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Market Outlook: July 12, 2019



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The economic numbers continue to be mixed, with the bond market pricing in three rate cuts in 2019.  The most recently released numbers show an increase in employment as well as hotter than expected consumer and producer inflation.  The market is pricing in a 100% chance of a rate cut in July, a 65% chance of a cut in September, and a 45% chance in December.  Fed Chair Powell’s recent statements indicate that the July cut is likely despite the stronger employment and inflation readings.

There are many signs that a recession could happen in the next six to twelve months based upon continued slowing of leading economic indicators.  However, with the Fed beginning a monetary easing cycle while lagging indicators (like employment) are still strong, we certainly could avoid a recession.  Manufacturing is already in recession territory, contracting based upon PMI readings, but given that the services sector is still expanding (and a significantly larger portion of GDP) the overall economy could keep GDP positive.

Bond Market

Over the past several weeks, the trend in yields at the middle and longer end of the yield curve has been down, inverting the yield curve below short-term rates.  However, with the Fed likely cutting rates at the short end, yields have been ticking up in the middle and longer end of the yield curve.  This is leading to a potential un-inverting of the yield curve as bond investors grow slightly more bullish on the economy.

Negative bond yields in Europe have grown slightly less negative in recent days.  Economic numbers for Germany, France and Italy have all come in stronger than expected in recent days, giving bond investors there hope that the stagnating socialist economies might show some life.

Stock Market

After the big sell-off in May where the market was down 6.5%, the market recovered 6.8% in June.  So far in July, we have seen the market move 2.1% higher to new all-time highs as investors are viewing the anticipated rate cut as a fix to the slowing leading indicators.

This may be a temporary thing since second quarter earnings begin being reported next week and there have been a significant number of companies pre-announce that their second quarter and balance of the year likely would not meet earnings expectations.  It will be a struggle for investors to continue to push the market higher on the hopes that a rate cut will stimulate the economy adequately to change the trajectory of corporate earnings versus what they companies are seeing in actual financial results and sales trends.

Trends and Technical Analysis

The S&P closed yesterday at 2,999.91, trading up about 19% for the year.  It has continued to make new historical highs over the course of the rally from 2016 to date.  We are in a sustained bull market from the 2009 lows of 666 to the todays high of 3,006 (as of this writing), with the long-term (yearly) bullish trend intact.

The monthly bullish trend came into question in May, with the month ending lower than the preceding month.  However, the June month-end was higher than May as well as April, meaning that if July closes higher than June our monthly bullish trend is intact.

We have two levels of technical resistance that we need to get through to confirm that this move higher can be sustained and that it would be safe for investors to add equity exposure.  There is a key Fibonacci Retracement level at 3043 and an upper trend channel line at 3067 on the S&P 500 Index, that if both are broken signals that a move higher to the 3,113 pivot point resistance level is possible.

If we see market weakness based upon corporate earnings disappointments, there is lower trend channel line technical support at 2,832 as well as 2,792 pivot point support level.  Additionally, the 50dma is sitting at 2,891 and the 200dma is at 2,780, both of which are strong support levels.  As long as these levels of support hold any downside price movement, the market will be in technically neutral territory until we see if July closes above or below June.

Macroeconomic Issues

The macroeconomic  issues discussed in the previous Market Outlook continue to be of concern in their current and potential impact to the economy and financial markets.  They are, in short:

  • Tariffs hindering economic activity and increasing inflation
  • Earnings estimates are being cut
  • Personal, corporate, and government debt bubble
  • Government Debt Ceiling on September
  • Fiscal Policy limited due to high levels of deficit and debt plus the tax cut has already been implemented
  • Growing acceptance of Modern Monetary Theory, negative Fed Fund rates, and pegging of bond market yields
  • Illegal Immigration putting pressure on viability of social safety net
  • Legal Immigration system needs overhaul to focus on increasing the number of visa going to skilled workers
  • Demographics in the western world are deteriorating, with few than required young people than needed to sustain social programs and economic growth
  • A Solar Minimum Cycle of Sunspot activity leading to cooler and wetter weather, brief extreme heat waves, reduced crop productivity, volcanic and earthquake activity
  • Leading economic indicators flashing warning signs of recession

Strategy Summary

With the stock market at its all-time high, and the various technical indicators we follow telling us that the market is over-valued, caution is warranted.  However, stock markets can continue to move higher for longer than makes sense.

In recent weeks, we have raised cash by booking profits on holdings that our analysis showed were over-valued compared to their discounted cash flow fair value.  We invested that cash in bonds and in gold miners to hedge against a prolonged downturn in the market, along with cash equivalents.  This allowed us to outperform our benchmarks in May as the market corrected as we anticipated and again in June as the market recovered.

In early June, the Federal Reserve announced additional monetary stimulus was back on the table and that they would be ending their policy of Quantitative Tightening in the Fall.  This caused the correction to reverse and stocks to go higher.  We have reduced the duration in our bond hedges and have marginally increased our equity exposure by adding to defensive stock names as well as higher growth names that sold off in May.

Now that we are back at all-time highs, we need to examine our cash/gold/bond hedges.

  • If the market can close above the resistance levels discussed earlier and sustain those levels for at least three trading days, we will add additional equity exposure in client accounts
  • We will keep a normalize amount of cash equivalents on hand along with our bond and gold positions.
  • We added to our precious metals hedge by adding some silver to client accounts via the SLV ETF. Silver has not participated to the same extent in the move higher by gold prices and has the added benefit of industrial uses in case the fed rate cuts start to stimulate the cyclical areas of the market

With the stock market signaling that recession is off the table and the bond market giving trying to un-invert, we are in a difficult investment environment given the deteriorating fundamentals in the economic leading indicators.   The Fed’s anticipated rate cuts may in fact positively impact these fundamentals, but until they do we have to stick with what is known.  Based upon this, caution is still warranted in equity portfolios at the present time, but taking out overhead resistance would be a good start to a sustained move higher.