Stocks Recover From Morning Selloff (Fed Futures Correction)

S&P 500 rallied steadily after opening the trading session lower. In this bull market, most of the gains have occurred late into the night in the after-hours session. That makes this rally unusual. S&P 500 increased 0.35% on the day. From its low, which was at the open, the index increased 0.89%. 

If you were waiting for the geopolitical event to cause a correction, you are probably disappointed. I’m not a geopolitical expert, but I was never expecting this event to cause a big decline. Recent selloff might not have even occurred because of the airstrike. It may have occurred because stocks were overbought or because of the weak ISM PMI.

Many mistakenly stated that odds of a rate hike were higher than they were because the CME Group FedWatch tool displayed faulty information. Fed Minutes didn’t cause the odds of a hike to spike sharply. Currently, there is a 3.3% chance of a hike this year and a 60.7% chance of a cut. 

Fed stated in its Minutes it was fearful low rates could cause speculation which could lead to financial instability. On the hand, it was also fearful of low inflation. It stated “participants generally expressed concern regarding inflation continuing to fall short of 2%.” The Minutes weren’t hawkish. Markets moved towards expecting more cuts because of the weak ISM manufacturing report and possibly the U.S. airstrike.

Specifics Of The Consensus

Wall Street isn’t optimistic on 2020 U.S. stock market returns. Interestingly, in 17 of the past 20 presidential election years the stock market increased. 3 down years were 1960, 2000, 2008. Since few banks or analysts are willing to predict a decline because they fear losing clients’ money, almost none are going against that trend. The chart below lists each projection. Only Mike Wilson of Morgan Stanley sees a decline. A 5% increase would put the S&P 500 slightly below 3,400.

None of these forecasts are calling for 10% or more gains. Therefore, it’s actually more common to see someone predicting a loss than an average year of gains. At the start of last year, when stocks were rallying quickly, we saw banks quickly raising their forecasts. That’s because the odds of a recession were falling. 

With the S&P 500 trading at a forward PE multiple of 18.3 as of January 3rd, I think banks will be less enthused to move up their price targets. A quick rally at the start of the year could have many of these predictions calling for a decline by the end of the year if they stick with them. Many don’t want to be caught bearish. Personally, I will be more likely to stick to my prediction, although, when facts change, I must adapt.

S&P 500 Versus ISM

ISM manufacturing PMI missing estimates helped push stocks lower on Friday. On Monday, stocks were pushed higher by the Markit services PMI beating estimates. PMI was 52.8 which beat estimates for 52.2 and November’s reading of 51.6. ISM services PMI comes out on Tuesday. It was a day later than the Markit report this month.

As you can see from the chart below, the difference between the S&P 500’s yearly Z-score and the manufacturing PMI Z-score is 4 standard deviations above normal. That’s the largest difference since 1996 and the 3rd such occurrence since the 1950s. There are a few counterarguments to this chart. Biggest one is that the S&P 500’s yearly change is going to reverse course. 

S&P 500 bottomed in December of 2018. Once the early months are lapped, the yearly change will be much lower. Even if stocks rise, they likely won’t rise as much as they did in Q1 2019. Secondly, the ISM manufacturing PMI is lower than other estimates of the sector. Finally, manufacturing is less important to the economy than in prior cycles.

Details Of Monday’s Action

Nasdaq was up 0.56%. The CES is currently taking place. A new trend of devices is laptops with folding screens. It’s the same technology in folding smartphones. This could be negative for Apple as it doesn’t even have touchscreen desktops or laptops. 

Apple’s MacBooks only have a small touch bar. Since the technology is in its infancy, it's highly doubtful Apple will release a folding phone or a folding screen laptop in 2020. So far, we have seen Lenovo and Dell debut folding screen laptops which will eventually run Windows 10X which comes out this fall. Lenovo’s folding screen laptop will come out in the middle of this year, while Dell’s are still concept devices.

Russell 2000 increased 0.14%. It might have ended its recent run of declines, but it still underperformed the S&P 500. VIX fell 0.17 to 13.85. CNN fear and greed index stayed at 93 which is extreme greed. It’s unusual for it to stay in the extreme greed category for long (more than a few days). WTI oil was only up 22 cents to $63.27 as worries about geopolitics died down. It did reach its highest level since April 2019 earlier in the session though.

Best sectors were energy and communication services which increased 1.22% and 0.78%. It was weird to see energy fall on Friday while oil prices rallied. Worst performing sector was the materials which fell 0.45%. 10 year yield has stopped falling in response to the airstrike and weak manufacturing PMI. It’s at 1.81%. 2 year yield being at 1.54% makes sense now that the CME FedWatch tool shows the correct data.

Conclusion

S&P 500 rallied again on Monday even though almost all analysts are calling for 2020 to be a below average year for returns. Even though I’m a bear, I can’t show the ISM PMI vs yearly S&P 500 Z-score without a few caveats. Investors see the manufacturing ISM PMI increasing in 1H 2020 and the S&P 500 having weak returns. 

In 2020, we should see EPS growth, a cyclical recovery in business investment and industrial production, and multiple compression.