Below is a round-up of Longview related views/research & trade ideas – the intention is to publish this most Fridays, updating key themes and highlighting key pieces of (often contrarian) research. Feedback, as always, is appreciated. Equally just ‘unsubscribe’ at the bottom if you don’t want to receive the email.
So what is this SELL-off really about?
Pinpointing exactly what’s behind this latest SELL-off continues to confound many market watchers, traders and investors. Initially it was assumed that it was driven by the back-up in bond yields. Once that explanation stopped working (i.e. with US 10 year bond yields peaking on 5th October), it was then assumed that it related to trade wars, before then morphing into earnings outlooks (and now concerns about peak profits).
“Putting your finger on what’s spooking the market in the past week or so has been difficult.
The recent sell-off appeared to be launched by fears of rising interest rates. When rates stopped rising, trade tensions were the new No. 1 concern. But on Tuesday morning, the announcement that Donald Trump would meet with China’s Xi Jinping at the upcoming G-20 summit to discuss trade didn’t calm markets. Instead, worry appears to have settled on the idea that we have hit peak profits”
Source: Stephen Gandel, Bloomberg columnist (https://www.bloomberg.com/opinion/articles/2018-10-23/stocks-investors-are-letting-their-emotions-take-over)
Indeed reflecting those ‘peak profit’ concerns, a number of single stock charts look ‘technically’ very troubling. Blackrock is a case in point (FIG 1). Equally 3M, Caterpillar, Texas Instruments, Amazon and Google are all bellwether stocks which have performed especially poorly, post earnings results this week.
FIG 1: Blackrock share price (shown with 200 day moving average)
Despite those disappointing earnings reports (& outlooks), though, with 229 S&P500 companies having reported (as of the close yesterday) the average earnings surprise is currently running at +6.1% (above the usual ~+4% ‘surprise’ level). On top of that, actual sales and earnings growth (according to S&P earnings) is +8.8% & +23.3%. As such the PE ratio of the S&P500 continues to move lower and is now not that far above its long run 40 year average of 14.2x (forward earnings).
FIG 2: US S&P500 forward earnings PER (1979 – present)
Of course, and as we have written about many times before (e.g. see Structural Report No. 14, “Does Valuation matter” – available HERE), bear markets can start with high or low PE ratios. It’s not possible to time the end of cyclical bull markets using valuation tools (except arguably our ‘dynamic valuation tool’ – discussed HERE in this piece).
We’ve written about our view on the drivers of this pullback on a number of recent occasions, both before it started and after (see HERE and HERE, for example). More important than looking backwards to describe what’s happened, though, is thinking about how various key global macro and market themes are evolving (incl. the outlook for the US/global economy, sector rotation, the euro, and oil).
How are key global themes evolving?
First, sector rotation into defensive, lower beta sectors is meaningfully advanced, although not yet complete. Our global sector risk appetite model*, having been in its upper (i.e. most risk-on) quartile as recently as July this year, is now just below its median level and seemingly trending towards low (-0.15/-0.2), bottom quartile levels (at which stage it will support a shift back into higher risk/higher beta sectors)**.
FIG 3: Global sector risk appetite model* vs. US 10 year bond yields
*which draws upon over 60 sub sectors in the global equity market, plotting daily risk curves using those 60+ sectors and their short term volatility readings
**NB while this model is expected to move lower (supporting a continued trend of outperformance by the defensives sectors), that doesn’t preclude a counter trend ‘wave two’ relief rally (with higher beta temporarily outperforming). As ‘wave three’ then asserts itself, and the trend/SELL-off is re-established, we’d expect this model to then reach its lower (bottom quartile) levels.
The Euro – Pressure Re-asserting Itself
Second, pressure on the EURO has reasserted itself (since the start of this pullback in late September). The euro is now just above its lows from mid-August (i.e. 1.13) and hasn’t been helped this week by a refusal by Draghi and the ECB to acknowledge any material weakness in the European economy (despite sharp falls in German and European new orders, amongst other data).
Draghi stated in his press conference:
“We’re talking about weaker momentum, not a downturn,” Draghi told a news conference after policymakers decided to maintain a long-standing assessment that growth risks were “broadly balanced”.
“Is this enough of a change to make us change the baseline scenario? The answer is ‘No’,” he said, adding that the ECB did not even contemplate extending its bond purchase program”
Source: Reuters (uk.reuters.com/article/us-ecb-policy/ecb-sticks-to-stimulus-exit-plays-down-bunch-of-uncertainties-idUKKCN1MY32N)
With that euro weakness, the net speculative positioning in the euro has turned SHORT for the first time since May 2017 (on latest data)……
FIG 4: EUR-USD vs. net speculative LONG/SHORT positions
…reflecting that and other factors, our EUR-USD market timing model has moved lower….but still remains above its BUY (EUR) level…..
FIG 5: Market timing model (Euro-USD) vs spot exchange rate
US economic growth outlook: Slowing in 2019 (‘where housing goes, so goes the economy’)
Third, current US economic growth remains robust, with annualised Q3 GDP growth reported today at 3.5%. Coming after 4.2% in Q2 (and 2.2% in Q1), growth has clearly accelerated from 2017 levels. That, however, is likely to be short-lived. Forward looking growth indicators (as we wrote about HERE and HERE) suggest a notable slowing of growth in 2019. Consistent with that, housing data this past fortnight was notably disappointing. Existing home sales (FIG 6), for example, has slowed sharply from its November 2017 highs. Interestingly, other than a one month blip in November 2015, existing home sales last slowed in a similar manner during 2013 into the start of 2o14. Of note US 10 year bond yields backed up sharply during 2013, and then peaked on 27th December 2013 at 3.02% (and then trended down throughout 2014).
As US economy watchers have been known to say:
“Where housing goes, so goes the economy”.
(and, with that, bond yields. We remain positive on bonds – expecting US 10 year yields to move lower over the next 6 – 9 months).
FIG 6: US existing home sales (millions)
OIL: Heading to US$100 – when to jump back in
Fourth, the OIL price continues to move towards attractive BUY levels, having given up some of its YTD gains. At the start of October, BRENT reached a record high for the year ($86.74 intraday). With that, sentiment has been bullish, positioning remained LONG (although has been unwinding all year), while by early October OIL was technically overbought on a medium term basis (using our medium term technical scoring system – FIG 7). At that time we laid out our view that OIL was a near term “SELL” (see Commodity Fundamentals, 11th October: “OIL: US bottlenecks easing, Iranian Sanctions overblown” – available HERE). That was predicated on a near term supply pick-up from various quarters which would more than offset the immediate supply challenges created by the Iranian sanctions. That thesis has been helped by; i) broad based risk off sentiment: & ii) the Saudi promise to ‘pump more oil’ (“Saudi Arabia is ready to raise its output to 11 million barrels a day ‘in the near future’ and has the ability to lift production as high as 12 million barrels a day if the market requires it, Al-Falih said.” - Bloomberg).
FIG 7: Brent medium term technical scoring system
In the medium term, though, we still favour a move in OIL to over US$100 (based on fundamentals – see analysis HERE). In terms of timing re-entry, trading models have moved notably lower (FIGs 7 & 8). Currently, though, they haven’t yet reached BUY levels, while BRENT also remains modestly above its key support level (i.e. above its 200 day moving average @ $73.80).
FIG 8: Brent market timing model vs. BRENT spot price
This past week…
This week we published various publications including: i) an update on our latest tactical (i.e. 1 – 4 month) equity market views. In that, we have reinstated (modest) LONG/OW equity positions. This is in anticipation of a ‘wave two’ relief rally (& supported by across the board, strong BUY signals from key market timing models). We’d expect to hold this position for a handful of weeks (if its correct). See HERE.
We also published our analysis of the outlook for the Brazilian economy and Brazilian asset prices. If Sunday’s election pans out as expected, then Brazilian equities are attractive. Of note, in that respect, as the right wing candidate’s popularity has increased in recent weeks, the correlation between Brazilian equities and the rest of EM has broken down. His agenda is notably pro market and pro business. For full analysis, see HERE.
FIG 9: Emerging market equity index vs. Brazilian Ibovespa***
***albeit a modest part of the divergence relates to currency effects (with EM equity index reported in USD, Bovespa in BRL)
Have a great weekend.
Kind regards,
Longview
Longview research recently published
This week:
Global Macro Report, 25th October 2018:
“Brazil: Inflection Point” – available HERE
Longview ‘Tactical’ Alert No. 47, 24th October 2018:
“‘Wave Two’ Relief Rally Expected/Due
a.k.a. Move ‘opportunistically’ OW Equities (on multi week view)” – available HERE
Weekly Market Positioning Update, 22nd October 2018:
"Speculators now net SHORT euro - first time since May"
Last week:
LV on Friday, 19th October 2018:
"Major AA Switch Brewing?"........& more on 'Wave Two Relief Rally' – available HERE
Longview Letter No. 116, 17th October 2018:
“Extreme Valuations
a.k.a. Is the cyclical bull market over? Should we be worried?” – available HERE
Weekly Market Positioning Update, 15th October 2018:
"Positioning suggests speculators wrongfooted"
