THE DAILY EDGE: 24 JUNE 2019: Fundamentally Technical

THIS IS THE WEEK!

Not because of the Trump-Xi meeting at the G20; we already know the outcome: a “very beautiful” meeting between two “truly great friends” who will agree to keep conversing for a while longer, yaddi, yaddi, yadda, which the market will love…until the next devastating tweet.

No, this is the week of my annual Atlantic salmon fishing trip on the “very beautiful” and “incredibly powerful” Moisie river with five “really superb human beings”, none of whom know the outcome of their “incredibly skilful efforts” other than that we will all have an “exquisite time” together, particularly at the dinner table where “truly unbelievable” stories will be graciously shared, riveting faithful narrations of “fabulous” tales, mostly about lost salmons, the “enormous” size of which fattening in sync with the number of “really exceptional” wines uncorked by our “extraordinarily convenient and generous” wine “connaisseur par excellence” friend.

Tight lines!

China says both U.S., China should make compromises in trade talks  Both China and the United States should make compromises in trade talks, Chinese Vice Commerce Minister Wang Shouwen said on Monday, ahead of a much anticipated meeting between the Chinese and U.S. presidents at this week’s G20 summit in Japan.

(…) Speaking at a news briefing on the G20 summit, Wang, who is also part of the trade negotiating team with the United States, said talks between the two countries’ trade teams were underway, though he gave no details.

China’s principles are clear, he said – mutual respect, equality and mutual benefit and meeting each other halfway.

“Mutual respect means each side must respect the other’s sovereignty,” Wang said.

“Equality and mutual benefit means the consultations have to happen on an equal basis, the agreement to be reached has to be beneficial for both sides,” he said.

“Meeting each other half way means both sides have to compromise and make concessions, not just one side.” (…)

“We hope that the U.S. can remove certain unilateral measures inappropriately taken against Chinese companies, in the spirit of free trade and the World Trade Organization.” (…)

U.S. Weighs Barring 5G Equipment From China The Trump administration is considering requiring that next-generation 5G cellular equipment used in the U.S. be designed and manufactured outside China.

(…) There is no major U.S. manufacturer of cellular equipment. (…) Based on the companies’ annual reports, Citi analysts Amit Harchandani and Robert Lamb estimate China represented 45% of Ericsson’s manufacturing-facility area and 10% of Nokia’s in 2018. Ericsson operated at about 75% capacity world-wide in 2018, they said, suggesting the Swedish company has flexibility to shift production to other countries. The analysts’ estimates don’t include the possibility that the two companies use Chinese subcontractors. (…)

U.S. Targets China’s Supercomputing Push With New Export Restrictions The Commerce Department is taking aim at China’s supercomputing push with export restrictions that cut off five major Chinese developers from U.S. technology.

Meanwhile, statistics reviewed by The Wall Street Journal show the Commerce Department has cut in half the number of licenses for U.S. tech companies to assign Chinese nationals to advanced engineering projects. (…)

The Chinese supercomputer developers are at the heart of Beijing’s key technological objective of making the country’s first exascale computer, a next-generation machine that would be capable of doing one quintillion—or one billion billion—calculations a second.

Supercomputing is integral to the development of nuclear weapons, encryption, missile defense and other systems, and the U.S. and China are competing for dominance in the field. The U.S. now has the world’s two fastest supercomputers, followed by a Chinese-built computer in third place. (…)

Commerce officials said that Sugon of Beijing and three of its affiliates, as well as the Wuxi Jiangnan Institute of Computing Technology, were determined “to be acting contrary to the national security or foreign policy interests of the United States,” according to a rule made public Friday. (…)

Computer chip-making companies have been particularly hard-hit by the licensing backlog, because their talent pool is stocked with Chinese nationals, who account for a large share of advanced engineering students in the U.S.

Chinese nationals accounted for more than 60% of all such licenses between 2013 and 2017, according to Commerce Department statistics. In 2018, however, they accounted for just 35% of approvals.

U.S. Existing-Home Sales Rose in May Demand for housing picks up as mortgage rates continue to ease

Sales rose 2.5% in May from the prior month to a seasonally adjusted annual rate of 5.34 million, the National Association of Realtors said Friday. (…)  Inventory of homes for sale is continuing to increase. The NAR said there were 1.92 million existing homes available for sale at the end of May, up 2.7% from a year earlier and a 4.3-month supply at the current sales pace. (…)

  

(Haver Analytics)

Eurozone Job Market Cools, Putting Economic Recovery in Peril Manufacturers hiring more slowly as demand for export weakens

(…) “Companies are tightening their belts, cutting back on spending and hiring,” said Chris Williamson, chief business economist at IHS Markit , a data firm that conducts the monthly survey of purchasing managers. (…) Other surveys point in the same direction, including a monthly poll by the European Commission that found hiring intentions at manufacturers were at their weakest in almost three years during May. (…)

Same in the USA:

Most jobs are in Services:

Source: @JeoffHall (via The Daily Shot)

TECHNICALS WATCH

Lowry’s Research just issued its first important warning this cycle:

a seemingly healthy bull market can develop weaknesses not readily apparent in the performance of the [major] price indexes. (…) investors should closely monitor the performance of OCO [Operating Companies Only] Small Caps, as a continued pattern of deteriorating strength would likely be consistent with an aging bull market, especially if this deterioration migrates into the S&P Small Caps.

This warning about small caps comes 10 days after I wrote SMALL STILL NOT BEAUTIFUL, revealing that small caps are not growing earnings other than through stock buybacks, are loaded with debt and far from being cheap, concluding with “in times like these when the economy is slowing, competition increasing, costs rising and supply chains up in the air, be large, be liquid.”

Equities being generally highly correlated with earnings, small cap stocks have underperformed, particularly since last March when investors realized that small companies’ EPS, already down in Q1, could be more impacted by the trade wars than larger companies.

Now, Lowry’s goes a step further, suggesting that the behavior of small cap stocks could be symptomatic of developing danger for larger caps.

Interestingly, Raymond James had these comments on June 14:

The Russell 2000 has underperformed the S&P 500 by 10%+ for the trailing 12 months for only the fourth time in the past 20 years. (…) Importantly, this performance differential typically only lasts a few months and has historically resolved itself through relative outperformance by the Russell 2000.

This is indeed a very appealing long/short proposition, if you believe, like the RJ strategist that

The fundamental drivers of the 2 indexes are too similar to have long term divergences in performance that are purely fundamental. This Russell 2000 under performance has little to do with EPS as EPS expectation trends in both indexes have been remarkably similar over the past year, but it is much more related to a substantial shift in valuation between the indexes.

The problem is that “EPS expectations” are not fundamentals, even less so when they prove to be far from reality, as they usually do.

The facts actually suggest much different fundamental drivers as I showed in my June 11 post which was an update to an April 2018 warning TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL. The S&P 500 Index has outperformed the S&P 600 and the Russell 2000 by 14% and 12% respectively since May 2018. These charts (mostly from Ed Yardeni) make the case:

  

Where it gets critical, linking with Lowry’s analysis, is when RJ, relating to its above relative return chart, says

Whether or not this resolves itself through the S&P 500 coming down harder than the Russell 2000 in a downturn or Russell 2000 outperforming in a rally is unclear, as there are examples of both happening historically.

If no economic downturn, leverage could benefit smaller caps for a while. But if a downturn there were, I would not want to hang on small caps to verify if larger caps will come down harder or not.

In the meantime, I would respect these two charts:

Stan Druckenmiller suggests to always listen to market internals. In the case of the S&P 500 Index, one can assume that investors are not as enthusiastic as the headlines suggest. Last 12 months, the best sectors have been Utes (+21%), Real Estate (+18%) and Consumer Staples (+15%) against a +7.5% S&P 500 Index advance. The most economy sensitive sectors are lagging with Financials totally stalled.

SENTIMENT WATCH

Investors Are Glum, Even With Stocks at All-Time Highs Gains have been accompanied by marked degrees of skepticism—but that isn’t all bad

The share of individuals who say they expect U.S. stocks to rise over the next six months has held below 30% for six consecutive weeks, according to the American Association of Individual Investors. That marks the longest such streak since the leadup to the 2016 elections.

 Money managers also are glum. Half of fund managers believe that the global economy will weaken over the next 12 months, up from roughly 5% in May and marking the biggest one-month jump in pessimism since Bank of America began asking investors the question in the mid-’90s. (…)

 Asset managers’ net long positions on S&P 500 futures—bets that they will rise—are approaching highs last hit in September, according to an RBC Capital Markets analysis of data from the Commodity Futures Trading Commission. (…)

Here’s a nice Buy-High/Sell-Low chart:

Source: Deutsche Bank Research (via The Daily Shot)

Trump Unleashes On Uber-Hawk Bolton: We’d Be Fighting “The Whole World At One Time”

Nearly 50% of Americans support military action!

Source: Statista (via The Daily Shot)

But in the above-linked interview:

And in another clear indicator that Trump wants to stay true to his non-interventionist instincts voiced on the 2016 campaign trail, he explained to Todd that:

I was against going into Iraq… I was against going into the Middle East. Chuck we’ve spent 7 trillion dollars in the Middle East right now.