Released this morning: Personal Income and Outlays: July 2018

U.S. Pending Home Sales Retreat

The National Association of Realtors (NAR) reported that pending sales of existing homes declined 0.7% during July following a 1.0% June rise, revised from 0.9%. Sales fell to an index level of 106.2 (2001=100) and remained down 2.3% y/y. Sales were 6.0% below the peak in April of 2016. (…)

  

Canada Voices Optimism on Nafta Deal As U.S.-Canada trade talks kick off in earnest, Foreign Minister Chrystia Freeland reveals that the two nations already reached an accord on autos.

Trump allows targeted relief on steel, aluminum quotas: Commerce Department U.S. President Donald Trump has signed proclamations permitting targeted relief from steel and aluminum quotas from some countries, the U.S. Commerce Department said on Wednesday.

(…) from South Korea, Brazil and Argentina and on aluminum from Argentina, the department said in a statement. (…)

International Trade Commission Blocks Proposed Newsprint Tariffs The U.S. International Trade Commission blocked the Trump administration from imposing tariffs on Canadian newsprint, handing the publishing industry a victory in a battle it said was crucial to the health of newspapers.

The ITC, an independent government agency, ruled 5-0 that Canadian paper imports didn’t cause “material injury” to U.S. paper producers. (…) The tariff case was pushed by One Rock Capital Partners LLC and its paper mill, North Pacific Paper Co., in Longview, Wash., also known as Norpac. (…) Earlier this year, the ITC also rejected U.S. duties on Bombardier Inc. in a case pushed by Boeing Co. (…)

Fresh Stress Grips World’s Weakest Emerging-Market Currencies The Argentine peso hit a record low and the Turkish lira resumed its slide, dramatizing the strains faced by emerging markets most vulnerable to a rising dollar.

While Argentina and Turkey are in particular trouble, many developing countries are being squeezed as the Federal Reserve raises interest rates, boosting the U.S. currency. The central bank’s actions are felt globally but it has no particular responsibility for international financial conditions, unless they feed back into problems at home. (…)

Some 48% of the world’s $30 trillion in cross-border loans are priced in the U.S. currency, up from 40% a decade ago. Exchange-rate fluctuations help determine the ease of servicing that debt. And with U.S. interest rates still low by historical standards and the dollar only halfway back to its 2016 highs, the stress could increase as the Fed keeps tightening. (…)

• Felix Zulauf: Continued Rally in the Dollar Will Be Bearish Nearly All Asset Classes

(…) The dollar is an important barometer of the world economy, he added, with a weak dollar usually signaling world economic expansion and acceleration. This happens because the credit system by itself creates more dollars in a feedback loop with economic expansion.

If the dollar is stronger, this signals a slowdown because the global economy isn’t creating as many dollars, given that it is the global reserve currency.

“This is a deterioration of global liquidity,” Zulauf said, and is “bearish in virtually all asset classes except prime quality bonds. If you’re looking into prime quality bonds, you have the U.S. Treasuries and you have German bunds.”

While Zulauf doesn’t find German bunds attractive here, he does see value in U.S. Treasuries, which he thinks will likely see falling yields into year-end.

He’s also not too concerned about the growing deficit in the U.S. or rising inflation rates, because forces outside the U.S. are dampening those factors.

If currencies outside of the U.S. decline further, we will have input prices for the U.S. going down, not up. With emerging market difficulties, the CPI dampened, and with commodity prices and foreign currencies both falling, the dollar should remain attractive.

From a macro point of view, this setup is not bullish for global equities, but he expects investors to be able to hide in U.S. bonds for some time. The strongest market will be that of the U.S. because the capital flow will lend support to our economy.

Soaring Corporate Profits Fueled by Tax Cuts, Solid Economy The Commerce Department measured a 16.1% year-over-year gain, the largest in six years. Profits were bolstered by large tax cuts and strong economic growth.

The Commerce Department said Wednesday that its broadest measure of after-tax profits across the U.S. rose 16.1% in the quarter ended June 30 from a year earlier, the largest year-over-year gain in six years.

Because of the lower corporate tax rate signed into law last year, taxes paid by U.S. companies in the quarter were down 33% from a year earlier, according to the government data, or more than $100 billion at an annual rate. (…)

SENTIMENT WATCH

MELT UP!

It’s ‘dangerous’ for bears to ignore the recent breakout in stocks, analyst says Recent breakout ‘is about as bullish of a signal as we usually get with the stock market,’ Raymond James analyst writes

(…) “It is dangerous to ignore breakouts from such bases, as they typically signal something has changed in the market.” (…) “A breakout to an all-time high is not typically viewed as a symptom of an unhealthy market,” he wrote.

Forget Summer Doldrums, Stocks Just Keep Rising

The S&P 500 Is Having a Wonderful August but Should We Worry About September?

(…) With just two more trading days left in the month, the S&P 500, up 3.5%, is on pace for its best August since 2014. If it gains another 0.3%, it would be the best August since 2000. (…)

But there’s good reason for the market to rally, writes Brad McMillan, chief investment officer for Commonwealth Financial Network. Among his reasons: The Fed isn’t worried about the economy, emerging markets aren’t threatening to bring down the global markets, and the Trump administration’s deal with Mexico shows that the threat of trade wars might actually lead to new deals, not just escalation. And all that’s happened in a short period of time.

“[In] the past two weeks, three of the major worries that have been holding the market back have eased significantly,” he explains. “With fewer worries holding the market back, continued appreciation in the face of strong fundamentals seems reasonable.” McMillan sees the S&P 500 hitting 3,000 by the end of the year.

But that doesn’t mean we shouldn’t worry about September. NatAlliance Securities‘ Andrew Brenner notes that it has been a historically bad month for the market. Bad. Really bad. The worst. Since 1950, the S&P 500 has averaged a 0.5% drop during September, and while that improves to a loss of 0.4% during a mid-term election year, it’s still bad. “With the Nasdaq up 4.7% this month and S+P up over 3%, the last thing that investors want to hear is the history of equities in the month of September,” Brenner writes. “No to those that think I am negative, just trying to keep reality in check.”

Market Pulse Signal: Trend Moves Equity Allocation to Full Investment

Breadth in positive momentum, as measured by the Ned Davis Research CMG US Large Cap Long/Flat Index’s (NDRCMGLF Index, or the Index) model, has driven today’s allocation to a 100% equity investment. The last Market Pulse signal occurred in April, when the model de-risked to an 80% equity allocation in response to negative price action associated with an embattled technology sector and unknowns associated with escalating trade tariffs. However, the model revealed improving market health beginning late in July after another strong earnings season. This shift in momentum was reflected in the model’s increasing composite score until its directional trend, an intermediate-term moving average, went positive to trigger full U.S. equity investment.

The model’s score closed above 65 for the first time since June, and continued to move upwards until the persisting trend of its score went positive, as measured by the model’s moving average. (…)

The Index’s model (i.e., Market Pulse) measures the overall health of the market through an evaluation of market breadth. In this case, market breadth refers to advancing and declining price trends and countertrends at the GICS industry group level. The model computes a robust moving average score daily to capture multi-industry and multi-term trend and countertrend measures to gauge overall market health. It then calculates the score’s directional trend to see if it is improving or declining. Collectively, the score and its directional trend determine the equity allocation of either 100%, 80%, 40%, or 0% − in which case the allocation would be to cash. Why Market Breadth Is Ideal for Guided Equity Allocation

There are a few key reasons why measuring market breadth provides sound trend analysis for guiding equity allocations. The Index’s co-developer, Steve Blumenthal of CMG Capital Management Group, Inc., wrote a whitepaper, Risk Management for all Markets, detailing this tactical approach. Mainly, market breadth has typically weakened before top-line prices have at major market peaks and breadth thrusts often occur just before major bull market recoveries. Furthermore, the S&P 500 is considered as a very efficient market, meaning the underlying securities’ fundamentals and macro environmental factors tend to be priced in almost immediately.

Here’s the NDR chart from Steve Blumenthal:

I just don’t see the “shift” to “positive momentum”. I only see 2 sectors (38.3% of the Index) pulling this bull forward against 2 (17.3%) reaching back 7 others (44.4%) which don’t really seem to want to contribute.

The two clear leaders

  

Two trying to keep pace

  

Seven laggers

  

  

  

 

This kind of breadth leaves me breathless.

But the two stalwarts have been very effective since mid-2016. They’ve gotten even more powerful since (they were 32.5% of the index then). The 13/34-week Exponential Moving Average chart remains very positive:

Chaikin Analytics has a Power Gauge Rating system that combines 20 financial, earnings, technical and sentiment factors into a single metric for every stock that can then be aggregated by sectors. Its Aug. 28 reading was ranked as follows:

I find the rank of Consumer Discretionary particularly interesting given its pull of the whole market. Chaikin notes this:

The Consumer Discretionary sector continues to consolidate below the highs after becoming overbought but remains above the rising 200-day moving average. The RSI of the ratio has not become oversold since last October which speaks to the strength of the current uptrend. Note that AMZN is a large weight in this index and the Power Bar Ratio in Chaikin Analytics is skewed to the bearish side. Many of the industry groups in this sector have poor relative trends such as autos, consumer durables, media and leisure.

Chaikin also has a proprietary relative strength measure that puts relative performance on a scale from 0-1, by looking at where the stock’s ratio to the SPY is in its own 6-month range. On that measure, the CD and IT sectors are the only two with a clear positive trend. HC is neutral but all other sectors are negative.

Small Stocks Hang On to Big Gains, for Now Soaring profits at smaller publicly traded companies are driving the Russell 2000 to new records as investors bet U.S. economic strength will boost smaller companies while trade frictions hit their multinational counterparts.

(…) With more than 90% of the Russell 2000 having reported second-quarter results so far, earnings throughout the index of small-capitalization stocks grew 35% from a year earlier, while sales jumped 10.5%, according to Michael O’ Keeffe, chief investment officer at Stifel Nicolaus & Co. That is better than the S&P 500, which grew profits and sales from a year earlier by 25% and 10%, respectively, according to FactSet. (…)

The S&P 500 gets about 30% of its revenue from outside the U.S., while Russell 2000 companies have foreign exposure of about 21%, according to a Bank of America Merrill Lynch research note. (…)

Third-quarter earnings projections for the Russell 2000 have gotten rosier, with companies’ profits expected to increase 37% from a year earlier, according to the data compiled by Mr. O’Keeffe.

Earnings growth will dip in the fourth quarter, according to the analysis, but growth rates of about 27% are projected for the first two quarters of 2019. (…)

The midterm equity boost

(…) UBS’s Keith Parker finds that between August and March of the last 17 midterm elections since 1950, the S&P 500 rallied about 14.5 per cent on average. In non-election years, returns during this same window averaged some 6 per cent. While US stocks tend to retract 1.4 per cent from the end of August through early October when midterms are coming up, they climb thereafter. About two weeks out, the performance gap in equity returns between election and non-election years starts to widen. By year-end, its even larger—a trend that continues for several months: (…)

Not all sectors feel the midterm boost. Ahead of the election, defensive stocks such as healthcare and consumer staples tend to do better than cyclicals, whose prices rise and fall with the overall economy. The same is true for high-quality bonds like US Treasuries and investment grade debt, which are seen as relatively risk-free options. After the election, however, growthier assets typically outperform again. Here’s Charlie Reinhard and Joe Fiorica of Citi’s Private Bank with the scoreboard six months before and after the midterms:

The midterm rally in US stocks holds even if the political status quo gets disturbed, which is not uncommon — Deutsche Bank calculates that the incumbent president’s party typically loses about 26 seats in the House and 4 in the Senate. The six times since 1950 that the president’s party lost either the House, the Senate or both chambers, the S&P 500 gained an average 7.3 per cent from the end of August to year-end, just a percentage point higher than the average performance when the distribution of power remained unchanged. The results of the 2010 midterms partly explains this divergence. As UBS points out, the elections were a vote against President Obama’s Affordable Care Act and other progressive policies. And when House Democrats lost 64 seats, markets rallied nearly 20 per cent:

If Republicans lose the House this time around, the political stakes are potentially far higher. Republicans are betting Democrats will investigate President Trump’s tax returns, his dealings with Russia, and a litany of other grievances. Others speculate Democrats will give impeachment a go. Rather surprisingly, though, none of it may matter to investors.

We recently looked at how financial markets performed when the Watergate scandal engulfed the Nixon administration in the 1970s. In the six months before he resigned, the S&P 500 declined, US 10-year yields rose with gold prices, and the trade-weighted dollar fell. As we wrote, these gyrations reflected much more than domestic politics, but rather the breakdown of the international Bretton Woods system of fixed exchange rates and dual oil and inflation shocks. Citi’s Reinhard and Fiorica draw a similar conclusion when it comes to President Clinton’s impeachment. Strong economic growth in the late 1990s propelled the S&P 500 higher, despite the scandal consuming the country: (…)

Before drawing conclusions from the Nixon and Clinton events, it is important to know the then market fundamentals. Nixon resigned August 9, 1974. Equities were in a bear market since January 1973 and had collapsed 46% by September 1974. That happened even though profits jumped 39% during the same period. The bear was caused by a quadrupling in inflation to 12% in the previous 2 years taking the P/E ratio from 18.4 to 7.0! (The Rule of 20 P/E dropped from 21.9 to 18.9 during the period). After Nixon resigned, profits peaked and declined 15% in one year but inflation retreated from 12% to 7%, boosting P/Es to 11.0 and the Rule of 20 P/E to 20.

The Clinton affair occurred during the Russian financial crisis which killed LTCM and created a short term panic.

Record-setting US stocks ignore yield curve’s red flag

• SF Fed: Yield Curve Suggests Rising, But Still Low, Risk Of Recession

Snapshot: 4 in 10 Still Strongly Disapprove of Trump

• 40% strongly disapprove of Trump’s job performance; 27% strongly approve
• Strength of approval has been stable since just after his inauguration

Despite a challenging week in which his former lawyer pleaded guilty to federal charges and his former campaign chairman was convicted of eight crimes, Donald Trump’s job approval rating and the intensity of Americans’ opinions of him are stable. His latest approval rating is 41% and disapproval is 54%. Twenty-seven percent of Americans “strongly” approve of Trump’s job performance and 40% strongly disapprove, on par with the three previous readings Gallup has recorded since February 2017, shortly after he took office. (…)

Majorities of both those who approve and those who disapprove of Trump do so strongly. However, a higher proportion of disapprovers (74%) than approvers (66%) feel strongly about their opinions of the president.

In the 84 times Gallup has measured strength of job approval, only two presidents have registered higher strong disapproval than Trump’s 40%: Richard Nixon (48% strongly disapproved of Nixon in February 1974, as he was mired in the Watergate crisis) and George W. Bush (44% in February 2006, as opposition to the Iraq War in the U.S. escalated). Both of those readings came during the president’s sixth year in office, as did Barack Obama’s highest reading of 39% strong disapproval. (Bush also registered 43% strong disapproval in December 2005, at the end of his fifth year.)

Sixty-eight percent of Republicans strongly approve of Trump’s job performance, while an even larger 77% of Democrats strongly disapprove.

(…) majorities of those under age 50 disapprove overall, but those 50 and older are about equally likely to approve as disapprove. (…)