Market Review: The Good, The Bad & The Ugly

 

For quite some time, we have been talking about weakening macroeconomic and earnings trends, which, combined with more aggressive Fed rate cuts, have historically denoted the beginnings of bear markets.” 

None of this has seemed to matter up to this point as market participants have continued focus on the “hope” of trade deals, and more importantly, further monetary stimulus from Central Banks. To wit:

“Investors are hoping a string of disappointing economic data, including manufacturing woes and a slowdown in job creation in the private sector, could spur a rate cut. Federal funds futures show traders are betting on the central bank lowering its benchmark short-term interest rate two more times by year-end, according to the CME Group — a welcome antidote to broad economic uncertainty.” – WSJ

This week, we are going to deviate from our normally more macro-market/economic view to specifically delve into the S&P 500 index and the underlying sectors. We will wrap it up with a review of our reasoning why Fed actions may not have the result investors are banking on. 

When looking at financial markets, price patterns can give us clues as to what the market participants are thinking as a whole. This year has been more notable than most, as investors have continued to “crowd” into a decreasing number of sectors in the ongoing chase for returns, liquidity, and potentially some “safety” from a weakening economic backdrop. As shown below, we can define these three “price patterns” as the good, the bad, and the ugly. 

Every week, we review the major markets, sectors, portfolio positions specifically for our RIA PRO subscribers (You can check it out FREE for 30-days)Here was our note for the S&P 500 on Thursday:

  • We are still maintaining our core S&P 500 position as the market has not technically violated any support levels as of yet. However, it hasn’t been able to advance to new highs either.
  • Yesterday’s sell-off did NOT violate support, but is also NOT oversold as of yet, which suggests further downside is possible.
  • There is likely a tradeable opportunity approaching for a reflexive bounce given the depth of selling over the last couple of days.
  • Short-Term Positioning: Bullish
  • Stop-loss moved up to $282.50
  • Long-Term Positioning: Neutral due to valuations

This week, we are going to review each of the major sectors as compared to the chart patterns above to determine where money is likely going to, where it is coming from, and what we need to be on the watch out for. 

Let’s start with the UGLY

The ugliest of sectors remains Energy (XLE). The trend remains sorely negative, and even the recent spike due to the Saudi oil refinery explosions failed at the downtrend resistance line. With the economy slowing, particularly in the manufacturing sector, the pressure on oil prices, and the energy sector, remains to the downside for now. 

Current Positioning In Portfolios: No Sector Holdings, 1/4th weight XOM

Small stocks remain in a declining trend overall. However, volatility in this market has provided some decent trading opportunities for nimble investors. However, Small Cap stocks are the most sensitive to changes in the economic environment and don’t benefit from share repurchase activity to the degree major large-cap companies do. With the small-caps trading below both their 50- and 200-dma, there is more risk to the downside currently. 

There is no reason to be invested in small-caps currently as they have increased portfolio volatility and provided an additional drag on performance.Buy and hold asset allocation models are not a suitable fit for late-stage bull market cycles. 

Current Positioning In Portfolios: No Holdings

Emerging markets, like small-caps, are very subject to changes in global trade, and in this case, “trade wars” and “tariffs.” 

Also, like small-caps, emerging markets have been in a long-term downtrend and have added additional drag, and increased volatility, to traditional asset-allocation models. With the 50-dma crossed below the 200-dma, the risk to emerging markets remains to the downside currently. 

Current Positioning In Portfolios: No Holdings

 Transportation is literally the “heartbeat” of the American economy. If you eat it, consume it, wear it, watch it, or listen to it, it was transported to you by truck, train, plane, or ship at some point on its way to you. The importance of this statement is that transportation tells you a lot about the the real-time activity in the economy. Currently, it is suggesting things aren’t all that great. 

With transportation trading below the 50- and 200-dma, the risk is to the downside. Importantly, the 50-dma is close to crossing below the 200-dma as well. A break of lows is an important signal for the sector and the economy, so pay attention. 

Current Positioning In Portfolios: No Sector Holdings, 1/2 weight NSC

Not BAD, More OKAY-ish

Financials have been trading sideways since May and have continued to consolidate. While the chart pattern doesn’t look so bad, the risk to the sector is rising as credit risk in the sector is high. There is a tremendous amount of debt sitting on the borderline between investment grade (BBB) and junk. There is also a good amount of junk debt related to the energy sector as well, and declining oil prices is accelerating that risk. If you are long the sector, that has been“okay” so far but watch lower support. A break of that level will signal a substantial increase in risk given the weighting of the sector to the overall market. 

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