Bumping Up Against the 200-DMA

The S&P 500’s 200-day moving average is important to trend-following tactical investors looking for signals about whether they should be in or out of the market. How might this work? Here’s one simple and popular iteration.

If the S&P 500 is above its 200-DMA, own it. If it closes below, shift to bonds (say, the Barclay’s Aggregate). This approach has provided slightly better returns than the S&P with lower drawdowns since 1997, when daily data became available. However, that result assumes perfect execution, free trading, and no taxes, none of which are available. Moreover, it assumes we’ll be able to stick to the model through thick and thin, through 160 signals during that time. Were you using that approach currently, for example, you’d still be out of the market despite its big gains since Christmas.

Anyway, last week provided a good example of how the 200-DMA can impact the markets. The S&P 500 has been recovering nicely since Christmas, but on Tuesday it ran up against the 200-DMA, leading to losing days on Wednesday and Thursday and only a slight uptick on Friday. Prior to those two losing days, the stock market had had only six losing days this year. The down-up market of the last few months has drawn out a nice little “V” sign on everyone’s stock chart. We’ll see if this difficulty is a blip or has the makings of a “W.”

Now the news.

Domestic stocks moved very modestly higher last week, helping most of the major indexes record their seventh consecutive weekly gain. Within the S&P 500, utilities shares fared best, followed by the larger industrials and information technology sectors. Energy stocks fared worst as oil prices drifted lower.

The Sino-U.S. trade dispute moved back into the headlines last week and seemed to play a large role in driving sentiment. Stocks reversed an early rally Thursday and headed lower following remarks from National Economic Council Director Larry Kudlow, who told Fox News that negotiators had “miles to go before we sleep,” echoing not only Robert Frost but also Commerce Secretary Wilbur Ross, whose remarks about being “miles and miles” from an agreement sent markets lower in late January.

Later Thursday, CNBC reported that President Trump and Chinese President Xi were unlikely to meet before March 1, the 90-day tariff truce deadline the U.S. has established prior to raising the tariff rate on Chinese goods to 25 percent. CNBC also reported that the U.S. was likely to keep the current 10 percent tariff rate steady in the absence of a meeting, but confidence in a delay seemed to diminish Friday, sending stocks lower again. Weak economic data from overseas, particularly from Europe, also seemed to weigh on sentiment.

The pan-European STOXX Europe 600 was slightly lower on the week amid fresh trade worries and weak data that underscored the extent of the growth slowdown in the eurozone and its largest economy, Germany. In Asia, Japanese were down a bit more for similar reasons while Chinese markets were closed last week, as the country brought in the Year of the Pig, symbolic of wealth.

After the Fed’s dramatic reversal nearly two weeks ago, analysts have been left to ponder why Chairman Powell and his colleagues changed course. The best bet is because of China, where the economic data are troubling. Three years ago, then Fed Chair Janet Yellen executed a similar course correction in response to weakening Chinese data. Instead of four rate hikes in 2016, as previously signaled, the Fed proffered only one. China’s manufacturing numbers today are back to where they were when Yellen’s Fed made its turn. A new turn is not predetermined, obviously, but Powell’s remarks give him that flexibility, should he decide to exercise it.

Last week’s jobs report was terrific, as I reported here a week ago, but the bond market’s reaction to it has been surprisingly subdued. On Friday, the benchmark 10-year U.S. Treasury note closed at 2.63 percent. That level hardly suggests an overheating economy. Indeed, Yellen recently said that it’s possible that the Fed’s next move could be a rate cut. I wouldn’t say that’s likely, but it’s hardly unreasonable. The evidence keeps getting clearer that, as I argued here a week ago, the Fed won’t likely do much on interest rates in 2019, which is good news for stocks.

Other news and notes follow.

The latest SPIVA results are in from S&P and they are consistent with what we have seen before. Institutional money managers routinely underperform their benchmarks, largely on account of fees. Morningstar came to a similar conclusion: 2018 was yet another year to forget for active managers.

I am not the only one identifying China as a key threat to the stock-market rebound, a month after warnings of a slowdown in the world’s second-largest economy rattled markets across the globe. However, international investors poured more money into Chinese stocks last month than in any month on record. As noted above, stock markets in China were closed last week, which also means at least seven days without any disappointing data. The U.S. is dispatching its chief trade negotiator, Robert Lighthizer, and Treasury Secretary Steven Mnuchin to Beijing to continue trade talks as a March 1 deadline nears. While the two sides have made progress, they are still a long way from a deal. And President Trump probably won’t meet Xi Jinping before the deadline.

Small business owners’ confidence in the economy fell for the fourth straight month in December, while their outlook on business conditions sank to the lowest since late 2016. Consumers’ future expectations for the economy posted the largest three-month decline since late 2011. The Fed’s latest survey of senior loan officers found that banks expected tighter standards, weaker demand, and worse performance for business and household loans this year. Such measures of sentiment continue to show negative economic expectations while actual economic trackers, such as the most recent jobs report, continue to be strong. That sort of divergence often augurs a coming downturn, sometimes within six months or so.

Twenty-six of the 30 stocks in the Dow Jones Industrial Average and 465 of those in the S&P 500 have climbed this year. All 11 S&P 500 sectors are in the green for 2019. After months of downward revisions, analysts now expect the S&P 500 to post a year-over-year earnings decline in the first quarter of 2019, according to FactSet. As recently as September 30, analysts predicted the earnings growth rate for the current quarter would hit 6.7 percent, in part due to the impact of the 2017 tax cuts burning off. Earnings growth in the fourth quarter of 2018 is on track to hit 12 percent, with nearly half of S&P 500 companies having released quarterly results so far. If their estimates prove to be true, it would be the first year-over-year contraction of S&P earnings since the second quarter of 2016.

How are President Trump’s tariffs working? A typical American family will spend $60 extra per year due to tariffs. Duties on steel and aluminum cost Ford $750 million last year, according to the company. As a result, profit-sharing checks to Ford’s hourly workers were slashed anywhere from $750 to $1,850 each.

Americans 60 years old or more owed $86 billion in student loan debt, their children’s and their own, at last count. Student debt is a major contributor to the overall increasing debt burden held by seniors.

After a banner year, many small businesses are becoming more cautious about their investment and hiring plans. Just 14 percent expect the economy to improve this year, while 36 percent expect it to get worse.

U.S. stocks and bonds have been rallying together of late, an atypical pattern that some worry suggests the January rebound in equities is fated to run up against a painful reversal.

Bill Gross, the one-time “Bond King,” retired after a disappointing final act. His farewell interview is here. Despite Gross’s misfire, active managers need to make risky wagers, even if they could go bust, if they are to outperform.

Senators Bernie Sanders and Chuck Schumer argue that it’s necessary to put limits on how much stock companies can buy back and on the dividends they pay, and at least five declared or likely Democratic presidential candidates want to restrict how much stock U.S. companies can buy back from shareholders. It may be good politics, but it is an argument lacking supporting evidence. Instead of restricting share repurchases or dividends, we should make it easier for Americans to invest in America via the stock market.

Amazon founder Jeff Bezos, President Trump’s foremost nemesis in the business world, has profited more than anybody else during the Trump presidency. Since the 2016 election, Bezos has become the world’s richest person, his net worth swelling by $66.8 billion, to $135.4 billion, making his fortune a third bigger than Bill Gates’s, and almost 50 times greater than the president’s, according to the Bloomberg Billionaires Index. Bezos also made big news last week by taking on The National Enquirer (leading to obvious jokes, such as “Alexa, destroy my enemies,” and an obvious New York Post cover). Under the headline “No thank you, Mr. Pecker” (referring to David Pecker, CEO of American Media, publisher of the Enquirer, and close friend and supporter of the president), Bezos posted the full text of emails from the publisher — including the cell numbers of two executives — that he said constitute “extortion and blackmail.” This will be a fight to watch.

General Motors began more layoffs last Monday, axing 4,000 workers. The new round of cuts means GM has eliminated more than 14,000 jobs in the U.S. and Canada since November. Car dealers are beginning 2019 with a heavier inventory of unsold vehicles on their lots.

Concerns about the government shutdown and a drop in new orders crimped the U.S. services sector’s pace of expansion in January. The Institute for Supply Management’s non-manufacturing purchasing managers index fell to 56.7 in January from 58.0 in December.

President Trump gave his State of the Union speech last week. Mr. Trump said only three things stand in the way of an “economic miracle” taking place: foolish wars, politics, and ridiculous partisan investigations. Notably absent from the list of impediments was the Federal Reserve.

A steady decline in foreign demand for U.S. government bonds hasn’t seemed to have the impact on rates some predicted. Foreign ownership of U.S. government debt has been decreasing since it reached a peak of about 55 percent during the financial crisis in 2008. Foreign ownership fell below 40 percent in November.

A wave of bankruptcies is sweeping the Farm Belt as trade disputes add pain to already low commodity prices.

SunTrust Banks and BB&T said they agreed to combine in a merger of equals valued at about $66 billion, an all-stock deal that will create the sixth-largest U.S. bank in terms of assets and deposits.

New research casts further doubt on corporate welfare. When companies promise thousands of high-paying jobs in exchange for major tax breaks and incentives, those jobs often don’t show up.

Maryland has become the latest state to propose a fiduciary standard for brokers and insurance producers. The SEC’s delayed best interest standard will likely come this fall.

Market Wrap-up | February 3, 2019

Written by: Robert P. Seawright, Chief Investment & Information Officer, Madison Avenue Securities, LLC

Domestic stocks moved higher last week, powered by good gains on Wednesday and Thursday. Communication services shares fared best within the S&P 500, helped by a sharp rise in Facebook after the company reported solid fourth-quarter earnings. Energy and industrials shares also performed well, with the latter helped by better-than-expected revenues from GE. A drop in longer-term bond yields weighed on the financial services sector by threatening bank lending margins.

Fourth-quarter earnings releases drove much of the market’s trading, with 117 companies within the S&P 500 reporting results. Stocks fell Monday after disappointing results from NVIDIA and Caterpillar. Stocks regained momentum at midweek, however, after Apple reported a slight gain in earnings and a smaller drop in revenue than many had feared given recent press over falling iPhone sales. The benchmark 10-year U.S. Treasury note closed the week yielding 2.70 percent.

The pan-European STOXX Europe 600 gained slightly, but its advance was tempered by ongoing Brexit and U.S.-China trade uncertainty, weak regional data, and news that Italy’s economy fell into recession. Chinese stocks gained as hopes for a possible trade deal with the U.S. offset concerns over an influential private manufacturing gauge that fell to its worst reading since 2016, the latest evidence of the country’s deepening growth slowdown. For the week, the Shanghai Composite edged up 0.6 percent and the large-cap CSI 300, China’s blue-chip benchmark, climbed almost 2.0 percent. Japanese stocks were flat to a touch higher last week.

Last week’s biggest news, while obviously impacting the markets, was not directly market-related.

According to the consensus view, two different trends have been moving markets of late. One is the China factor, which is manifested in two separate ways. The first of these is the health of the Chinese economy generally, a huge market for businesses around the world. China’s economic difficulties are sending shock waves worldwide as its growth is down to its slowest rate in three decades. At least 440 Chinese firms said their 2018 financial results deteriorated, with 373 saying they’ll post a loss. Roughly 86 percent of those incurring losses were profitable in 2017. The other part of this trend is the trade war between China and the U.S. Any sign of peace is deemed good for riskier assets (mostly stocks), and vice versa

The second trend is central bank action or the lack thereof. At the beginning of December, it seemed as if all the major central banks were set to tighten what had been remarkably easy monetary conditions, perhaps precipitously. Cheap money generally boosts riskier assets (mostly stocks) by providing greater access to capital and by pushing investors there in search of yield. 

After listening to Federal Reserve Chairman Jerome Powell’s press conference Wednesday, after the Fed raised short-term interest rates by a quarter point in December and signaled two rate increases were likely in 2019, and after nine well-telegraphed interest rate hikes since 2015, it now appears that higher rates are off the table, at least for now. The Fed might even dial back its plan to work down its bloated balance sheet. At his previous press conference six weeks ago, after boosting interest rates for the fourth time in 2019, Powell ushered in the final and most dramatic stage of the pre-Christmas sell-off in the stock market by sounding far more hawkish than anyone in the market thought possible. Now, he’s doing the opposite. 

The following sentence appeared in the Federal Open Market Committee’s December statement.

“Some further gradual increases in the target range for the fed funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective.”

That sentence was nowhere to be found in Wednesday’s statement, but the following sentence was added.

“In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.

After just six weeks (and a significant market drop), the Fed went from a clear signal that more rate increases are likely to expressing the need for “patience” with no prediction about the future of rates. That’s about as dramatic a shift as you are likely to see from a central bank.

That said, the market’s reaction to this news was far more muted might be expected. The benchmark 10-year U.S. Treasury note yields fell three basis points to 2.68 percent, having been as low as 2.54 percent at the start of the year, and at 2.89 percent on the eve of the previous Powell press conference, while the yield curve steepened. The S&P 500 had a good day, jumping 1.55 percent to bring its gain since the day before Powell’s previous press appearance on December 19 to 5.30 percent. The damage of the previous appearance, in other words, had already been undone in the stock and bond markets. In barely six weeks, we have gone from the Fed leading the markets to the other way around.

A hawkish Fed generally leads to a stronger dollar, which makes life harder for emerging markets, undermines the U.S. trade agenda by weakening the competitiveness of American exporters, and impedes the dollar-denominated profits of U.S. multinationals. Now: the opposite. And it’s not just the Fed. A slowing global economy and low inflation has central banks around the world rethinking plans to pull back on financial stimulus. However, bear in mind that the last three times the Fed was forced to stop its rate hike cycle, a recession soon followed. 

Friday’s jobs report was outstanding. The economy added 304,000 jobs in January — significantly more than the 170,000 economists were expecting — while the unemployment rate ticked higher to 4.0 percent, reflecting the impact of the government shutdown. Average hourly wages for private-sector workers grew 3.2 percent from a year earlier. Neither the federal government shutdown nor market turmoil had any apparent impact on private hiring. The job market is also getting stronger. In the last three months job creation was its fastest in three years. Most notably, the U.S. is defying its demographic headwinds. The participation rate (the share of the population working or looking for work) is supposed to be falling as the baby boomers retire. Instead, it has climbed to 63.2 percent, a five-year high. That’s largely thanks to surging participation among prime-age workers, especially women, whose participation, at 76 percent, matched its highest rate since 2003.

Other news and notes follow.

Banks and smaller companies propelled stocks to their best January in 30 years, a sign that investors are favoring sectors tied to the U.S. economy. The Dow and the S&P 500 both closed with their biggest monthly gains since October 2015. The blue-chip index’s 7.2 percent rise was its best January performance since 1989, while the S&P’s 7.9 percent advance marked its best start to the year since 1987. The Dow and the S&P have each climbed 15 percent since Christmas Eve, their largest such percentage gain between the trading day before Christmas and the end of January since 1975, according to Dow Jones Market Data.

From 1926 to 2016, just 90 stocks of 26,000 account for half of all gains.

Europe’s economy is giving people the jitters. Investors are backing away from European assets, as worries over slowing growth and political uncertainty push the European Central Bank to rethink plans to tighten monetary policy this year. EU GDP grew at a tiny 0.3 percent in the fourth quarter of 2018, capping a year of low showings and as Italy slipped back into recession. Slow European growth is a concern for the global economy, too, particularly as China’s growth lagged last year, too.

Greg Mankiw, Harvard professor and Chair of the Council of Economic Advisers under President George W. Bush, took a look at President Trump’s economic plan and found it wanting.

The Department of Justice is seeking to shut down EcoVest, a sponsor of real estate investment programs, all focused on conservation easements, that it deems fraudulent. 

Overall, only 39 percent of Americans are well-disposed toward socialism, with older people and men particularly negative. However, 61 percent of Americans aged 18-24 have a positive reaction to socialism while the positives for capitalism are at only 58 percent.

President Trump announced new sanctions against Venezuela, targeting the wealth of Nicolás Maduro. “The world’s democracies are right to seek change in Latin America’s worst-governed country,” The Economist writes in a lead editorial.

The Treasury Department will have to borrow $1 trillion to pay for the government’s growing budget deficit, a consequence of increasing government spending and smaller revenues due to President Trump’s 2017 tax cuts. Meanwhile, the 35-day government shutdown eroded the economic benefits of tax reform and spending increases, according to the White House’s projections. $3 billion in economic activity was permanently lost to the shutdown, the Congressional Budget Office estimates. Even worse, the tax cut has had no major impact on business capital expenditures.

New York’s top financial regulator will allow life insurers to use data from social media and other nontraditional sources when setting premium rates, although they will have to prove the information doesn’t unfairly discriminate. 

PG&E, which is California’s largest utility, filed for bankruptcy protection as it struggles with billions of dollars in potential liabilities from its role in sparking California wildfires, triggering one of the most complex corporate reorganization cases in years.

As the two sides resumed talks last week, the U.S. and China were sharply divided on trade issues, suggesting a hard slog ahead of a March 1 deadline. However, progress was said to have been made and President Trump expects to meet with Chinese President Xi Jinping later this month to resolve the conflict that has rattled the global economy. 

Brexit keeps going nowhere fast.

Pending home sales fell 2.2 percent in December, meaning almost 400,000 fewer contracts were signed to buy existing homes. It’s part of an ongoing slump that’s seen 12 straight months of year-over-year declines. It’s also the lowest December sales reading since 2013. Existing home sales had been trending higher but also reversed course last month, falling 6.4 percent from November to a seasonally adjusted 4.99 million sales in December. That’s down 10.3 percent from December 2017’s 5.56 million sales when the metric was moving in the opposite direction.

More than 50 investment advisers are under pressure to settle federal claims they steered customers to mutual funds that charged excessive fees, even though asset manager fees are being squeezed generally. Meanwhile, the outsourced-CIO market is booming – and its influence is reverberating across the asset management industry.

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