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Weekly Market Update: The Jury Deciding The Stock Market's Fate Is Still Out

The equity market continues the choppy trading pattern in the process of what I believe will be a ‘W’ bottom.

Conflicting data continues to leave stock market participants in a quandary.

Investing is a process. It’s never too late for investors to review and re-position their holdings.

September comes to an end; we get closer to the end of Q3 and the beginning of Q3 earnings season.

Some readers may remember my use of the following quote regarding investing in an earlier missive. It fits so well in this time of market confusion.

"It never can be easy because the rule of the market is that you have to act before you know enough. Because it is a process, there is no one moment, or single point, at which one can make an obvious 'sure' decision."

While it applies to our everyday actions in the markets, I thought it even more appropriate now given the market reaction to the Fed decision last week. The market, for the most part, acted deeply confused. If one steps back and looks at the situation, it does make perfect sense. As I pointed out last week:

"The dovishness is without doubt a positive for most stocks, bonds, and FX, but the lack of confidence in the US economy and the confusion around what the committee is now targeting justifies selling for some."

Bottom line, the investing landscape just got more difficult with this added uncertainty. Now there is no reason to obsess over something investors can't control, so let's go back to what we can control, ourselves.

First and foremost for me in the short term, the Fed decision doesn't make any difference. However, how the market interprets these signals surely does affect the short term. All one has to do is look at what transpired this past Monday as a 20 point S&P rally was wiped out when this mid-day headline showed up:

"Fed's Lockhart Says Rate Rise in 2015 Still on the Table"

Ms. Yellen added more color to the bizarre interest rate scenario, when she announced on Thursday, that there would likely be an interest rate hike in 2015. The market now seemed to like the fact that rates will rise, signaling that the economy is on firm ground, and the world will not end. After Ms. Yellen's comments, the market rallied, as the S&P initially rose by as much as 20 points, only to finish lower on the day, as the tug of war on this issue continues.

Over the past couple of weeks, the message has been to avoid being swayed by the market's whipsaw reactions to every headline. The past 7 to 10 trading days are a clear sign of what I was referring to.

The current economic crosscurrents and the technical issues swirling around the market are sending mixed signals at every turn. It is a perfect time to re-evaluate how one should be positioned in the uncertain environment.

I like to ask myself the question. Am I being a disciplined investor or am I just being stubborn about the way things really are? "I'm going to be proven right eventually", can turn into famous last words.

Now that could be the mark of a true contrarian who is confident in their analysis. I always say that you must have a high level of conviction in your positions, especially when the tide is going against them. OR, it could be the mark of an investor who is unwilling or unable to be flexible in their approach and admit when they're wrong. There's a fine line between a disciplined process and overconfidence. It dovetails with the Justin Mamis quote perfectly, as we rarely have that precise signal to be "sure".

That brings me to the point that the financial markets are constantly forcing people to call into question their own process and strategy. It is never ending, and at the moment, it is magnified due to the volatility that is present. This is probably the best and worst part about investing. The markets either keep you honest and humble or they can drive you crazy and cause mistake after mistake. Avoiding that trap is difficult.

The process of investing isn't easy, and I like to always keep in mind that it is a "process". That is why I think it important to not bury your head in the sand, but remain focused and diligent in whatever "plan" is in place.

We often hear the words "overweight, "underweight" and "equal weight" when it comes to sector allocation in a portfolio. I often sit back, write the different sectors down and look at the current allocation models that are available from any number of sources. Then start to evaluate how my holdings stack up to some of these models.

In my view, most investors should seek diversity to balance risk versus reward. For this reason, even the least favored sectors may be appropriate now for portfolios seeking a more balanced equity allocation. There are gems out there, given the price reductions that investors have seen in these sectors. Each investor has to decide for themselves given their unique position, whether they should seek a more aggressive investment style by choosing to overweight the preferred sectors and entirely avoid the least-favored sectors. I am not a big fan of that approach, nor would I recommend that.

The following is probably what many investors have seen from various sources regarding allocations. A reminder, these weightings are not "gospel", but rather a template.

Overweight - Information Tech, Financials, Consumer Discretionary, Industrials

Equal Weight - Health Care, Consumer Staples

Underweight - Energy, Materials, Utilities, Telecom

No big surprises here. It is what we hear on a daily basis from analysts and the media, with their views on the most loved, and most hated sectors. If you are taking a long term view however, the most hated "underweight" areas, may be worth a look.

Respecting what the market may or may not be telling us with this volatile trading pattern, I suspect that many here may want to be positioning portfolios more conservatively with a greater emphasis on capital preservation and income generation. Then again, for those that are still in their portfolio growth phase, they need to react differently to the short term market gyrations.

Before I get chastised for leading investors down a merry path of highlighting sectors and stocks in times of uncertainty, I add this important note.

The thoughts, ideas, that I put forth here regarding portfolio management, should not be taken as an all clear to buy equities now. To the contrary, with all of the unknowns swirling around, it is my way of suggesting a review of how portfolios are positioned to take advantage of what may occur. That is correct, take advantage. During times of uncertainty, take control of the situation, instead of the situation taking control of you.

As the market situation unfolds it is never too late to review and possibly reposition, if necessary. The reason, if you are in the "need to protect and generate income" crowd, a strategy to do just that should be "at the ready", in case this market does break down.

For those in the growth phase, a plan should be set up to be ready for what could become a golden opportunity. Employ that strategy that best fits your own goals and needs, centered around your personal risk tolerance.

In my own portfolios, I have moved money from my under performers, to more dividend payers. Other than the mini "flash crash" morning, the net result of my adjustments saw no net adds to my equity exposure at this time. The first step in my strategy as market developments unfold.

Continuing my thoughts from last week, it is also a good idea to review the thought process that goes into that portfolio review.

"Many times we all get caught up in looking for that "diamond in the rough" that is mired in a downtrend. I have some thoughts on changing that mindset. Start taking a look into stocks that are not broken and continue to move higher."

Starting with that as a backdrop, the leading sectors and stocks in those sectors are prime candidates for review. Any discussion has to start with Apple (NASDAQ:AAPL), and then proceed from there.

There are many stocks that fit the description of presenting a good technical picture while delivering strong fundamentals. Search those stocks out and put them on a list.

Looking at the "out of favor" sectors reveals an interesting combination of high dividend, low beta names. It may not be such a bad idea to research a VZ or T in the Telecom sector paying 5+% yields in this zero interest rate environment. They may hold up better if this paranoid market decides to test downside levels.

The same applies to the energy sector. Stocks with good yields and a record of dividend growth are out there for review. Anyone with a long term time horizon may look back at this 'fear" in the energy patch with prices at these levels, and utter the words, "what was I thinking".

It is currently best to let the stock market "speak". Listen to the message of Mr. Market, and then put "the plan" to work.

In keeping with the idea that investors are constantly challenged, I would be remiss if I didn't bring up the possibility of new "issues" the market may face. I would normally classify the following issues as "noise", toss them aside, and proceed as usual, amidst the silliness that prevails.

I highlight them now because of the fragile state the market finds itself in. The bulls will look for saner heads to prevail, to avoid more technical damage to the market, and perhaps a complete breakdown.

While market participants have been focused on the Fed, another concern has been growing in recent weeks. The federal fiscal year ends on September 30th. Congress has yet to come up with the appropriation bills or a Continuing Resolution that would fund the government into October. Without that, a partial government shutdown looms. Notices were sent out last week to government agencies to prepare for a possible shutdown. While there is still time, the odds appear to be better than even that we will see a shutdown.

Even if Congress manages to fund the government in the near term, there is a possibility of a government shutdown over the debt ceiling. Treasury has already reached the debt ceiling, but it can dodge that constraint for a while through some creative accounting. Such actions have limits, and the federal debt limit is now expected to become truly binding in early December.

A short government shutdown need not be too unsettling for investors, since we have already "been there, done that". Given all of the other uncertainty and issues facing the market now, it's not going to help the situation, as it will damage confidence and boost volatility. Two issues that the bulls do not want to see more of. The bottom line though, is that a small government shutdown is very unlikely to create a lasting impact.

However, that this is not true of the debt ceiling, where a misfire could result in absolute chaos in both capital markets and the real economy. I along with the rest of the investment community, do not want to see the economy used as a bargaining chip in an ideological battle in Washington. A government shutdown would only create a flesh wound of collateral damage versus a possible mortal wound from a debt ceiling mishap later this quarter.

It is no wonder why the three non-politicians are leading the Republican party polls. Enough already, all of this should be a non-issue.

If that isn't enough to be concerned about, for those that believe in history repeating, Ryan Detrick reminds everyone that the next 3 weeks are can be very difficult.

Perhaps it is time to look at your situation and review what is in your portfolio.

Consumers are an increasing powerful force in global economies. In many developed countries such as the U.S., spending by consumers accounts for two thirds of GDP. Here in the U.S., the consumer appears to be on solid ground as noted in an article by Scott Grannis.

  • U.S. Household net worth at record levels

  • Household debt leverage at levels last seen 30-35 years ago.

The picture that is painted in that article is far different from what we saw in 2007-2008.

Housing continues to be a bright spot. The headline reads "Existing home sales come in lower than expected"

Looking at the details reveals a different picture. Drastically reduced inventory.

Lawrence Yun, chief economist at the NAR:

"We continue to experience a tight inventory situation. Even though real estate agents are the busiest they have been in years, sales are unlikely to return to pre-recession highs any time soon because of a relatively thin supply of properties for sale.

With inventories low, the median price of existing homes stood at a relatively pricey $228,700 in August. While prices tapered off in August, they have risen 4.7% from the same month of 2014 and that might be squeezing some buyers out of the market. Watching the average home price starting to increase isn't such a bad thing.

Conclusion. While the headline read negative, the details revealed some interesting positives, and are not indicative of market weakness. My view on the housing sector remains bullish as new home sales hit their strongest pace since 2008.

"Seasonally adjusted August new home sales increased 5.7% m/m to 552,000 annualized units. This was above consensus of 515,000 (+21.6% y/y) and the strongest pace since February 2008."

"Fifth District manufacturing activity slowed in September. Order backlogs and new orders decreased, while shipments declined. Average wages continued to increase at a moderate pace this month, however manufacturing employment grew mildly. Prices of raw materials and prices of finished goods rose, although at a slightly slower pace compared to last month."

Staying with the "not so good", the Markit services Flash PMI, while in line with consensus estimates, fell to 55.6 - prior reading was 56.1.

Chris Williamson, chief economist at Markit said:

"The survey data point to sustained steady expansion of the US economy at the end of the third quarter, but various warning lights are now flashing brighter, meaning growth may continue to weaken in coming months."

No surprises with the release of the revised 2nd quarter GDP on Friday, as the number now shows 3.9% growth. The same could be said for the Michigan consumer sentiment survey that was released on Friday, as it came in at 87.2 versus 87.1 expected.

This week's data on the state of the global economy mirrors the reports that we have seen for the last few months. China continues to show signs of slowing while the Eurozone continues to slowly improve.

A private Chinese manufacturing gauge slows to a level not seen since 2009.

"The preliminary Caixin China Manufacturing Purchasing Managers' Index, a gauge of nationwide manufacturing activity, fell to 47.0 in September, compared with a final reading of 47.3 in August. The reading was the lowest since March 2009, when China was grappling with the global financial crisis."

Eurozone Flash PMI indicates their slow recovery is still on track. This report on the eurozone data showed few signs the slowdown in China's economy was significantly undercutting growth throughout Europe.

Timo Del Carpio, an economist at RBC Europe in London;

"In a word, resilience. We're still seeing survey indicators coming through that are pointing to fairly robust momentum in the third quarter, despite lingering uncertainty over both the domestic and external demand backdrop."

"New orders grew at the fastest rate in five months and a gauge for the amount of raw materials bought by manufacturers stood at a 19-month high, signaling increasing production in the coming months."

"The German economy is expanding at its strongest pace since 2011, and the domestic demand will benefit from growing incomes and receding energy prices. The outlook for exports is less certain as emerging markets such as China struggle to rein in a weakening of growth."

"Extremely strong domestic demand pushes domestically focused parts of the economy like trade and services to thrive. Domestic demand is so strong that it compensates for a slowdown in manufacturing."

Here we are again faced with conflicting data and headlines, leaving investors in a quandary regarding equities.

As September comes closer to an end, we get closer to the end of the third quarter and the beginning of the Q3 earnings season. History reveals that major market declines occur after business cycle peaks, sparked by severely declining earnings.

The forecasts reveal that while we will see a slowdown in earnings, I don't see enough evidence to believe that we will experience the extremes that coincide with a bear market.

FactSet's latest earnings insight discusses the rising dollar's effects on U.S. companies heading into earnings. According to its analysis, companies with more global exposure are expected to report weaker sales and earnings growth in Q3.

The EPS estimates;

  • Ex-energy, S&P 500 EPS is expected to grow 3%.

  • For companies with more than 50% of sales in the U.S., estimated earnings growth is 8.8%.

  • However, for companies that generate less than 50% of sales inside the U.S., earnings are expected to decline 4.9%.

The Revenue estimates;

  • Ex-energy, estimated S&P 500 revenue growth is 3%.

  • For companies with more than 50% of sales in U.S., revenues are expected to increase 5.3%.

  • However, for companies with less than 50% of sales in U.S., revenues are expected to decline 3.9%.

The USD creeps into the conversation on a daily basis, reminding investors how much of an impact it has had, and will have, on corporate earnings.

Food for thought, a quick look at the chart of the USD shows that it has been flat for 6 months. For now, the impact that we have seen from the quick rise in the USD in 2014 may have crested, leaving me to wonder if next quarter's earnings might not be as bad as analysts forecasts.

The week after the Fed's inaction saw investors leave stocks in droves.

For those with a contrarian bone in their body, this is encouraging.

WTI started off the week on a positive note, and when the stock market turned lower on Tuesday it took crude oil prices with it. That correlation seemed to fade on Thursday as I watched the S&P drop another 20 points early in the day, but WTI was up during that same time.

I read the latest missive from Scott Grannis this past week and my attention was focused on the presentation regarding credit and swap spreads.

"We continue to see the notable disconnect between credit and swap spreads. This suggests that the underlying fundamentals of the economy and the financial markets are still quite healthy, and that the distress in the energy sector is not spreading to other sectors."

I have agreed with that assessment for quite some time. I'll have more thoughts and data on the banks and their loan exposure to the energy sector next week to prove that point.

WTI closed at $45.70, and once again has held what I believe is the critical $43-44 support level. A small victory this week for the bulls.

Readers should be reminded that when I speak to the "technical" side of the market, I am attempting to illustrate "probabilities" that may unfold.

Anything that assists investors in slanting the odds in their favor, should be at the very least taken into consideration. In my work I use technical analysis extensively, but not exclusively. Rest assured, the computerized program trading models and the associated "algos" have a huge impact on trading these days.

Simply ignoring the technicals that are also employed in these trading models may be very unwise. While all of this is short term oriented in nature, it can be somewhat predictive of where the long term outlook is headed.

Example, my discussion given the recent break in the 20 month MA for the S&P. That isn't voodoo, it is real. One look at the long term chart below, and the consequences of ignoring that fact, speaks for itself.

The 20 month MA is still rising and that is positive. The best case for the bulls is a retake of that moving average (1999) to negate the signal.

This week's trading is an example of a market struggling to regain price momentum. The two issues that I highlighted a while ago, the above picture and the Dow Theory sell signal still loom in the background.

Monday's low held above the 1953 level of last Friday, then cratered on Tuesday, as many market participants got the "turnaround Tuesday" memo and hit the sell button.

That action set the market up for more gap down, gap up openings of more than 1%. In 2015 we've had seven 1%+ gaps down already and the market has only bounced from the open to the close twice. Another indicator that questions the market vulnerability here. S&P 1903 was tested on Thursday as the average dropped to 1908 before rallying back, to close the week just under resistance.

The daily chart shows the potential for the "W" bottoming process to take place.

Short term support is the same that has been in play during this churning process, the 1929 and 1901 pivots, with resistance at the 1956 and 1973 pivots.

As I pointed out already, discarding every story that comes out with their versions of "Fed speak" will be beneficial in the long run. The same applies to what I call the "propaganda" stories, meant to "sensationalize" an issue.

Example, take a look at the biotech stocks which sold off on Monday due to this headline from the NY Times. Followed by a tweet from Hillary Clinton.

Yes, let us all listen to Ms. Clinton advise us on how to invest in the pharmaceutical industry (sarcasm intended). Absurdity reigns when these stories hit the airwaves, just like they did on Monday. While I do not ignore the validity of what is implied in this article, it hardly applies to every drug stock out there, yet all were down significantly.

The weakness continued throughout the week right up to the close on Friday.

Let's take a look at the prime suspect in this article, Turing Pharmaceutical. Yes, that is correct, Turing Pharmaceutical, that household name in the biotech industry, the core holding for many professional money managers. The face that is THE poster child for the entire drug industry (sarcasm intended).

This type of rhetoric has been seen before and at that time presented a buying opportunity. GILD, CELG and others fit the bill for appreciation over time. I expect the same this time around as well, as I look to see if these two stocks will hold at these levels or go on to challenge the mini flash crash lows on August 24th. Either way this sector remains a prime candidate for purchase in due time.

These knee jerk reactions are opportunities to get involved in the long term growth story in the sector. Not only were the biotech stocks sold off, big pharma names were also hit hard. The epitome of irrationality.

When I see the entire market react to negative company-specific headlines (VW and CAT), it is a clear sign that the mindset of market participants is clearly one of bearish gloom and doom. At the moment, that is not a great sign for the bulls. Then again the sentiment that has embraced investors has been negative on every front for a while now. Quite frankly the contrarian bones in me are totally confused.

For sure the investing environment is different now than in the past 3 plus years. However, there are indications of some positives out there. When I see the divergences that are around, I lean to that positive side, while respecting the negative story. I take that approach, because the market can fool many. Many of the soothsayers out there are saying the bull market is over. Might they finally be right? Maybe, but in my case, I follow what has worked for me over the years.

Don't jump to conclusions, and be patient. That is not easy when you see the water rising around you. It is at that time that I look for a potential lifeline.

A rational thought entered my mind. Looking ahead to 2016, the consensus for S&P earnings is $125. Let's take those estimates down to $120 and put a multiple of 15 on that. S&P 1800 is the result. The S&P now stands at 1930. The recent stock market weakness might be suggesting that scenario, thus signaling a potential worst case that is about 7% from here. That coincides with the "bear" case that was laid out this past July, where I called for a range of 1755 to 1872 for the S&P, if things didn't go just right.

One step at a time, as I continue to remain ready for anything, amidst the dichotomy in the data that is being presented - mindful of the technical "sell" signs flashed last month.

The jury is indeed still out as to what the next meaningful move will be for the S&P.

Best of luck to all!