More Than Meets The Eye Happening Here

I attended a holiday gathering for one of my advisor clients on Friday evening. While everyone appeared to be in the spirit of the season, when the conversation eventually turned to the market action, the mood quickly changed.

In talking with fellow financial professionals throughout the evening, the theme of the conversations was consistent. To a man, everyone agreed that (a) this was the worst market they'd seen in a VERY long time, (b) the action "felt" like an old-school bear (relentless selling, no lift, no obvious catalysts), and perhaps more importantly, (c) there is more going on here than meets the eye.

The latter is a lesson we learned from the 2007-09 financial crisis. Honestly, before then, very few investment managers (including yours truly) had ever heard of the now-famous alphabet soup of derivative securities or the "mark to market" rule that combined to nearly crush the global banking system.

Today, we all know that "forced selling" (fund blowups, margin calls, and a myriad of programmatic systems) can cause markets to collapse into a vacuum as buyers simply stand aside when the algos begin to roll and/or folks "need" to sell at any price.

But, on Friday evening, everyone agreed that this market definitely feels different. The point is that since 2011 - the time when many believe that high speed algo trading began to dominate the market landscape - all episodes of "forced selling" eventually ended and after a couple of days, a "face ripping" rallied tended to ensue. But this time, as the group said in unison, "there is NO LIFT at all." ALL intraday rallies are sold into - within minutes.

The group further opined that this market appears to be different than even the 2011 whipsaw party, where the market moved up and down and down and up in what Tony Romo might call large chunks. The difference was that those trends moved in a straight line and then reversed and went the other way - with reckless abandon in both directions. In my humble opinion, this was news-driven (U.S. debt downgrade, Europe crisis, etc.), high-speed trend-following at its finest. But again, the current action feels different.

Since December 3rd, the market has indeed moved in a straight line, becoming what is referred to as a "waterfall decline" in the process. But, there are no headlines to trigger the moves. No, something else appears to be at work here. And the real problem is no one is really sure what that "something" is.

So, this morning, I thought I'd run through some of the possibilities kicking around in my head. There are three.

Premise #1: It's the Earnings, Stupid

One narrative being bandied about is the slowdown in earnings growth could be worse than anticipated - especially given what is happening to oil again.

Mathematically, it is obvious that EPS growth for the S&P 500 had to fall given the 25%+ growth we saw in 2018. Everybody knows that a healthy chunk of that growth was attributable to the tax cuts and as such, won't recur. This isn't the problem. Remember, something everybody knows isn't really worth knowing in this business (because it's already priced into the market).

I think the real problem is that EPS could fall significantly more than the market has been expecting. Think about it... Higher interest rates. Tariffs. Rising wages. Economic slowdown. Any of these - and especially a combination of these - could impact corporate profits (and not in a good way).

As Exhibit A in my thesis, below is a chart of Consensus Estimates for S&P GAAP EPS.

View Full Size Chart Online
Source: Ned Davis Research

Note the accelerated decline of the salmon-colored line in the upper right. This shows that the GAAP (generally accepted accounting principles) version of EPS estimates are falling - fast.

From my seat, the real problem is that these estimates may need to fall even more - and even faster.

The reasons? #Oil and #GrowthSlowing.

Oil's Dance To The Downside

Don't look now fans, but oil is cratering again. Not like it did in 2014/15, but the USO (United States Oil Fund ETF) has plunged -41% since October 3rd. Yowza - talk about moving in a straight line!

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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

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