It has been a rough ride… but calmer seas should be on the horizon

Markets declined last week as the trade dispute between the U.S. and China flared.  On Monday, China provided a detailed list of tariffs on 128 U.S. products; the announcement was targeted retaliation for the 25% tariff on steel and 10% tariff on aluminum exports previously announced by President Trump.  On Wednesday, the U.S. released a list of proposed tariffs on approximately $50 billion of Chinese imports, including medicine, aviation parts, and semiconductors.  China responded with plans for reciprocal tariffs on $50 billion of U.S. goods, this time including high-visibility products such as soybeans and aircraft.  On Thursday, President Trump threatened tariffs on an additional $100 billion worth of Chinese imports; China then promised “to hit back forcefully and without hesitation.”  Despite the escalating threats, no tariffs are yet in force.  The U.S. and China each have much at stake; the economies of both countries, and global GDP, would likely suffer in a trade war.  Most analysts and political observers believe the parties will end up at the negotiating table; as of yet, though, there are no plans for discussions.   

Past trade negotiations, such as NAFTA, which were similarly marked by headline-grabbing rhetoric, provide a path to resolution.  Indeed, the White House hopes to announce the broad outlines of an agreement-in-principle on NAFTA negotiations at next week’s Summit of Americas in Peru.  For now, investors have adopted a wait-and-see attitude while the trade dispute with China unfolds. Although this latest announcement raises uncertainty and poses real market risk if the Administration presses further, we view this as a classic Trump negotiating tactic. As various Trump advisors walked back the severity of  trade war rhetoric and calmed markets, the President likely felt they were undercutting his negotiations, hence he may feel the need to prove he's capable of following through with his threats. This move may appeal to his base ahead of mid-term elections, while also keeping NAFTA negotiation headlines (like auto source concessions) off the front page. As trade uncertainty grows, we believe investors will be well served to find companies levered up to the significant fiscal policy stimulus coming from tax cuts and new federal spending.

Technology stocks remained under pressure; fallout from Facebook’s mishandling of user data, Tesla’s production challenges and auto-pilot car crash, and President Trump’s repeated attacks against Amazon weighed on the group.  Since the end of February, the Nasdaq, which includes the largest technology stocks, is the worst performing major index.  Meanwhile, economic data this week was somewhat mixed.  Fewer-than-expected jobs were added in March, although severe winter storms in the Northeast likely contributed to the lackluster results.  Still, unemployment remains low and wages are rising.  The ISM manufacturing and non-manufacturing indexes both revealed a modest slowdown in growth while remaining firmly in expansion territory; robust new order activity in both reports point to favorable economic conditions for the near-to-intermediate-term.  And, new car sales in March grew 5.5% year-over-year; higher dealer incentives may have aided results.  Analysts expect sales to decline modestly in 2018 for a second consecutive year though overall sales levels remain near all-time highs.

It appears that the market is trying to put in a low- but we're waiting to see stronger breadth and follow through. Valuations of the fifty largest stocks in the market today are nowhere near those of the one-decision Nifty Fifty stocks of the 1970's and those of the dotcom bubble. While there are pockets of overvaluation, the fundamental underpinnings for further gains are much stronger today. The dispersion of valuations in the group suggests that there are real opportunities for active management.

First quarter earnings reporting season begins next week with results from JPMorgan Chase, Wells Fargo, Citigroup, Blackrock, and Delta Air Lines.  The recent rise in short-term rates relative to long-term rates (known as a “flattening yield curve”) has pressured the financial sector.  Investors will assess the impact of the interest rate moves by focusing on banks’ net interest margins.  The growing use of aggressive ticket pricing, including “Basic Economy” fares, have weighed on the airline stocks.  Delta’s results will provide insight into the merits of these strategies.  Overall, first quarter EPS for companies in the S&P 500® Index are expected to grow 17.3% year-over-year, the fastest pace in seven years.  The reporting period may refocus attention on corporate fundamentals.

As the 2nd quarter gets underway, here are the 3 questions we’ve been asked most frequently from clients over the last few days…

1. Will the S&P make a lower-low?

The only thing we know for certain is that we don’t know. But with the put/call ratio in the 95th percentile and positive

divergences taking shape under the surface (e.g., fewer stocks making 20-day lows last week), we wouldn’t be short here.

The conditions often found at or near tradeable lows have started to take shape and seasonality through April is a tailwind.

2.  What do you want to see out of a rally from here?

Good lows are almost always accompanied with exceptional breadth. Quickly studying recent examples, the market’s response off the 2010, 2011, and 2015/16 lows include a number of days with 90% of stocks advancing. This is our framework for evaluating a rally moving forward. Friday’s move fell short of this hurdle with breadth coming in at a respectable, but not resounding, +4:1. If this is ultimately the start of a more pronounced distribution or bear phase, it will likely become more obvious into the summer months with tepid advances and poor leadership (but that is not our base case).

3. Is “FANG” finished?

We can’t recall having much success owning a group with a regulatory bullseye on its back (e.g. the Banks post crisis), but we’re also sensitive to the idea that – perhaps with the exception of Facebook – most of the FANG and related names were in solid uptrends, leadership stocks, and not showcasing much evidence of weakness before the latest rout. It’s said that the best stocks often get hit last in these corrective phases, and that seems to be the case recently. As a group, FANG is still some 14% above its 200-day moving average so we wouldn’t rule out that they may need to come in further. The next rally will be key… do they reemerge as relative leaders? That’ll be an important tell for the longer-term call

Please feel free to call or email us with any questions you may have.

*Source:  Pacific Global Investment Management Company and Strategas

Chart reflects price changes, not total return.  Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.


Last Week's Headlines

1. Total Construction spending during February 2018 was estimated at a seasonally adjusted annual rate of $1,273.1 billion, 0.1 percent (±1.2 percent)* above the revised January estimate of $1,272.2 billion. The February figure is 3.0 percent (±1.5 percent) above the February 2017 estimate of $1,235.7 billion. During the first two months of this year, construction spending amounted to $176.3 billion, 4.4 percent (±1.3 percent) above the $168.9 billion for the same period in 2017. - US Census Bureau

2. New orders for manufactured goods in February, up six of the last seven months, increased $6.0 billion or 1.2 percent to $498.0 billion, the U.S. Census Bureau reported today. This followed a 1.3 percent January decrease. Shipments, up fourteen of the last fifteen months, increased $1.0 billion or 0.2 percent to $500.5 billion. This followed a 0.7 percent January increase. New orders for manufactured durable goods in February, up three of the last four months, increased $7.2 billion or 3.0 percent to $247.3 billion, down from the previously published 3.1 percent increase. This followed a 3.6 percent January decrease. Transportation equipment, also up three of the last four months, led the increase, $5.5 billion or 7.0 percent to $83.5 billion. New orders for manufactured nondurable goods decreased $1.2 billion or 0.5 percent to $250.7 billion. - US Census Bureau

3. The nation's international trade deficit in goods and services increased to $57.6 billion in February from $56.7 billion in January (revised), as imports increased more than exports. (April 5, 2018) - US Census Bureau

4. The unemployment rate was largely unchanged. However, over the year, average hourly earnings have increased by 2.7 percent on average. Total nonfarm payroll employment edged up by 103,000 in March, following a large gain in February (+326,000). In March, employment grew in manufacturing, health care, and mining. - Bureau of Labor Statistics

5. US total vehicle sales came it at a healthy 17.48 million, ahead of Reuter's Poll, which was 16.9 million.


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