October Buy-the-Dip Trick or Treat?
So much for the typical October strength in equities – a month in which the major US indices historically have gained ground 75% of the time. We’ve seen major index support levels broken while earnings beats have been smaller than we’ve seen over the past year with revenue and forward guidance giving investors jitters.
Over the summer and through September we warned that this earnings season would likely be a very bumpy ride as earnings would probably be decent, but guidance would not support the market’s multiples. Our concerns have proven warranted. Overall this earnings season the average company that has reported saw its shares fall 2% on its earnings reaction day – if this keeps up it will be the worst stock performance reaction on record since 2001.
How bad has it been?
- On Wednesday, October 24, the Nasdaq had its worst daily drop since 2011, closing the day down over 10% from its recent highs and by the close of the trading day, the Dow Jones Industrial Average and the S&P 500 had lost all their gains for the year. If the market’s close in the red again Friday, the S&P 500 will have closed down 15 days during the month thus far, the most since 2012.
- The FAANGM stocks entered a bear market this week, losing 4.4% on Wednesday – the worst decline since August 2011.
- The Global MSCI All World Index hit a 14-month low, in bear market territory with a more than 20% decline since the January highs, losing 11% in October alone – the biggest decline since the financial crisis. This week only 4 of the 47 countries in the MSCI all country world index were above their 200-day moving average.
- Homebuilder stocks have fallen more than 40% from their January highs – the canary in the consumer coal mine. New home sales plunged 5.5% in September versus expectations for a -0.6% decline as the supply of homes for sale rose +2.8% (the sixth consecutive increase) to the highest level since 2008 while demand has fallen to a 2-year low. Tell me again how great that consumer is doing and how they might contend with 5% mortgages? As those homes become more expensive to purchase, fewer Middle-Class Squeeze consumers will be filling out a mortgage application.
- The only two S&P 500 sectors in the green this month are defensive – Consumer Staples (+1%) in the midst of its longest winning streak since November 2009 and Utilities (+3%). Even one of the must-have lifelines for our Digital Lifestyle investing theme mobile service wasn’t a safe haven as AT&T (T) shares fell some 9% this week hitting a new 52-week low in the process.
- This week the Russell 2000 small cap index fell over 15% from its highs, closing Wednesday just 5 points away from a new 52-week low.
- After spending 262 consecutive days above its 200-day moving average, oil closed this week below that marker. Streaks of such magnitude have only happened two other times over the past 30 years – April 10, 2000, which ended a 272-day streak and September 2, 2008, which ended a 330-day streak. Those dates are worth noting.
- The first 18 trading days in October have seen a daily open to close loss 83.3% of the time, besting the previous 75% record in September of 2000. If the market rallies from open to close on the next 4 trading days, October’s closed in the red versus open will be 65.2% of days – the worst for any single month since October 2008 which was at the height of the financial crisis – and that is the very BEST we could hope for.
Investors are taking note with the weekly sentiment survey from AAII reporting that bullish sentiment fell to 27.9% from 34%, the fourth weakest reading for bullish sentiment this year. Bearish sentiment rose from 35% to 41%, the highest reading since the last week of June. Other indicators, such as the CNN Fear & Greed Index which fell to Extreme Fear (6) this week from Greed (64) a month ago, also point to increasing investor unease.
What is driving all this is the market starting to sync up with the reality of geopolitics and economics.
- The era of central bank continual infusions of liquidity is over. The flow has not only stopped, but in the case of the US, reversed course.
- We are facing trade wars and tariffs. The recent Federal Reserve Beige book was packed full of executives complaining about the impact of such on their businesses.
- A decent portion of the domestic economic acceleration has been thanks to unsustainable fiscal deficits. The market is just starting to figure that out as the headlines move from cheerleaders to more rationale skeptics. Our Safety & Security investing theme is making headlines as a solid portion of growth has been driven by increases in defense spending which shifted from an average annual -2.1% rate of decline from June 2009 to March 2017 to a +2.9% average annual rate of increase since April 2017.
- The Italian problem is not going away. It is too big to save and to say its current leadership is incompetent is putting it mildly, (as someone who lives a good portion of my time in Genoa of the collapsed bridge fame) and the clock is ticking on its sovereign debt bomb. As an example of the breathtaking level of incompetence, after two months basically no progress has been made on replacing that bridge despite its vital importance to not only Italy’s economy but to the greater Eurozone given its link to a major port.
- China is in a full bear market, its economy is saddled with a staggering level of debt, and the Chinese yuan has dropped to its lowest level versus the dollar in a decade. We are watching these and other data points with an eye toward our Rise of the Global Middle-Class investing theme.
- Geopolitical tensions are mounting around the world and the current Saudi situation highlights just how much the balance of global power is shifting.
The big question is where do we go from here?
Just 13% of stocks in the S&P 500 are above their 200-day moving average – these are mostly in the aforementioned Consumer Staples and Utilities sectors. This level has only occurred a few times in the past, marking just how oversold near-term the market has become. There is not one Energy or Industrial sector stock above its 50-day moving average. Rebounds are to be expected with such near-term oversold conditions.
Looking at the economics, the Citigroup Global Economic Surprise Index has been in negative territory, (meaning more data coming in below expectations than above) since April – the longest stretch in 4 years. The October Eurozone PMI fell to a 25-month low. Back in the US, the Richmond Federal Reserve local business conditions index for services hit a 7-year low, similar to what we’ve seen on the manufacturing side.
The employment situation is increasingly worrisome. The Richmond Fed’s wage expectations index for 6 months out recently jumped dramatically up to a level not seen since March 2000 as the available pool of labor has dropped to an 11-year low. Looking at who has been getting jobs recently, 70% of job gains over the past 6 months and 100% over the past 4 months have gone to folks with just a high-school degree or less. While we love to see more people getting jobs, from the corporate side of things, that means that companies are having to hire those with the weakest skill set. Great for the person getting a job as they can now develop more skills, but brutal for the employer who is facing weaker productivity as a result – that hurts earnings which are already facing rising costs from tariffs and trade wars as well as rising interest rates.
The bottom line is we are likely to see some interim rebounds, but it doesn’t look like the market is yet in sync with global realities. We have been pointing out for months that US stocks indices have been outperforming the rest of the world to a degree that was simply not sustainable.
The market is starting to appreciate the magnitude of the fiscal stimulus economic sugar high, that trade wars aren’t so easily won, that geopolitical risks are material, that the change in central bank liquidity flows matters and that future earnings growth is likely slower. We haven’t even gotten started when it comes to the fireworks I’m expecting from the Italian situation. We are likely to see the occasional rebound, but my money is that more pain is yet to come. That is great news for those that are focused on solid, long-term investing themes like the ones we have developed at Tematica Research, and have a shopping list of stocks ready for the bargains that will be coming our way.
