Overall Market - May 25

[dan_s]

Comments below are from Mitch Zacks on 5-25-2019

On the surface, it looks like the bull market is hitting resistance on multiple fronts. Just when many market participants thought a trade deal with China was in the offing, talks broke down and tariffs went up – the exact opposite of a ‘market friendly outcome,’ in my view. Now, as corporations grapple with a new layer of uncertainty, the United States is also dealing with multiple geopolitical situations, from Venezuela to Iran to North Korea. And as if all these challenges aren’t enough, earnings were flat in Q1.

If some investors are starting to feel less bullish these days, I’d understand why. But I’m not one of them.

Let’s take a closer look at each of the above-referenced situations and see what’s really there.

U.S. - China Trade: I’ve said before that I believe a trade deal is a key factor in giving stocks room to run, so seeing these talks stumble was disappointing. The market didn’t like it either – on the day it became evident that talks weren’t advancing the S&P 500 fell by over 2% with 90% of stocks declining.2

We do not know when or if a deal will get reached, and it’s very difficult if not impossible to measure the impact of uncertainty. But if we forecast a 0.3% or perhaps on the high end a 0.5% hit to GDP as a result of increased tariffs, I think we’re still a far cry from undoing 3.2% GDP growth (Q1 initial estimate). What’s more, it’s important to remember that exports only comprise around 12% of U.S. GDP, while consumption accounts for nearly 70% of our economy.2 To the extent prices don’t go up too much with the latest round of tariffs, the U.S. consumer will likely weather this storm.

The one point of caution I’d underscore, however, is that investors should not read too far into 3.2% GDP growth in Q1.3 For one, it’s just an initial estimate. But second and more importantly, the start of the trade war last year resulted in quite a bit of supply-chain padding for many corporations – which gave a one-time boost to GDP. Looking deeper into the data, an investor would find that final sales (excluding inventories and net exports) grew at a more modest rate of 1.4%—the weakest performance since 2015. It’s still growth – which keeps me bullish – but it’s certainly late cycle growth, which keeps me cautious.

Escalation with Iran: We learned this week that Iran may be weeks away from exceeding an internationally-agreed cap on stockpiles of low-enriched uranium.4 It follows that this development would make them steps closer to production of nuclear weapons, which has drawn scrutiny from the international community and has led to posturing by both Iran and the United States.

Iran wants sanctions relief, while the U.S. continues to deepen sanctions and increase military prescence in the area. Statements by the U.S. National Security Advisor, John Bolton, made it appear as though the U.S. would be ready to engage militarily at any time, though President Trump has indicated he does not want war with Iran. For stock markets, an unexpected escalation or a miscalculation on either side would likely result in volatility, but I’m not convinced at this stage that either nation is doing anything more than posturing.

The Weak Earnings Picture: Looking at Q1 as a whole, earnings growth is expected to be effectively flat (down -0.1%) on +5.1% higher revenues. Investors generally do not like to see flat earnings.

But there’s an upshot here, too. Total earnings for the 450 S&P 500 members that have reported earnings showed 77.1% of them beating EPS estimates and 59.3% beating revenue estimates. Those are reasonable levels of earnings beats, and I think we can expect an earnings recovery in the second half of the year (assuming the trade dispute is resolved by then, which I think it will be).

Bottom Line for Investors

Remember, the stock market has thrived historically even in challenging moments. Over time, there are events and obstacles that seem insurmountable, and sometimes these events result in mass casualties or the destruction of numerous businesses, banks, or even industries. Yet stocks have managed to battle through the adversity and have continued throughout history to trend higher, reaching new highs in every cycle.

In some cases, the gains seem to defy logic, but at the end of the day it’s just the course that history has carved (and will continue to carve, in my opinion). Stocks love to climb a wall of worry, and stocks have shown over time that solid long-term returns have come to those who wait. Waiting requires patience and an ever-constructive attitude about human potential and the potential for relentless growth in the global economy. My constructive outlook today keeps me bullish until proven otherwise.

I believe that one way to stay focused on the long-term, and not get swept up in short-term emotional reactions, is to focus more on the fundamentals then day-to-day price movements.

[dan_s]

MY TAKE: Crude oil prices dropped on Wednesday & Thursday because...

1. Breakdown in the talks to end the U.S. vs China Tariff War: It it goes on and on it will have an impact on oil demand, but probably not as much as some people fear. My guess is only 100,000 to 200,000 BOPD less demand in 2H 2019, which will immediately go back up with any trade agreement.

2. Unexpected build in U.S. crude oil inventories: Yes, oil inventories did go up 4.7 million barrels for the week, but not much in comparison to U.S. refinery runs of 116.2 million barrels for the same week. EIA reported a small increase in U.S. oil production, but as I said at our luncheons, EIA has been grossly overstating U.S. production (high by 342,000 BOPD in February alone). U.S. crude oil inventories go up and down each week because of the timing of tankers uploading, which is just moving inventory from ships to onshore storage tanks. Just remember that EIA's weekly numbers are just estimates based on formulas.

3. The BIG NEWS that impacted oil prices the most last week was when Trump stormed out of the meeting with Pelosi, refusing to move forward with an infrastructure bill. Both parties are to blame for the crap going on in Washington. Seems that all they care about is posturing for the next election. Hope springs eternal and eventually an infrastructure bill will be passed, since there is a lot of work that needs to be done.

[k1f]

<<MY TAKE, 1, 2, 3>>

Dan, the explanations you reiterate for the energy slump contribute to the weakness but don’t address the howling problem: according to a recent chart I’ve seen, Energy is still the least popular sector of the market (of eight), whereas Technology remains by far the most heavily invested. While it’s true that sector-sentiment can change overnight, no theory so far can account for the overdetermined causality. It might be useful for EPG to track sectors as a measure of Energy's health.