Weekly Preview / August 22
Notable Events on our Weekly Watchlist:
Monday: N/A
Earnings: PANW, ZM
Tuesday: New Home Sales
Earnings: AAP, DKS, INTU, JD, M
Wednesday: Durable Goods
Earnings: CRM, ADSK, BOX, NVDA, WSM
Thursday: Jackson Hole Symposium
Earnings: PTON, DELL, DG, FTCH, ULTA, VMW, WDAY
Friday: Personal Income / Spending, Powell's Speech
Earnings: N/A
ETFs to watch: SPY, XLY, XLK
This week, we are continuing to add videos to our articles. Also, an important update is near completion for our Research subscribers. Stay tuned!
The last 2 months saw a blistering rally in equities from mid-June to present. The gain in SPY was about 17%, and took the market to extreme overbought conditions the likes of which we haven’t seen in the past 2 years. The reversal from “extreme bearishness” to “extreme bullishness” was brutal and included one of the largest short covering events in recent history. It came as no surprise then, that the advance softened in the past week, as deviations from short-term moving averages pushed double digit deviations. As it stands right now, the market cooled from overbought conditions, but we are nowhere near “BUY” points.
SPY Analysis
With an Overbought/Oversold score of 84/100 (right scale) SPY is no longer “officially” overbought. However, the 50-day moving average sits -6.27% lower than the current close, and a retracement to that level is a technical move that often takes place. The current overall picture is one of a “correction” within a longer term bull market, as denoted by the upward sloping technical channel. As such, we are inclined to add to our equity exposure in the Sigma Portfolio, at two key junctures: 412-415 level (near the lower technical trendline and yellow S2 level), as well as near the 50-day DMA (currently at 394). The assumption would be that support would hold and the bull market will resume. This is a purely technical assessment, one that is highly challenged from a fundamental point of view as we will see below.
Volume Analysis
While the bulls found the recent FOMC minutes slightly reassuring, there is one undeniable fact underlying the actions of the Fed. They are draining liquidity from the the markets. As financial conditions tighten via QT and rate hikes, dollar transaction volumes are dropping to below average levels and starting to trend down. This is the case with QT reducing the balance sheet at a pace of $95 billion/month. Starting this month, the Fed will ramp up that reduction to 3-times the previous run rate.
The Fed is hoping this reduction will not cause severe disruption in credit and stock markets alike. History proves that previous cases of tightening have led to a crisis of some sort. Bulls bet that “this time is different” and a dovish pivot from the Fed is close by. They may be early, as the Central Bank currently has no reason whatsoever to let up on its hiking campaign. The labour market is going strong, and corporate earnings have yet to revert.
Market Fundamentals - Median EPS Analysis
As our Market Fundamentals Instrument shows (we are tracking median EPS across S&P500 companies in this view), periods of flat EPS growth have led to below-par returns in the market. At present, 87% of S&P500 companies have reported earnings, and while overall figures are holding up well, there is little EPS growth to speak of. The cycle appears to be peaking. Moreover, according to FactSet, if we take energy out of the equation, the Q2 EPS growth rate of 6.7% would flip to a decline of 3.7%.
Energy makes up only 4.4% of S&P500 holdings.
Takeaway:
We will continue to give the market the benefit of doubt for now. We will aim to follow our algorithmic models and be patient to increase exposure in the equity space. Our investment thesis revolves around companies in the energy and basic materials spaces. A good complement to that portfolio would be productivity enchanting tech (the business-to-business kind, not the consumer-oriented kind). This would help create a properly diversified portfolio, that would also work in a disinflationary scenario. We are staying clear of consumer discretionary companies (including online marketplaces and video streaming names), as people are more likely to pull the plug on subscriptions and reduce spending on non-essential items due to inflation.
Andrei Sota