Financial Markets Weekly: February 16th

February 21, 2018

Here's your financial markets weekly report for February 16, 2018.
Last week saw the S&P 500 post its best weekly gain since 2013. With the S&P 500 rising 4.37 percent. Not to be outdone, the Nasdaq leapt 5.36 percent, and the emerging markets index soared 5.04 percent.
Of course, the real story was what transpired the week before...
Two weeks ago, the Dow Jones Industrial Average traversed 20,000 points. Remarkable, given how low volatility was only the week before. Historians will note that the unwinding of the volatility trade triggered numerous consequences in financial markets.
And those financial firms offering the public a chance to directly play the volatility trade were wrecked. Like Deutsche Bank. A sponsor of exchange-traded notes tied to volatility indices. Whose market cap lost 25 percent in a week. And Credit Suisse. The sponsor of XIV, the ill-fated inverse VIX index. The one that plummeted from 140 to 5.
Remember the plight of Icarus. Whose arrogance and ignorance brought him to fly too close to the sun. Only to watch his wings melt as he careened earthward.
During such periods of market volatility, I'm reminded of 2008. As we were preparing to leave the large Wall Street firm for which we had long labored. Having made the decision to forgo a big check from another big firm. And to instead create a wholly independent wealth management firm.
Anyway. During the 2008 meltdown, I'll never forget how many of my colleagues were no less lost and terrified than their clients. Nor how the firm continued to make decisions in its best interest, as opposed to those of its clientele. These were among the many reasons we decided to exit the publicly-traded Wall Street brokerage firms entirely.
At any rate, early February's epic plunge was an old-fashioned, out-behind-the-woodshed, not-gonna-tell-you-again, I-didn't-do-it-dad!-style whooping. A whooping that was well deserved. Necessary even. Here's why.
After months of prognosticators stating that the lack of volatility would lead to something big, something big arrived. The S&P 500 began dropping on Friday, January 26. 10 percentage points lower as of Thursday, February 8, the market had finally succumbed to semantics. 10 percent being the definitive frontier across which an index must fall from the previous high in order to officially merit the term, correction. A bear market? Essentially the same, but twice as deep. Supplanting the 10-percent drop with a 20-percent plummet.
As for that record low volatility incurred throughout last year, when markets were calm enough to lull a baby to sleep? Sayonara. The VIX/volatility index soared from 9.5 to nearly 50. A level last seen in 2011 when U.S. Treasuries were downgraded. And sent the S&P 500 down 19.5 percent.
By Thursday, February 1st, a bottoming pattern was taking hold. As equity indices fell through the lower level of their Bollinger Bands, and the relative strength index dropped to 33. Both signs of an oversold market. And sure enough, stocks spent Friday being bandied back and forth like a shuttlecock over a badminton net. Only to catch a bid around 1:30 pm, and bust out from the negative two percent level to which the S&P 500 had fallen, careening to a 1.5 percent gain to by the closing bell.
And then, after the blitzkrieg, we endured a weekend of pins and needles (Is it over? Are we safe?). Which led to Monday's (February 5th) classic-rebound session. And one could begin to discern the shape of a bottoming pattern. At which lows are set, and rebounds occur.
The action was heart-pounding. Like watching Steve McQueen in the 1963 thriller, "The Great Escape." Bulls and Bears literally fighting to the final bell for cosmic dominance of the stock-market galaxy.
And so much for talk of the market's frothy valuations. As the previous week's drama recalibrated the P/E ratio for the S&P 500 to 16.5 on expected 2018 earnings. Down from the 18.1 mark at which it began the month. A skoshe above the 25-year average. Not the drastic overvaluation about which so many pundits had been crowing.
Today, opportunities abound. Both foreign and domestic. We are emboldened by the knowledge that bull markets typically end on the eve of recessions. And the indicators we follow reveal little chance of recession these next 12 months.
Of course, that will provide little solace to those lemmings who ran for the exits these last two weeks. Who rode the market lower. Pulled out. And entirely missed the recent bounce. Part of a diaspora of capital that was withdrawn from equity funds. Because following a long-overdue and healthy pullback, many investors became convinced again that there is no money to be made in equities.
Interest rates remain low. Energy is cheap. Corporate earnings are rising. As is consumer and business confidence. Wages are higher. Regulations and federal red tape are being cut. Along with individual and corporate tax rates. All excellent reasons for long-term optimism. If you feel differently, you need to stop watching the news.
Need more fodder for optimism? Research by Jason Goepfert at reveals that when the market had its worst week in more than a year - after hitting a 52-week high - stocks moved higher 100 percent of the time. In 90 years, this situation has occurred 10 times. And each ended with stocks higher one, three and six months later.
Of course, the more lemmings leave the party, the more bounty becomes available to optimists. So let 'em go. We won't miss them. But we will straighten our spines, lean into our futures, and let logic and pragmatism serve as our guides.
After last week's rally, the market has a ways to go towards recovering its previous highs. And Bears will be waiting. Mounting attacks along the way. Trying to further separate the weak from the strong. Those lacking conviction from those gritty optimists. All in an effort to stymie the rebound, sever the upward trendline and send stocks, finally, downward.
Nor would we be surprised to see stocks drop yet again for a healthy test of the recent lows. Which would only set the stage for another bounce, establish a bullish head-and-shoulder's chart pattern, and pave the way for new highs down the road.
Upward and onward!
In D.C., the Elephants and Donkeys finally agreed to a $4.4 trillion budget deal. One that adds a trillion dollars to the national debt. Which becomes a problem as interest rates increase.
Last year, net interest payments on the national debt equated to nearly seven percent of federal outlays. According to the Office of Management and Budget, interest on the debt will reach 10 percent of the national budget in 2020. And nearly 12 percent by 2024.
Eventually, the pain sets in.
Ever had maxed-out credit cards? Had to contend with those painful monthly interest payments? What happens when that transpires at the federal level? When wasteful spending becomes so obvious that everyone notices, perhaps then we will tackle the government spending problem. A problem that has nothing to do with the amount of revenue the government takes in. But with the amount of expenditures the government chooses to make. Year in, year out. Spending your tax dollars like a teenage girl with a credit card.
Economically, January retail sales fell 0.3 percent. Well below the consensus estimate of +0.2 percent. The number was hurt by a drop in auto sales, and a 2.4 percent plunge in building materials. Which appear to be mean reverting following the post-hurricane jump. Moreover, after the incredibly strong Q4 numbers, it's natural to incur a softening in the data.
More importantly, the recent volatility was primarily driven by inflation concerns. Rendering last week's inflation reports even more important.
The January Consumer Price Index (CPI) rose 0.5 percent. Above the 0.3 percent consensus estimate. Core inflation rose 0.3 percent, above the 0.2 percent consensus. Bringing the annualized rate of core inflation to 2.9 percent. Mostly on the wings of a 5.7 percent jump in gas prices. In all, inflation is slowly rising. But not enough (for now) to scare markets. And equities responded accordingly. Rising on the news.
Elsewhere, Venezuela's Marxist experiment is disintegrating. As the nation's GDP will likely fall 15 percent this year. And inflation is estimated to be 15,000 percent. Hyperinflation mixed with price controls and rationing? A toxic economic mix. Disturbing when one considers that Venezuela has the world's largest oil reserves. How inept must a government be to own the world's most valuable commodity supply, yet still preside over an economic catastrophe?
Production at Venezuela's state-controlled oil company, Petroleos de Venezuela SA (PDVSA), is collapsing. Soaring debt, mismanagement, corruption, and outdated infrastructure due to lack of capital investment have catalyzed a perfect storm. Workers no longer trust the value of their paychecks. So, they no longer show up for work.
Maduro's government has likely entered its last innings. With Columbia massing troops on the border to stem a growing refugee crisis. And the international community standing by as the population starves.
Marxism in a nutshell. Venezuela. North Korea. Soviet Russia. Cuba. Cambodia. Show me a Marxist government, and I'll show you a big, hot economic mess.
Socialism is full of high-minded theories and intentions. But in reality, its adherents end up starving. Awaiting crumbs in government bread lines. Capitalism, on the other hand, may lack for lofty philosophical theories. But in practice, it delivers the goods.
Stay tuned for your next financial markets weekly update…
Financial Markets Weekly Recap
Major indices finished up last week. The DJIA gained 4.25%. The S&P 500 rose 4.30%. The Nasdaq climbed 5.31%. While small cap stocks gained 4.45%. 10-year Treasury bond yields rose 2 basis point to 2.87%. While gold closed at $1,347.10, up $30.95 per ounce, or 2.35%.
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