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Healthcare Vote: Macro and Micro Implications, March 23, 2017

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The healthcare vote in the House later today will have an effect on stocks in the short and long term, regardless of the outcome, so I wanted to run down the various scenarios along with sector winners and losers depending on whether the bill passes or fails.

US Capitol

Healthcare Vote: Macro and Micro Implications

Scenario #1: Bill Passes

Likely Short-Term Market Reaction: Knee-jerk, risk-on rally that likely will see cyclical sectors outperform.

Impact On Other Assets: Dollar up/bonds down/gold down/commodities down (all due to the perceived increased likelihood of tax cuts). Basically, this would be a short-term reignition of the “reflation trade/Trump-on trade” that’s driven markets higher since the election.

Likely Long-Term Market Reaction: Not a bullish game changer. Despite the likely positive reception by the market, this event by itself won’t be a catalyst for the market to move new highs. That’s because even if the healthcare law passes the House, it still has little-to-no chance of passing the Senate, and as such probably won’t become law. So, while it would be an incremental step towards the ultimate goal of corporate tax cuts, it still wouldn’t be material progress. Longer term, this outcome wouldn’t make me add or reduce stock exposure… it would elicit a “wait and see” response.

Effect on the Healthcare Sector and ETFs: This section is for subscribers only. You can sign up for a free trial to access at 7sReport.com. 

Next Important Event in this Scenario: Memorial Day. If the bill passes the House, then markets will give the Republicans more of a benefit of the doubt. However, healthcare needs to be done by late April/early May (or Memorial Day at the latest) if corporate tax cuts can be completed in 2017, so the clock will soon be ticking.

Scenario #2: Bill Fails

Likely Short-Term Market Reaction: A resumption of Tuesday’s sell-off. Cyclical sectors led by banks would likely pull markets lower, and a drop down through sup-port at 2300 in the S&P 500 would not be at all surprising by the end of the week. Defensive sectors would out-perform.

Impact On Other Assets: Dollar down (likely big)/bonds up (10 year yield could break down through 2.30%)/gold up (likely big)/commodities up (all due to the perceived reduced likelihood of tax cuts). Basically, this would cause a short-term reversal of the “reflation trade/Trump-on trade” that’s driven markets higher since the election, and we can expect a similar trading pattern to Tuesday.

Effect on the Healthcare Sector: This section is for subscribers only. You can sign up for a free trial to access at 7sReport.com. 

Next Important Event in This Scenario: Memorial Day. If the bill fails, the market will hope Republicans pivot and focus on tax cuts, and perma bulls will herald that as a positive. However, make no mistake, a failure of this bill to pass is not a positive for tax cuts, where the fight over border adjustments will make healthcare look tame. Regardless, if there is a pivot to tax cuts, then there needs to be concrete motion on a tax cut bill by Memorial Day, otherwise markets will begin to doubt tax cuts in 2017, which will be a market negative.

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Oil Outlook: Getting More Bearish, March 15, 2017

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Oil Rig - Oil Report was BearishWhy the Monthly OPEC Report Was Bearish Oil

An excerpt from today’s Sevens Report—get a free 2-week trial of the report with no commitments.

Oil remains the big story, as its early morning sell-off to multi-month lows prompted a pullback in stock futures, and ultimately the major US equity indices opened lower. WTI futures finished the day down 1.43%, only slightly above where they opened ahead of the late-November OPEC meeting, where members agreed to collectively cut output.

OPEC released its monthly oil market report yesterday, and the big catalyst in the data was a self-reported increase in February oil production by the de facto leader of the cartel, Saudi Arabia. According to direct communication, Saudi Arabian oil output rose 263.3K b/d to 10.01M b/d. The dip below the psychological 10M mark in early 2017 helped futures stay afloat above $50, as Saudi Arabia was showing their commitment to price support by cutting below their allotted quota (which in fairness they are still below). While data gathered by secondary sources showed another drop of 68.1K b/d to 9.80M b/d in Saudi production, the markets focused on the bearish direct communication data, as it suggests that Saudi Arabia’s commitment to oil cuts may be becoming exhausted.

Another notable takeaway from the release was that OPEC only projects that US oil supply will grow at 340K b/d in 2017. Still, at the current pace (which we will admit does not seem sustainable through the medium term), US producers have already brought 318K b/d online in 2017. Today’s EIA report very well could show an increase through that annual expected rise of 340K b/d.

Bottom line, the rapid increase in US production in recent months has been the biggest long-term headwind for the oil market, as it has offset the efforts of the global production cut agreement while simultaneously causing angst within the ranks of OPEC (namely the Saudis) as they start to see market share slip away.

Without the full commitment of Saudi Arabia to the global production cut agreement, the deal loses a lot of its luster, as they are the key player who has always taken on the bulk of the cuts and taken the near-term hit in market share for the longer-term benefit of the entire cartel. Meanwhile, “compliance cheating” by other members is historically high, and the chances that compliance remains as high as it is right now if Saudi Arabia begins to increase production are essentially zero.

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Senate Math Primer. March 7, 2017

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Senate Math Primer from the Sevens Report: One of the easiest ways to cut through the seemingly unending amount of political noise in the markets is to focus on the fact that there are only two important questions that need to be answered.

  1. Will Republicans agree on border adjustments and a corporate tax cut?
  2. Can that plan get approved in the Senate?
Senate in Session

Republicans have a simple 52 to 48 majority—but that’s not really that powerful.

We’ve already covered the first question from multiple angles in the full subscriber edition of the Sevens Report, but I think the second question is just as important.

In fact, part of the reason I’m covering this is because I get the sense that a lot of people think that once a plan has general Republican support it will automatically become law, because Republicans “control” the House, Senate and the presidency.

While the first and the last are truly under control from Republican leadership, the Senate is anything but.

Looking at the math, as mentioned yesterday, Republicans have a simple 52 to 48 majority—but that’s not really that powerful.

First, it’s well short of a filibuster-proof 60-person majority, and there’s zero chance eight Democrats will break with Republicans on Obamacare or corporate tax cuts.

That’s why both those issues have to be passed via a budget process called “reconciliation.” Reconciliation only requires a simple majority, so 52 to 48 would work.

But, it gets more complicated than that.

First, to say Republicans have a hard 52 votes on any issue is an overstatement. Senator Susan Collins of Maine (technically a Republican) acts much more like an independent. The same can be said for Alaska Senator Murkowski (she’s taking a hard line against supporting an Obamacare repeal that rolls back Medicaid expansion).

Then, there are Senators McCain and Graham. Both are solid Republican votes, but I think it’s fair to say they despise President Trump for multiple reasons. So while it’s unlikely they’d derail passage of Obamacare repeal/replace or tax cuts, they are going to be tough “gets.”

Finally, Rand Paul is more Libertarian than Republican, and he (and others) will have a hard line approach to any tax cuts that might increase the deficit.

Bottom line, while Republicans “control” the legislative and executive branches of government, the Senate is still a bottleneck in the legislative process, and getting Obamacare repeal/replace through the Senate by Memorial Day will be a tough task—never mind corporate tax reform by the August recess (remember, there aren’t even hearings scheduled for the Supreme Court nominee yet).

Again, I’m not trying to throw cold water on this rally, or the optimism fueling it. I’m just trying to keep everyone focused on facts, and the outlook for passage of major reforms through the Senate remains dicey at best.

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets. Sign up for your 2-week free trial at 7sReport.com.

How Many Rate Hikes in 2017? Last Week and This Week: March 5, 2017

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The Economics excerpt from today’s Sevens Report, which focuses on the most important financial news and takeaways for investors, financial advisors, and CPA’s, last week and this week.

Even uber-dove Lael Brainard supported potentially hiking in March.

Last Week:

The major takeaway from the economic data and Fed speak last week is that because of continued strong data and hawkish Fed speak, a March rate hike now is expected by the markets. Probability (according to Fed Fund futures) of a rate hike on March 15 rose from just over 20% two weeks ago, to over 70% at the end of this week… and that was a legitimate surprise for markets.

The reason that change didn’t cause a pullback in stocks is simple. Economic data last week showed continued acceleration in growth and inflation, and as such that helped cushion the blow from the increased rate hike expectations.

To that point, there were three big numbers from last week and they all beat estimates. February ISM Manufacturing PMI rose to 57.7 vs. (E) 56.4, February ISM Non Manufacturing PMI rose to 57.6 vs. (E) 56.5. And, the core PCE Price Index (the Fed’s preferred measure of inflation) rose 0.3% in February, the biggest monthly increase since January 2016. While the core PCE Price Index rose 1.7% yoy, same as January, the headline PCE Price Index rose 1.9% yoy, just below the Fed’s 2% target and the highest level since February 2013!

Not every economic data point was strong last week (Pending Home Sales missed estimates as did Core Durable Goods. And, headline revised Q1 GDP was a touch light at 1.9% vs. (E) 2.1%). Still, the good data handily outweighed the bad data.

Bigger picture, it’s hard to understate how important continued good economic data has been for markets in 2017. Strong data has helped buy Washington more time on corporate tax cuts, and now it’s helping to cushion the blow from a potentially more hawkish Fed. Strong economic data continues to be the unsung hero of the 2017 stock rally, and it needs to continue given the increasingly bleak policy outlook, and potentially a more hawkish Fed. Frankly, watching and correctly interpreting economic data hasn’t been this important in years.

Looking at Fed speak from last week, it was almost universally hawkish. Clearly the Fed is trying to pave the road for a March rate hike. Fed officials Williams, Dudley and Powell all signaled that a rate hike could come in March, and even uber-dove Lael Brainard supported potentially hiking in March.
Then, as if there was any doubt left by the end of last week, on Friday Fed Chair Yellen basically said that if the jobs report is in line, the Fed is hiking rates (her exact words were more general, and a bit more eloquent, but that was her point).

Bottom line, the Fed appears to be sticking to its promise of three rate hikes in 2017, with the first likely coming in 10 days.

This Week:

Are Janet Yellen and the other members of the Fed supporting more rate hikes in 2017?

Jobs reports are always important economic releases but due to the potential for a March rate hike, this jobs report is even more important than normal because it will decide whether we get a hike next Wednesday.

As usual, it’s jobs week, so that means we will get the ADP report on Wednesday, weekly jobless claims on Thursday (which continue to hit levels last seen since the 1970s), and the official jobs report Friday.

I’ll do my normal “Goldilocks” jobs preview later this week, but the bottom line is that as long as this jobs re-port remains firm, the Fed will hike rates next week.

Outside of the jobs report, it’s actually a pretty quiet week, economically speaking.

In the US, the only other notable report is Productivity (out Wednesday). Low worker productivity has been a major downward influence on inflation, but it’s shown signs of ticking higher lately. A continuation of that trend will be slightly hawkish. Finally, looking internationally, China will be in focus as we get Trade Balance (Tuesday) and CPI/PPI Wednesday.

Data from China has been consistently decent (including last week’s February manufacturing and composite PMIs), so it’ll be a big surprise if the data suddenly turns south, but China remains a macro area to watch as any hints of a slowdown will make waves for global markets.

Bottom line, this week really is all about the jobs report. If it’s close to in line, the Fed will hike next Wednesday. And, if it’s hotter than expected, get ready for talk about more than three hikes this year (and that idea is a risk to stocks).

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. Start your free 2-week trial of the Sevens Report today.

If A Rate Hike Is Expected, Why Aren’t Rates and the Dollar Higher? March 3, 2017

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Get the simple talking points you need to impress clients and prospects from the Sevens Report. Here is an excerpt from today’s full report.

If A Rate Hike Is Expected, Why Aren’t Rates and the Dollar Higher? 

If a rate hike is expected, why isn’t the dollar index higher?

That’s a fair question to ask, given two weeks ago there was no expectation of a May rate hike. Then, a week ago, there was no expectation of a March rate hike. Now, a March hike is fully expected.

Yet despite that relatively quick shift, as mentioned the Dollar Index still isn’t materially above 102, and still not close to the recent 103 high. Meanwhile, the 10-year yield is still decently below 2.60%.

The reasons we haven’t seen greater rallies in the dollar or yields are twofold.

First, a rate hike is not a foregone conclusion because of the jobs report next Friday. If it’s disappointing then a May hike makes more sense.

Second, the market still doesn’t believe the Fed is materially more hawkish. So, even if the Fed hikes now, the market still expects just three hikes the remainder of the year, which is what the Fed said in December.

The point is, the currency and bond markets still haven’t fully priced in a March hike yet, nor have they accepted the existence of a “hawkish.” Fed. However, if that jobs number is strong I believe we’ll see further upside in the dollar and yields.

But the big jumps in both will come when the market realizes the Fed is more hawkish than it currently expects, and that likely won’t happen until we see more inflation or proof of actual fiscal stimulus.

Regardless, barring an economic set back the trend higher in the dollar and rates is close to resuming, and investors should be positioned accordingly.

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. Get your free two-week trial of the Sevens Report today.

How Far Could Stocks Go? Let’s Look at the Charts. March 2, 2017

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How Far Could Stocks Go?

Stocks have screamed to all-time highs in recent weeks, and with new highs always comes the question of how far could stocks go? We like to regularly offer fundamental valuation updates as we did two weeks ago, but it is also important to outline what the charts are telling us as far as upside targets and key support levels for near-term price movements.

This stock market technical update is an excerpt from our March 1st Sevens Report. Claim your free 2-week trial today and cut through the jargon to specifics to support your client conversations. 

In the wake of the election there were a lot of very important technical developments. The two most notable were the shift from a bear market signal to a bull market signal in Dow Theory when the S&P was trading at 2165, and confirmation of that signal when the S&P broke to all-time highs November 21.

Currently, both the technical trend and upside momentum of the market continue to suggest the path of least resistance is higher for the medium term. That is the case in spite of the fact that there are countless fundamental uncertainties, most important are related to politics and fiscal policy.

Prices taken at market close on Feb 28.

Prices taken at market close on Feb 28.

In a situation like this, where technicals are largely divergent from fundamentals, many financial professionals and investors look for some direction as to how far stocks could rally from current levels and where a pullback would most likely pause if not reverse. So, we put together a few upside targets as well as downside support levels to watch for the S&P 500.

In a quick review, when any issue (stock, bond, commodity or currency) is trading in never-before-seen territory, there are only two ways to come up with targets in the direction of the new highs—measured moves, and likely areas of interest for options traders. The latter is relatively easy to figure out, as options volumes generally cluster around the big round numbers (in this case 2350 and 2400).

 

Tracking Measured Moves.

Measured moves, on the other hand, are a little more scientific. The idea behind a measured move is that if the market moved a certain distance against the dominant trend, it will more than likely move at least that far back in favor of the trend once it resumes.

  • Our next upside target is actually a combination of two measured moves and a likely area of interest for S&P option traders: 2450. On the daily chart, a measured move can be calculated from the late-October lows (2084) to the late-December digestion area (2271), which results in a measured move to 2458 in the S&P from current levels. In a supporting fashion, a measured move on the weekly chart can be calculated from the previous S&P highs of 2126 to the February ’16 lows of 1810. That results in a target of 2442.
  • This gives us an ultimate target window of 2442-2458, which encompasses a likely options trader target of 2450.

stock market charts, March 2

  • Bottom line, we are not suggesting that this bull market will end in the mid 2400s; however, for those looking to take profits, you likely will not be alone in doing so in that window around the 2450.

Support Levels

Turning to support levels, the February melt-up in stocks has left a large “volume gap” on the chart, which basically means stocks sprinted from around 2300 to 2360. Because of the velocity of that move higher, there were not many logical support levels created in the month of February. And a set up like that raises the odds that there could be a swift move back through that area.

  • There is an initial and minor area of support around 2343, where there was minor consolidation on February 16. This area will at least be noticed by technical traders and volume-driven algorithms.
    Secondary and more formidable support lies near the previous set of new all-time highs established in December in the band between 2270 and 2280. Here there will be buyer support from both bulls who missed out on the breakout as well as faster-money short sellers looking to book profits.

March 2, book profits

  • Our final support zone is derived from a weekly timeframe, and again at a previous all-time high of 2100, where the most consolidation occurred since the tech sell-off finally ended in 2002.

These levels are meant to provide you with a general idea of the most important technical levels on either side of the broader stock market right now. This information, we have heard in the past from advisor subscribers, is very useful in conversations with clients.

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The Political Outlook for Stimulus is Darkening, February 28, 2017

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This is an excerpt from today’s Sevens Report. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets. Sign up for a free 2 week trial.

It’s obviously impossible to say “when” this will matter to stocks, but I want to make very clear to everyone that the political outlook for stimulus is darkening, and the chance of any pro-growth measures hitting the markets in 2017 are falling, quickly… and sooner or later that will be a problem for this market.

To that point, yesterday there were three separate areas where the outlook for fiscal stimulus darkened. First, while Treasury Secretary Mnuchin did a good job in both his major interviews (WSJ and CNBC) he didn’t add anything incremental regarding corporate tax cuts, and was downright vague on the idea of border adjustments, which is the key to corporate tax cuts.

Yes, he did say he expects a broad corporate tax reform bill by the August recess, but that’s just repeating what Speaker Ryan has said (i.e., nothing new). Bottom line, the outlook for corporate tax cuts in 2017 (and maybe at all) continues to get worse.

Paul Ryan

Speaker Paul Ryan has said he expects a broad corporate tax reform bill by the August recess. The outlook for corporate tax cuts in 2017 continues to get worse.

There were some additional headlines regarding this issue late yesterday afternoon when President Trump told Reuters he supported “some form of border tax.” Markets initially took this as a positive (implying he was supportive of border adjustments) but that’s premature because what he meant was unclear as his subsequent comments more implied he supported tariffs in some form (not the full scale border adjustments needed to pass corporate tax reform).

Beyond Trump’s comments, the major hurdle for border adjustments and corporate tax reform remains in the Senate. There is little support for that idea in the Senate currently, and until that chances, corporate tax reform is unlikely.

Second, Axios reported that Trump is punting infrastructure spending to 2018. That was treated as a notable headline yesterday, but we and others have been saying for weeks now that infrastructure spending never was on the table for 2017. So, while this isn’t an incremental negative for the market, it was a headline that we wanted to cover.

Third, as we’ve covered, the way things are looking right now Republicans must get the repeal/replace of Obamacare done before they can tackle corporate tax reform. Well, Politico reported that Republican Alaska Senator Murkowski won’t vote for any repeal/replace that reduces the Medicaid expansion. With just a 53/47 majority in the Senate, the chances of just getting 50 votes on a repeal/replace continue to dwindle, and by all reports Republicans remain fractured on how to handle the repeal/replace.

Now, I’m not pointing this out for political reason (you know I’m politically agnostic in this Report). The reason I am pointing it out is simple: No Obamacare repeal/replace, then no corporate tax cuts in 2017, and that’s a problem for stocks (how much of a problem will depend on economic growth, inflation and interest rates, but it’s still a problem).

Bottom line, I don’t want to sound like the boy who cried wolf, but I just want to point out consistently and clearly that the gap between market policy expectations and policy reality is widening—and again, that’s a risk that should not be ignored.

This is a volatile, politically sensitive investment landscape—you need the Sevens Report to stay ahead of the changes, and to calm worried clients.

The FOMC Expects a Rate Hike “Fairly Soon” – Here’s What We Think That Means. February 27, 2017.

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This is an excerpt from today’s Sevens Report. You can get a free 2-week trial and see for yourself how the Sevens Report can give you fresh talking points for your client conversations, and help you outperform your peers. Read on to see our predictions for when the FOMC will announce the next rate hike.

There were only two notable economic events last week and neither were particularly positive for stocks (although they weren’t outright negatives). For weeks, the economic data has been supporting markets through consistent policy disappointment from Washington, so it’s notable that last week the data wasn’t particularly supportive, and incremental disappointment finally weighed slightly on stocks. Going forward, with policy outlook continuing to dim, data will need to be consistently good to further support this rally.

Last Week

Looking at last week’s data, the February flash PMIs (both manufacturing and service sector) were surprisingly disappointing. The flash manufacturing PMI declined to 54.3 vs. (E) 55.5, which was a surprise miss given the very strong Empire and Philly surveys from two weeks ago. The flash services PMI also missed estimates at 53.9 vs. (E) 55.9, again posting a surprise decline. Additionally, most of the details in these reports, including New Orders in the manufacturing PMI (which is a leading indicator), also fell. Meanwhile, the manufacturing input price index rose slightly while the selling price index declined slightly, implying margin compression in the manufacturing sector.

Now, to be fair, the absolute levels of these two PMIs remain high and by no means does the mild pullback imply a loss of economic momentum. However, the market needs consistently better data to offset the noise from Washington, and that didn’t happen last week.

The FOMC expects another rate hike "fairly soon," but it is unlikely to be in March 2017.

The FOMC expects another rate hike “fairly soon,” but it is unlikely to be next month.

The FOMC minutes were the other notable economic event last week, and while the minutes were taken as slightly dovish by the currency and bond markets, in reality they only confirmed that May is now (in our opinion) the next likely date for a rate hike.

The key phrase in the minutes was the FOMC expected another rate hike “fairly soon.” The reason that was taken as slightly dovish is because fairly soon isn’t the “next meeting” (that’s what has appeared in the FOMC minutes before the previous two rate hikes). The takeaway is that a March hike is unlikely, though that’s not incrementally dovish because the market wasn’t expecting a March rate hike anyway. If we get a strong inflation number this week and a strong jobs report Friday, odds of a March rate hike could creep closer to 50% from the current 22% (and that could be a headwind on stocks).

This Week

This will be a busy and important week for the economy as we get some critical data on growth and inflation, and if stocks can maintain this rally, the former needs to be strong and the latter doesn’t. The most important number this week is the PCE Price Index contained in Wednesday’s Personal Income and Outlays report. February CPI and PPI were both much stronger than expected, and if the Core PCE Price Index (which is the Fed’s preferred measure of inflation) moves close to 2% (currently at 1.6%) then we will see expectations for a March rate hike increase, and that will send Treasury yields higher and send the dollar higher—and that will put a headwind on stocks.

The next most important number this week is the ISM Manufacturing PMI, out Wednesday. Normally, this would be the most important number of the week, but even if this confirms last week’s flash PMI and pulls back a bit from January, it’s still a very high absolute level and it will take several months of declines before anyone would get worried about activity in the manufacturing sector. Nonetheless, it is still a critical number and if it’s soft we could see a bit of stock weakness.

There are other notable reports this week including Durable Goods (today) and the services PMI (Friday). Finally, revised Q4 GDP comes Tuesday, and analysts are still looking for around 2% growth (Q4 GDP was 1.9% in the advanced look last month). As we said, all the data is important given strong data has helped offset growing policy worries, so these number meeting or beating estimates will be generally supportive. Bottom line, data needs to stay good and inflation needs to stay tame in order to support this market, because Washington policy expectations are a growing headwind.

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Oil Market Internals Confirm Our View of “Lower-for-Longer” Price Environment, February 24, 2017

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This is an excerpt from today’s Sevens Report. Sign up for your free two-week trial to get everything you need to know in your inbox, by 7am in 7 minutes or less.

We have recently been monitoring the calendar spreads and term structure of WTI crude oil futures with a little more attention, as there have been notable developments.

As a refresher, a calendar spread is simply the difference in price between two contracts with different expirations. For example, contracts with a December ’17 expiration are currently trading at a roughly $1.00/bbl premium to contracts expiring in December ’18 (this is called an inverted market, or backwardation, and is not typical in energy markets). Normally, back-month con-tracts are more expensive than front-month contracts to reflect the price of storage and other variables. Such a structure is called normal contango.

The trend is long-term bearish oil.

The trend is long-term bearish oil.

Over the last week or two, calendar spreads have surged, which would be considered very bullish in normal market conditions like we had late last year when OPEC announced their agreement to cut production with several large NOPEC producers. After that announcement, the entire WTI expiration curve rallied on the speculation of that bullish development in the supply-demand fundamentals with front-month contracts out-performing back months (calendar spreads rallied, con-firming the move in active-month futures).

In the current case, the strength in the calendar spreads has been the result of weakness in back-month contracts like December ’18. Think about the simple equation a – b = c (calendar spread). If “a” (Dec ’17) and “b” (Dec ’18) are both increasing, but the pace of a’s increase is faster, “c” will be positive (so the calendar spreads would be rallying, which is bullish). Right now, “c” is rising because of a faster decline in “b” than in “a” and that is far less of a reason to be optimistic on this current, sluggish trend higher in oil prices.

Stepping back, this development in the calendar spreads confirms what we have been saying, and that is we remain in a lower-for-longer price environment in the energy market.

The logical reason for a faster decline in back-month contracts such as December ’18 expiration suggests that US producers are hedging out future production for wells they have either just brought online or are in the process of bringing online. And this concept supports our idea that US production has not only bottomed, but has begun a cyclical move higher.

Bottom line, that trend is long-term bearish oil for two reasons. First, the obvious fact that rising US output will offset the efforts of the production cut agreement overseas is supply side bearish. Second, OPEC producers are not likely going to be comfortable with the idea of losing market share to the US again (after all, that is the reason they switched to “full-throttle” policy back in summer 2014, which led to the near-80% plunge in oil prices over the subsequent 18 months). The more market share OPEC loses to the US the more likely their compliance to individual quotas will begin to fall, which is very bearish for prices as that is what this current recovery into the $50s is fundamentally based on.

Looking ahead, we could very well see a continued run higher towards our initial target of $57.50, or to our secondary target of $60/bbl, as optimism surrounding OPEC compliance remains elevated. The longer-term outlook is not so bright, and the low $50s will likely remain a “magnetic” level for WTI futures.

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“Is the Stock Market Too Expensive?” February 23, 2017

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“Is the Stock Market Too Expensive?” 

That’s a question I’m getting asked a lot lately by subscribers and colleagues.

With stocks at record highs, there is a lot of worry that the market is unsustainably expensive. But, that’s simply not the case.

Yesterday, in the full edition of The Sevens Report, we broke it down.

  • Provided a three-part analysis of what makes the market 1) Expensive, 2) Fairly Valued (with some room for upside) and 3) Cheap
  • Named each catalyst that would decide that valuation level
  • Listed specific sector and style ETFs that we believe can outperform in this valuation environment.

Excerpt from that research below:

Valuation Update: How Overvalued Are Stocks?

It’s no secret that stocks are richly valued, but while those high valuations make me generally uncomfortable (I’m a value investor at heart) I do feel the need to push back a bit on the idea that valuations, alone, are a reason to lighten up on equity exposure.

Yes, in some scenarios the stock market is simply “too expensive.” Still, there are other, more plausible scenarios where I can show the market as reasonably valued or even cheap. Here are a few of those scenarios.

The Market is Too Expensive If: You’re Looking at Current Year Earnings. Looking at current year earnings, the S&P 500 is historically very expensive. With consensus $128 2017 S&P 500 EPS, the S&P 500 is trading at a whopping 18.44X current year earnings. Anything above 18X has proven (longer term) historically unsustainable.

The Market Is Not Too Expensive (Yet) If: You Look At Next Year’s (2018) Earnings (And This is Without Any Tax Cuts). Consensus 2018 (so next year) EPS are around $135, which does not include any benefit from a corporate tax cut. At $135, the S&P 500 is trading at 17.4X next year’s earnings. Yes, that is expensive (the 20-year average is 17.2X per FactSet) but it’s not unsustainable, not in an environment with historically low interest rates and an apparent macro-economic acceleration.

In fact, if the macro set up doesn’t change (and we don’t get any definitively bad news from Washington), I could see investors pushing that multiple to 18X, or 2,430 in the S&P 500 (about 3% higher from here).

Above that, I think the market would get somewhat prohibitively expensive, but that would depend on what’s happening with the economy, inflation and rates.

The Market Is Cheap If: Real, Material Corporate Tax Cuts Get Implemented. If we do get material corporate tax cuts in 2017, most analysts think that would add at least $10/share to S&P 500 EPS, bringing the 2018 number from $135 to $145.

At $145 EPS, the S&P 500 would be trading at just 16.3X next year’s earnings, which in this environment could easily be considered reasonable if not outright cheap.

“Is the stock market too expensive?”

Six Value ETFs That Can (and Have) Outperformed

From a practical standpoint, the fact that the stock market is on the expensive side historically does reinforce my preference for value-oriented ETFs. Since late 2016, we’ve focused our tactical strategies on sectors we considered a “value” and they have handily outperformed the S&P 500:

  • In September of 2016, we strongly advocated getting long banks due to 1) Compelling valuation and 2) The start of the uptrend in bond yields. Since that call on September 26, our preferred bank ETF has risen 41%!
  • In late 2016, while many analysts were chasing cyclical sectors in the wake of the election, we instead advocated buying value in super-cap internet stocks. Our preferred internet ETF has risen 9.8% in 2017, handily outperforming the S&P 500.
  • At the start of 2017, we cited the maligned healthcare sector as our preferred contrarian play for 2017, based on the idea that overly negative political fears had created a value opportunity. Our two preferred healthcare ETFs have risen 7.3% and 7.5% so far in 2017, and we think that trend of outperformance will continue. 
  • More broadly, we have identified two “Value” style ETFs that we believe will outperform the markets in this current macro-environment, and these two broad ETFs remain our preferred vehicle to be generically “long” the market.

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“This is a huge value add. If I can avoid even a modest portion of significant market pullbacks, and be well-invested during bull markets based on your Dow Theory calls, my clients will be extremely happy with me. I already look like a genius to them!” – Financial Advisor with a National Brokerage Firm, New York, NY.