Week In brief: September 30

October 3, 2016

Stocks finished mixed last week. As Deutsche Bank's woes continued to rattle financial markets. And markets digested a continuing rally in oil prices.
Domestic large caps were higher. But foreign and domestic small-caps fell. All of which brought the curtains down on a Q3 that saw the S&P 500 forge 3.75 percent higher. And now rests just one percent below last month's all-time high.
Q3 saw small-cap outperformance. Mega-cap underperformance. Value stock outperformance. And those companies doing business overseas benefited by a weaker U.S. dollar. A rare occurrence these last two years.

Essentially, Q3 was a rotation from what worked in the year's first half into that which had not. Which suddenly worked quite well.
Ain't that the nature of markets?
Which brings us to October. A month well known for its exciting movements. The crashes of '29 and '87. The bull-market resumption and pivot higher following the 19.5 percent drop in 2011. Leaving us to wonder, does the uptrend remain intact?
The S&P 500 bottomed in February. Beginning 2016 like a boxer who finds himself struggling off the mats just seconds into the fight. The index regained its footing. And went on to hit an all-time high in July.
Yet, the latest survey by the American Association of Individual Investors (AAII) reveals that the percentage of bullish investors has plummeted. Falling 38 percent beneath the average. Counterbalanced by the rate of bearish investors. Sitting 22 percent higher than the historical average.
Of course, you and I know this makes perfect sense. As investor sentiment tends to be the opposite of what it should be. Bearish when it should be bullish. And bullish when markets merit caution.
Which is why the blundering herd makes such a nice contrarian indicator.
With the S&P 500's 200-day moving average in a strong uptrend, we believe stocks will head higher. Because stocks in rising trend lines tend to remain above their 200-DMAs for extended periods. So pushing their trendlines ever higher.
Current investor bearishness confirms our thesis. Providing the perfect indicator for the continuing elevation of equities. As the market exists to disappoint the maximum number of investors as frequently as possible.
Further, where equities are concerned? Q4 traditionally represents the strongest time of the year. Averaging an average historical gain of 2.7 percent. Since 1928, the average Q4 gain has been 4.3 percent when the index has been up through September's end. With the best-performing sectors being consumer staples, tech, health care and industrials.
From a valuation perspective, multiples have been permitted to rise. Driven, we believe, by corporate share buybacks. As the level of corporate debt outstanding has more than doubled the amounts hit prior to the Credit Crisis. Despite non-defense capital expenditures having dropped 10 percent. And real net fixed business investment (after depreciation) down another 20 percent.
Translation? If corporations are spending less on capex and fixed-business investment, yet issuing more debt than they have in years, to what end are they allocating capital?
Sherlock Holmes believed that one should never theorize before having possession of the proper data. Lest one end up twisting facts to suit theories. Instead of twisting theories to suit facts. And here, the data more than adequately points us to corporate stock purchases. And the purchase amounts required to maintain the market's status quo has risen quarter by quarter.
Speaking of Holmes, keep in mind that there is nothing more deceptive than an obvious fact.
To that end, clients have grown accustomed to our droning on about the idea that it's never the perceived dangers that kill you. But those threats you did not know existed.
Though we doubt the prescience in describing share buybacks as a potential bubble, we believe that it could represent one of the unforeseen consequences of an extended low interest rate environment. One that could eventually do portfolios harm. And so merits close attention moving forward, dear Watson.
Alas, the game is afoot.
Yet, not all areas of the market have been propped up by corporate share repurchases. Some have performed well enough on their own merits.
Defense stocks have outperformed. With the defense company iShare up 11 percent YTD. Twice the S&P 500. Why? Because the world order that existed a decade ago has destabilized. Leadership has descended into a vacuum. And defense alliances have come under scrutiny. Toss in the threat posed by radical jihadists the world over. And we find that more nations are arming themselves than at any period since the Cold War. Even NATO nations are spending more of their budgets as a percentage of GDP on weapons. As U.S. intentions, and even the very merits of the alliance, have been recently called into question.
Large cap U.S. defense contractors have done well. But the better play has been small- and mid-cap Israeli weapons technology firms. A land that has been surrounded by her enemies for decades on end. Yet manages to keep her chin up. And push back hard whenever threatened.
The Israelis have been ahead of the curve for decades. And are now leading the way in the design, manufacture and sale of drone, missile and remote control technologies.
Unfortunately, we do not foresee these trends slowing anytime in the near future.
Another underappreciated area? Water stocks. Those utilities, infrastructure and manufacturing concerns meeting the hydration needs of a burgeoning global population. Considering that demand for fresh water -- which comprises only 2.5 percent of the world's total water -- has skyrocketed alongside growing urbanization and population trends. While many of these positions have returned north of 10 percent year to date, we believe this to be a longer-term trend. And another worth following.
In fact, the water theme goes hand in hand with defense, as both hold the security of the world's population at their core.
Moving on, some have been asking, "Whatever happened to those big IPOs?"
Appears that IPOs may be prepared to make a comeback. While the onset of 2016 was quite inhospitable to them. There were no IPOs in January. Which marks a rare occurrence. By March, bankers were whining about the lack thereof. By May, no IPO had been priced above its opening range for nine months.
Today, however, there is no paucity of stocks poised for pricing. The most in over a year. In fact, there could be upwards of 18 IPOs this month. The most since June. And the most in a September since 2000, when seemingly every profitless, dog-food-selling dotcom went public to great fanfare.
So, as we'll ask in the missive below, do we approach a witching hour? A moment at which to sell stocks, take profits and sit quietly in the corner?
A recession would represent a reason to sell stocks. But, we don't see one in the near term. Monetary policy remains loose. And will still be loose even if the Fed raises rates in December. Tax rates could come down, but remain relatively low by historical standards. Nor is free trade in retreat. Moreover, the housing recovery has much further to go. And consumer financial positions have improved from a decade ago.
So please. Ignore the headlines. The vast majority of which are high-production hyperbole. Focus instead on fundamentals. Which tell us that the recent volatility was needed. And that the weeks ahead will likely bring a rebound in stocks.
European equities have outperformed these last few months. Beginning with June's Brexit vote. Continuing since. We believe that, in the near term, the rally will be difficult to sustain. As euro stocks depend so heavily on banking and financial stocks. Which, like Deutsche Bank, have been kicked in their less-than-perfect teeth.
Eventually, the disappointing euro financial sector will provide an opportunity. After achieving classic value status. As stocks like Deutsche Bank - which have been taken to the guillotine - will eventually leverage inroads into markets like China. And enable courageous, forward-looking investors to reap the rewards.
In Asia, Japanese stocks have returned to their 1987 levels. Shocking, considering that Westerners largely believed Japan was going to eat their lunches and then the diner up until roughly 1990.
The Bank of Japan looks like its sleepwalking through another catastrophe. And the country remains mired in a twenty-year recession. And with global economic growth appearing to barely exhibit an EKG pulse, we could really use an emergent Japanese economy to spur much needed growth.
Domestically, WTI crude oil continues to levitate in the mid-to-high-forties-per-barrel price range. Some of the smarter analysts have advised to buy at $40 and sell at $55. So that could be the near term trading range.
Last Monday, the two presidential candidates squared off at Hofstra University. The television audience set an all-time record. And they got that for which they tuned in. Scandal. Vacuous accusations. Empty rhetoric. And a lack of originality.
Trump displayed the diplomatic skills of a fourth grade class president. While Hillary hit him with empty accusations and touted a career heavy on insider experience and weak on actual accomplishments.
I don't understand the fascination with the "birther" issue. Nor the talk of Donald's original sentiments on the Iraq war. Neither have a lick to do with the most pressing issues of the day. But, being right all the time is tiring. So, I'd imagine both candidates will be well rested on Sunday.
And why Hillary would accuse Trump of degrading comments against a Miss Universe contestant who happens to have allegedly become a porn star and friend to cartel barons? Beyond our analytical purview.
Such is modern politics. The bar so low the contestants can moonwalk over it.
Historically, this was not the case.
56 years ago last Monday night, John F. Kennedy and Richard M. Nixon squared off under similar circumstances in Chicago. The first-ever televised presidential debate.
That evening, the topic was domestic affairs. And nearly 70 million watched. The summation? Those tuned into their radios believed Nixon carried the day. Yet, those watching television thought Kennedy the victor. Influenced by the contrast between Kennedy's healthy appearance against Nixon's sallow visage and five o'clock shadow.
Kennedy, who'd been campaigning in California, sported a glowing tan. Nixon would later comment, "I had never seen him looking so fit."
Nixon, contrarily, had just spent two weeks in the hospital following knee injury. He'd shed weight. Refused makeup. And appeared to sweat throughout the debate.
Yet, more notable than the candidate's physical attributes was the level of preparation both men brought to the evening. How articulately they discussed all ranges of arcane policy topics. And the level of gravitas both men conveyed. Neither candidate used a debate coach. And Kennedy hardly prepared at all.
Hillary, meanwhile, was quarantined as of Wednesday. Preparing for Sunday wholly five days in advance. While Trump, as evidenced by the first debate, will likely not prepare at all.
Moreover, even though Kennedy and Nixon did not care much for the other, they remained civil during the debate. Displaying a level of respect for each other often lost on today's caustic, egocentric candidates.
Fifty years later, JFK aide Ted Sorenson would say:
"There was far more substance and nuance in that first debate than in what now passes for political debate in our increasingly commercialized, sound-bite Twitter-fied culture, in which extremist rhetoric requires presidents to respond to outrageous claims."
And that was said six years ago.
The first debate beat Monday Night Football's rating. No small accomplishment in this country. So, until the second debate airs this Sunday, please chew on this "Hillary-ious" little tidbit. Compliments of Funny or Die (here).
This Sunday, both candidates will likely be asked about the deteriorating situation in Syria. Where last week saw U.S.-led coalition weaponry attack a Syrian army position, killing 62 Syrian soldiers, injuring 98, and destroying eleven pieces of military hardware.
Immediately after the event, ISIS militants were able to launch an offensive. And fierce fighting ensued.
The Americans called the attack an "error in target coordinates." While the Russians very publicly doubted that excuse. While accidents happen, especially in war, this will likely end the fragile cease fire established by the U.S. and Russia.
Whatever became of that Russian Reset?
All of which bears watching. Because geopolitical upheaval during the final quarter of U.S. presidential contests can bring volatility. And are not without precedent. Vietnam in '72. The Iran crisis in '80. The financial crisis in '08. All impacted the outcome of the presidential contest.
So, if Syria really comes to a boil, who benefits?
Over in the oil patch, OPEC appears on the brink of crying "uncle." Having agreed to the "need for" a production cap. One that could be established at its November meeting. And while much could still go wrong within this commodity rich goat rodeo, a production cap would be a welcome floor under the pricing of dinosaur goo. And not a moment too soon.
Since January 2015, more than 100 U.S. and Canadian producers have declared bankruptcy. Representing a combined $67 billion in debt, opines Dallas law firm Haynes and Boone.
Finally, The sports world lost two one-of-a-kind stars last week. Golfing legend and iconic gentleman Arnold Palmer passed away Sunday at the age of 87. Palmer changed the way we viewed golf. And then conquered the business world. Impacting the lexicon of luxury with his eponymously named beverage, the "Arnold Palmer." Which also works with a little bourbon...
Also, Florida Marlins ace pitcher Jose Fernandez and two friends were found dead when the rising star's boat crashed into jetty off the coast of Miami Beach.
Unlike Palmer, the 24 year-year old Fernandez was not yet an icon. But one in the making. As he'd defected from Cuba as a teenager. Having only succeeded after his third escape attempt, followed by a harrowing ocean journey. He took the baseball world by storm. And after having already done so much at his tender age, he had yet so much to achieve.
Both will be missed by so many.
Speaking of being missed...
This week represents the 25th anniversary of Nirvana's signature album, Nevermind,the platinum album that produced such anthems of teenage angst as "Smells Like Teen Spirit" and "Come As You Are."
Overview of the Zika Threat
Increasingly, the rapid spread of the Zika virus in the Americas rates as a massive public health concern. One for which national healthcare systems are ill prepared.
An arbovirus, Zika has been common in Africa and Asia. But was not reported in the Western Hemisphere prior to the current outbreak which began in Brazil. While the first human infection was confirmed in May 2015, evidence suggests the virus was around as far back as 2013.
The virus has spread rapidly in South and Central America. As well as in the Caribbean. Including the U.S. Territory, Puerto Rico. Zika made its first U.S. appearance in August 2016, having been detected in Miami, Florida.
The number of confirmed Zika infections in the Americas crested over 110,000 by August 25. Though the number of suspected cases is more likely nearing 500,000. And while fatalities have been extremely low (only 10 as of 8/25), the virus has been tied to a number of serious complications in a small number of infected individiuals. Most of them neurological. With microcephaly having been identified as the most serious fetal neurological complication. One that is associated with abnormal brain development within infected infants. And leads to lifelong problems attributable to a broad spectrum of impaired cognitive ability and neurologic function.
There has also been a correlation between Zika infection and Guillan-Barre Syndrome.
While the prevailing view has been that the majority of infections cause either mild symptoms or no symptoms at all, recent lab results indicate that Zika can infect adult brain cells. Should this be confirmed, the long-term threat posed to humans will have to be reconsidered. As an initial infection causing little symptomology could lead to delayed central nervous system (CNS) pathology, causing future CNS disorders.
Unfortunately, there remains no prophylactic vaccine for Zika. And only general anti-viral therapeutic drugs than can be used to treat the infection. As Zika remains a textbook example of an emergent infectious pathogen for which health care systems have no specific defense and lack the ability to quickly mobilize biopharmaceutical resources to develop such a defensive R&D effort. Zika, SARS, MERS, H5N1 and Ebola all provide evidence that although human populations remain extremely vulnerable to infectious pathogens, little has been done to mount any serious defenses at the international level.
[Source: TIS Group]
Weekly Results
Major indices finished mixed down last week. DJIA gained 0.26%, S&P 500 rose 0.17%. The Nasdaq climbed 0.12%. While small cap stocks lost 0.24%. 10-year Treasury bond yield fell 2 basis points to 1.60%. Gold closed down $21.79 per ounce, or 1.63%.

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