Week in Brief: September 18

September 21, 2015

Last week began with stocks headed higher in anticipation of a rate hike. Expecting a confirmation of a solid domestic economy. The Fed saw otherwise. China. Europe. Emerging markets. The possibility of foreign concerns crashing the domestic soiree. Resulting in a delayed rate adjustment and a reversal in equity fortunes.
Investors loathe stocks. Again.
Following a six-year bull market notable for its lack of conviction and enthusiasm, investor sentiment appears to be waning yet again. Main Street, Wall Street, Newsletter writers, all bearish. Representing good tidings for us. For if history is any guide, the more bearish they become, the better the opportunities ahead.
Since 1963, the S&P 500 index has risen an average of 11 percent in those years after newsletter writers surveyed by Investors Intelligence were as pessimistic as they are today. That compares to an historical average of 8.3 percent.
This remains the most-hated bull market of the last half century. And because of the level of anxiety, investors remain on the sidelines. Which brings us to ask, who is left to sell? Everybody sitting in cash on the sidelines represents a potential buyer. All of them having bailed out of stocks with each scary headline since 2009. The euro crisis. Ebola. Falling oil. Greece. And now, China's economic woes. Of course, that market distrust has prevented the euphoria that typically appears in late stage bull markets. That euphoria representing the biggest historic threat to bull markets.
Fear dominates. Spreading faster than any time since 1984. In August, the S&P 500 fell 10 percent over four days. At the start of September, the bull-to-bear ratio in Investors Intelligence survey of stock market newsletter writers fell to a four-year low of 0.9. That following a 4.1 showing in April as stocks headed for new all-time highs and bulls dominated the landscape.
Today, the cost of hedging portfolios via options and futures has increased faster than Ole Miss's score against Alabama. Bearish contracts outnumber bullish ones by the most in three years. But, when so many investors become so bearish, everyone begins to short and hedge. Which becomes a bullish contrarian indicator. Because when so many people are positioned negatively, anything that goes right can send markets markedly higher.
Historically, this bull market has seen its biggest rallies when sentiment has been at its worst.
Bearish newsletter writers eclipsed bullish ones three other times during the last six-and-a-half years. April 2009. August 2010. And October 2011. Each turned out to be a buying opportunity. With the S&P 500 rallying for two straight quarters each time. Achieving gains of over 20 percent during all three periods.
U.S. unemployment has fallen to its lowest level in seven years. Housing and auto sales have upward momentum. While rising retail sales show that investors may be looking beyond recent market turmoil. Further, many analysts report that trouble emanating from China and emerging markets will likely prove overblown, as the picture isn't as dire as many have made it out to be.
Remember, stocks must always ascend the "wall of worry" on their way to higher highs. Once investor anxieties ease and abate, then euphoria begins. And the animal spirits really take hold. Which typically plunges a dagger into the heart of every bull market.
Following last week's Fed decision - which topped an otherwise solid week - the question du jour reverts to earnings. How will Q3 play out? Lots of speculation forecasting a poor earnings season. Especially after Q2 results were down. Let's clarify. Strip away the energy sector, and total S&P 500 Q2 earnings would have be plus 5.2 percent on plus 1.3 percent revenues. Looking forward, we believe the same will pattern in Q3. Ex-energy, earnings will be up roughly 1.7 percent on plus 0.7 percent earnings.
Purge energy companies and Q3 earnings will have patches of strength and weakness. As does any earnings period within an aging economic cycle.
Those likely to underperform will be Industrial Products, expected to dip -24.5%, Conglomerates, -15 percent, Basic Materials, -13.3 percent, and Consumer Discretionary, -12.5 percent.
On the positive side, Financials should have another good quarter with earnings expected to rise 8.8 percent. Other sectors likely to post positive Q3 earnings growth include Transportation (+16.5 percent), Autos (+21.3 percent), Construction (+8.7 percent), and Medical (+8.1 percent).
Investors should attempt to overweight positions within sectors garnering positive expectations, while underweighting their antipodes.
Bottom line? We would not be surprised were stocks to neither take off nor fall precipitously from their current perch. Rather, a continuation of the recent trading range, only with higher and lower bookends, would enable the fundamentals to catch up even as all of the current uncertainties play out. Which would create a true stock-pickers market for as long as such conditions persist. Allowing certain positions -- those currently undervalued as well as those able to generate dynamic earnings growth - to provide income and growth even as indexes trade sideways.
At any rate, we don't want to jump to conclusions. For all we know, stocks could rise like Lazarus. We wouldn't, however, get too bullish until the S&P 500 (now at 1966) closes back above its 12-month average at 2052. And this must hold through the end of a calendar month. Till then, we expect more volatility and episodic weakness into mid-October.
Finally, investing presents enough inherent challenges. Let's not allow the astrological calendar to rank among them. Avoid any near-term, knee-jerk decisions. Lest you fall victim to Mercury retrograde (here).
. . .
Europe's migration chaos worsened last week. Desperate immigrants from the war-torn regions of Syria and Libya continue pouring into Europe. Divided European leaders hold an emergency summit in Brussels this week. Discussing how to to respond to Europe's worst migration crisis since WWII.
Some believe that the current crisis, unabated, represents an existential threat to the future of the European Union. Of course, we heard the same apocalyptic commentary when the Greek crisis was unfolding.
The reality? Newer members of the 28-nation bloc are ill-prepared to handle their own crises. Let alone one involving hundreds of thousands of immigrants. And the developed members like Germany, France and Belgium have only begun to transcend their recent economic woes. They remain understandably worried about absorbing hundreds of thousands people with little in the way of resources and networks to fall back on.
. . .
Culturally, the Emmys occured in L.A. Sunday night. Swank event. So my sister - who has attended - tells me. I watched a bit. Adam Sandberg as host? Funny guy. Yet, what struck me were not the fashion statements, speeches or stage design. Nor that half the winning shows would not qualify as must-see television for most time-pressed Americans. What really struck me was how Sandberg's writers chose to call Donald Trump a racist within the opening monologue. Couldn't wait to get it out. Had to say it while the night was young and the audience awake.
Now, Sandberg immediately followed with a joke about Bernie Sanders. Something about his appearance being that of a rumpled traveler.
Trump? Racist! Sanders? Rumpled traveler. Nothing about the embattled former secretary of state. Nor any other candidates for that matter. GOP front runner? Racist. Trailing Democratic long shot? Sloppy dresser.
An apt summation of Hollywood's bias. Good news? The television audience was the event's smallest ever. Increasingly, the only facet of America concerned with Hollywood's opinions is Hollywood itself.
The Good
The economy's high-frequency, low-attention economic indicators remain positive... Homebuilder confidence hit the highest level in ten years...Q3 earnings estimates may be too pessimistic... Initial jobless claims moved lower to 264k... Home equity improved to 56%, showing U.S. residents have more wealth and less debt...
The Bad
Rail traffic declined significantly... technical indicators show all ten S&P sectors face are in downtrends... Industrial production fell a bit more than expected... Retail sales rose slightly less than expected... Housing starts were weaker than expected... Philly Fed index showed contraction...
The Ugly
Europe's continuing immigration crisis. What will it portend for the eurozone? To what lengths will American politicians go to reduce Europe's trauma? The human toll is tragic. The economic toll, unknown.
Weekly Results
Major markets finished mixed last week. The DJIA lost 0.29%, the S&P 500 fell 0.15%, and the Nasdaq added 0.10%. Small cap stocks rose 0.48%. And the 10-year Treasury bond yield fell 5 basis points to 2.13%. Gold added $31.49 per ounce, or 2.84%.

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