10 year spread, which is important and has widened. FactSet also said that in reaction to the increase in global trade tensions, there’s a slowdown in global manufacturing activity, as evidenced by the dramatic decline in many countries’ manufacturing purchase manager index readings over the last 18 months. Within the G7, only the U.S. and France are currently showing expanding manufacturing sectors. And gold prices, which are at six-year highs, deserve your attention. Expectations of lower long-term interest rates and the resulting weaker dollar are both contributing to gold’s strength. Separately, U.S. economic growth was 3.1% annual rate in the first three months of the year, the Commerce Department said Thursday, stronger than the 2.2% rate in the fourth quarter of last year. Personal-consumption expenditures, a measure of household spending on everything from carpet cleaning to computers, rose a seasonally adjusted 0.4% in May from April, the department said Friday. Spending growth also was stronger in April than previously thought. The department lifted its estimate to 0.6% from an originally reported 0.3% Bottom Line: Continued choppy action through Q3. Quote of the Week: From WSJ: Ahead of a meeting on Monday, some OPEC member nations are expected to argue for deeper curbs than previously agreed, OPEC officials say. But Saudi Arabia, OPEC’s de facto leader, is unlikely to back those proposals. “This is not going to happen,” said a Persian Gulf delegate. “Everyone should strictly comply with the [existing] cuts.” Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to /.

• Your Weekly Roadmap

Jun 21, 2019

Funny what a couple of words from the right person can do. It’s true that happy times can follow on a comment from your spouse, or your boss. Or just maybe—if it’s the stock and bond market—it’s a few words from the Federal Reserve chairman. Since the Great Recession of 2008 and the stock market trough in 2009, it’s been clear that the stock market has risen on the growth of earnings per share but also on the succor from a Federal Reserve that has gone to great lengths—read that quantitative easing—to support financial assets in general and equities in particular. And it’s happened again. Truth be told, the tinder was laid by a comment—I mean tweet—from President Donald Trump who said Tuesday that he had “a very good telephone conversation” with China’s President, Xi Jinping. (See page 11.) Once the Fed chimed in Wednesday about a potential rate cut, the match was lit and it was rockets red glare for stocks and bonds (see page 5). The rise in oil prices helped the energy sector, which was up almost 3%, but not so high enough to put investors off, given the increased tension in the Middle East after Iran downed a U.S. drone. Equities partied so hard last week that new all-time records were set Thursday, though markets eased back slightly Friday. The Standard & Poor’s 500 index rose 2.3% to finish around 2950. And this time round, the venerable Dow Jones Industrial Average—which hadn’t produced new highs in April when the S&P 500 did—also reached all time highs Thursday. Friday it closed at 26,719, up 2.4% on the week. The DJIA had been lagging, says Peter Andersen, who runs Andersen Capital Management in Boston, mainly on the trade fears. The Dow is chock-a-block with giant global companies whose revenues come from all over the world. Hence, he notes, investors only reading the tariff headlines were concerned that these companies would be unduly affected by an intensifying trade war. The market’s view on trade friction is a bit simplistic, Andersen continues. Indeed, the trade tiff between the U.S. and China has been generally not well understood by investors, he says. The situation was never going to be resolved in days and weeks, as the president said over and over again in tweets. Investors believed that, but the reality is more nuanced and complicated. The Chinese government is said to take the longer view, thinking in months and years, he adds. The market is finally adjusting to the idea that a deal will come but that “it isn’t going to be quick,” Andersen says. President Trump and Xi Jinping are expected to meet at the G20 Summit next week in Japan. With the economic data kind of “meh,” perhaps markets are sniffing out a somewhat better than expected world in the intermediate term. Andersen is sanguine about the next three to six months based on decent expected earnings growth and low unemployment numbers. The market’s price/earnings ratio is 17.7 times this year’s EPS and 15.8 times next year’s EPS. Now I realize that all this can go to smithereens in heartbeat, given the state of world events. The downing of the U.S. drone by Iran could have—and might yet still—turned out far worse, for example. And yes, the global data isn’t so sweet. Friday’s European factory output data suggested a decline in activity for the region, as the IHS Markit Eurozone Manufacturing PMI came in at 47.8 in June 2019, versus consensus expectation of 48. Meanwhile, orders booked at Japanese factories were at the weakest level in three years. Moreover, though I remain bullish I admit to recognizing some cognitive dissonance in the bond market, where the yields on the 10-year briefly slid below 2% before finishing at 2.06%, down from 2.08% one week ago. The bear looks at that and says, “See, the bond market is telling you a recession is possible.” The bull looks at that and says yields are dropping because the Fed is telegraphing that it will reduce the Fed funds rate soon. Again, I tend to go with the latter—at least until the global economic numbers worsen appreciably, which I don’t expect. For more on why that might not happen, see Tom Lee’s comments on page 3. Bottom Line: Continued choppy action until Q3. Quote of the Week: From The Wall Street Journal: “We were cocked & loaded to retaliate last night on 3 different sights when I asked, how many will die,” Mr. Trump wrote on Twitter on Friday. “150 people, sir, was the answer from a General.” Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to /.