E Trade Truce, Check! S&P 3,000... We'll See, And Why?

A quick review from some of my notes in the prior weekly Research Report before we get started, if you please…

“The most near-term risk to the market rally is the G-20 Summit meeting between President Trump and President Xi.  To reiterate, Finom Group believes the base case scenario is a trade truce that includes:

  • Agreement that no additional tariffs will be levied by either country
  • Timeline is set in place to remove certain restrictions placed on Huawei’s business operations with regards to U.S. suppliers and buyers.
  • Additional timeline for monitoring improvements made by China with regards to intellectual property theft
  • Agreement to increase commodity purchases from the U.S. by China

“The markets have had a great run through June and now they have become mostly overbought, skewing risk to the downside near-term.  Hedging activity remains elevated going into a critically important geopolitical event.  We anticipate seeing a sideways to slightly lower market outcome for the week.  Get your shopping list ready should the market defy the analysis and outlook.”

Much of what I outlined for the trading week, in terms of expectations, came to fruition with the major averages losing ground on the week and a trade truce between the U.S. and China enacted.  It’s difficult to realize the major averages were all lower for the week given the uptrend that persisted from Thursday through week’s end.  This is especially true when we reflect on the Market On Close order Friday that was one of the largest I’ve seen in 20 years.

All Things S&P 500

Nonetheless, indeed all 3 major averages finished slightly in the red for the week, with the Dow Jones Industrial Average lagging, down .45% for the week.  The Nasdaq (NDQ) was down .32% and the S&P 500 (SPX) was the outperformer, down just .29% for the week.

The month of June was quite spectacular, as the S&P 500 captured its greatest month of June since 1955.  For the month, the S&P 500 jumped 6.9% and up more than 17% this year, marking its biggest first-half gain since 1997. If there is one thing the stock market is historically and profoundly adept at doing it’s “climbing a wall of worry”.  And there has been a great deal to find concern about in 2019. 

From trade feuds to subdued earnings and weakening economic data, the S&P 500 has found itself in an uptrend since the December 2018 bottom. A sudden May 2019 seven percent correction took just 2 weeks for the S&P 500 to recapture all that it had lost.

Speaking of the Q4 2018 market correction, which equaled 20% or a technical bear market, many investors may have overlooked this point of fact and may still not realize that it paved the way for a NEW bull market.  The media doesn’t discuss the current bull market as being just 6 months in duration given the rapidity for which it has risen from the bear market territory expressed in Q4 2018. Nope! In fact, the only way investors will likely be privy to the understanding that this is indeed a new bull market, based on textbook definitions of bear markets, is if the bull dies rather quickly.  Then the media will finally discuss the shortest bull market in history. But until then and remembering the former bear market in 2018…

“Investors had very low conviction at the start of this year, but those who were brave enough to once again get into risk assets reaped rewards,” said Wouter Sturkenboom, chief investment strategist for EMEA & APAC at Northern Trust Asset Management. “It’s a good lesson for investors not to stay scared for too long.”

With the S&P 500 up more than 17% in 2019, what most investors desire to know is how this typically plays out for the rest of the year and over the next 12 months. The good news is; it tends to add to its gains.  The following table from Bullmarkets.co outlines that historically, when the S&P 500 is up more than 15% over a 6-month period, it continues to add more gains from a week later to 12 months later.

I should also note that the last 3 times the market was up more than 15% over the first 6 months of the year, the back half of the year did really well. What is probably most vexing about this year’s market rally is not only has it come with strong equity outflows and climbing a tall wall of worry surrounding the weakening economic conditions, but it’s the first year since 1995 that the S&P 500 and long-term U.S. Treasuries were both up 10%+ in the first half. (Bespoke Investment Group Table below)

While the relationship between the performance of equities and U.S. Treasuries has changed over time, positive equity performance has coincided with weaker performance in treasuries and vice versa, but not always as is being evidenced once again 2019.  This year is more predominantly about the Federal Reserve. Investors have been buying into both stocks and bonds in bets the Federal Reserve will reverse on monetary policy, bringing rates down to boost the economy. By all accounts, investors are largely winning on both fronts as the Fed has signaled the greater probability of cutting rates should their inflation mandate continue to fail achieving its stated target range of 2% inflation. 

“Bonds have risen all year “despite a stock market which continues to trend higher. The stock market appears optimistic about the future of this recovery, whereas the bond market is acting increasingly nervous,” said Jim Paulsen, chief investment strategist at The Leuthold Group, in a note. Determining which market is right “is a tough call, but for equity investors we continue to lean toward the view that what doesn’t kill you will likely make ‘the stock market’ stronger.”

According to Paulsen, the combination of fear, room in valuations and accommodative central bank policies are setting up the market for even more upside in the year’s second half.

”[There’s] a lot of support for this economy and this market — and a lot of fear and caution. That’s a powerful combination, I think, for higher levels here down the road,”

I would tend to agree with Paulsen, fear and worry combined with strong technicals and now a trade truce could induce a market melt-up through year-end. It may not happen in a straight line, but the probability increases for each and every headwind removed from the economy and market.

As far as the technicals are concerned, the algos have likely been triggered. Why do I suggest this?  Trend-following strategies are tied to technicals and one of the most popular trend-following strategies is as follows:

  • Buy when the S&P 500 is above its 200-DMA.
  • Buy when the S&P’s 50-DMA is above its 200-DMA (golden cross).

With both criteria satisfied presently, the algos have been engaged and will likely add support to the market on dips. Even when considering this important fact of the current market trend, investors have remained very, very uneasy about the market trend in 2019. Bank of America Merrill Lynch analysts led by Michael Hartnett, chief investment strategist, says that investors have never been so negative on a market that is rallying so persistently.

As mentioned in previous reports, the negative sentiment underlying the stock market rally and cash on the sidelines has the potential to reverse and invoke a market melt-up. All it needs is the right catalyst.  With the weekend headlines on trade, this may prove the catalyst the market has been awaiting. But still yet, there remain other considerations. 

An interesting note on the VIX and S&P 500 for the year comes from our friend Russell Rhoads, formerly of the CBOE.  "First Half 2019 ‪VIX Average will be around 15.82 at the end of today Q2 2019.  This is lower than the 2H 2018 Average of 16.96.  Since 1990 the ‪SPX has never had a down 2H when the 1H VIX Average is lower than the previous 6 months and below 16.  Average SPX, +8.6% for those 6 observations."

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Barry Hochhauser 11 months ago Member's comment

it's nice that they keep willing to negotiate with trade talks... until they break off again.

Gary Anderson 11 months ago Contributor's comment

So Seth, Tariff Man cannot help himself. He is back destroying goodwill as he threatens Europe. The Chinese and Europe should abandon the USA isolationism and grow closer. China will never trust the US again. Trump is destroying the US economy. It will show up if he does not back off.

Seth Golden 11 months ago Author's comment

I don't agree with his methodologies, but destroy the economy in 4 years seems unlikely. Much that has been undone and then instituted (tariffs) by the administration can just as easily be undone by the next. He'll back off in due time as noted in the article, just a place cardholder until the time is right.

Gary Anderson 11 months ago Contributor's comment

I sincerely hope you are right. Historically, tariffs seem to stick. Even if he loses the election it is likely that a tariff warrior will come from the Democrats.

Farah Kincaid 11 months ago Member's comment

I was actually wondering about that Gary. Are there any stats on how often #tariff decisions are overturned when there is a change in administrations?

Gary Anderson 11 months ago Contributor's comment

I think there is little info. It appears that tariffs are kept on certain products and industries. We know Democrats seem to be for tariffs. Some were angry that Trump gave Huawei a pass! This article goes into the problems that occur with tariffs:

taxfoundation.org/impact-of-tariffs-free-trade/

Seth Golden 11 months ago Author's comment

Theres little history regarding tariff implementation and using history isn't likely the appropriate way to rationalize given this the first occurence with a truly globally intertwined economy.