stock market – Page 91 – Sevens Report Research

What Caused The Mid-Day Selloff?

July 28, 2017/in Investing/by Tom Essaye

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The most likely “cause” of the midday reversal and selloff (which frankly looked ugly for an hour or so) was a cautious report from JPM quant analyst Kolanovic, and the reasons it caused a dip are twofold. First, Kolanovic is very respected on the Street, and he was one of the first analysts to correctly identify the role of “Risk Parity” funds in the violent market declines of August 2015.

Second, he outright suggested investors hedge equity exposure.

Now, to be clear, it wasn’t a bearish report, as he did note there are strong, positive fundamental factors supporting stocks including a rising economic tide and growing earnings.

However, he made the point that, in his opinion, market volatility is now at an all-time low. The specific accuracy of this claim can be debated, but let’s all agree market volatility is close to, if not at, all-time
lows.

The all-time lows in volatility have caused funds to use increasingly leveraged strategies to generate outsized returns. Selling volatility options is one of the simplest leveraged strategies, but the point is this: Quant funds and traders will ratchet-up leverage in low volatility environments to increase returns amidst perceived lower risk. And, since volatility is at or near all-time lows (and has been for some time) these leveraged strategies are both abundant and large.

And, this all-time low volatility and explosion of leveraged strategies is coming right at a time when global central banks are reducing monetary accommodation for the first time in, well, a decade.

So, while the analogy of fireworks sitting on top of a powder keg is a bit over the top, it does illustrate the general idea behind Kolanovic’s caution.

Bottom line, in my opinion, this report by itself isn’t a reason to materially de-risk, as the same argument could have been made about this market over the past few months (as it’s made new highs). But, Kolanovic is a smart guy, so his caution should be noted.

Finally, two anecdotal points. First, I believe what really spooked markets yesterday was that Kolanovic referenced this current set up as being similar to “Portfolio Insurance,” a strategy that failed miserably and contributed to the crash of 1987. Obviously, that’s not an uplifting analogy.

Second, for those of us watching the tape yesterday, the mini-freefall we saw in tech and specifically SOXX and FDN, was a bit unnerving. Things steadied, but the pace of the declines midday yesterday was a bit scary. That tells me these are very, very crowded trades, and I am going to have a “think” on potentially lightening up some exposure to that tech sector in favor of shifting it internationally (Europe, Japan, and perhaps emerging markets). Food for thought.

Getting back to the markets today, the Employment Cost Index is the key number to watch. If it’s hot, we could see yields rise, and that might pressure stocks mildly. Meanwhile, a soft reading will send yields lower and likely push stocks higher short term. Inflation remains a much more important influence on the markets right now than measures of economic growth.

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What Does “Reflation” Actually Mean?, July 7, 2017

July 7, 2017/in Investing/by Tom Essaye

What Does “Reflation” Actually Mean?

One of the reasons I started the Sevens Report more than five years ago was because I hated the overuse of jargon by analysts and commentators. Frankly, markets and economics are not particularly complicated topics. There are a lot of variables involved, so getting the future right is difficult. However, understanding market dynamics and economic conditions is actually mostly common sense, because markets and economies are just the sum of collective actions by people. And, since people generally act in their own best interests, it’s not too difficult to understand markets and economics once you get past the jargon.

To that point, I’ve found myself using the terms “reflation” and “cyclical” entirely too much lately. That’s jargon, and I want to make sure that everyone knows exactly what I mean when I say “reflation trade” or “cyclical outperformance.”

So, what is Reflation?

Reflation is simply the idea that economic growth is going to accelerate in the future. To understand why we use the term reflation, think of the economy as a soccer ball. The ball is full of air when we have consistent 3% GDP growth. But, fallout from the financial crisis has put GDP growth around 2% for nearly a decade. So, the soccer ball (i.e. the economy) is deflated.

However, if we see economic acceleration back to consistent 3% growth, the ball (i.e. the economy) has been “reflated.” So, any economic news that implies better growth is termed “reflation.”

And, since reflation is just the expectation of an accelerating economy, people (i.e. investors and the market) react to that expectation. That reaction, typically, is comprised of:

1) Selling bonds (so higher rates) because in an accelerating economy central banks hike rates and inflation rises, both of which are negative for bonds.

2) They allocate investment capital to sectors of the economy that are more reactive to better economic growth.

These sectors are called cyclicals, because their profitability rises and falls with economic growth (like a cycle). Banks (better economy=more demand for money), industrials (better economy=capital investment in projects), small caps (better economy=rising tide for products and more availability of capital), and consumer discretionary (better economy=more spending money) all are cyclical sectors.

Companies in those sectors usually make more money when the economy is getting better, and the anticipation of that attracts capital at the expense of bonds and “non-cyclical” sectors such as utilities, consumer staples, healthcare, and, increasingly, super-cap tech.

Up until June, the non-cyclicals outperformed because there was no evidence of higher rates or better growth. But in June central banks sent a shot of confidence into the markets, and since then, in anticipation of that economic acceleration, cyclical sectors have outperformed. And, if today’s jobs report is strong, beyond any short term “Taper Tantrum 2.0” that’s likely a trend that will continue, especially given the trend change in bonds.

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Volatility—What Goes Down Must Come Up, But It Can Take a Long Time!, May 10, 2017

May 10, 2017/in Investing/by Tom Essaye

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Historically low volatility is becoming a bigger topic in the markets these days, and while earlier in the year low volatility was referenced with more of an observational tone, recently I’ve been hearing the bears touting low volatility as something that simply must revert soon, and as such we should be cautious on markets.

I don’t have a crystal ball, so I don’t know when normal volatility will return. However, I do want to spend a few moments pushing back on the idea that low volatility by itself means a correction is coming (obviously volatility will return, but as usual the key question is “when,” and ultra-low volatility doesn’t always mean it’ll return to normal levels soon).

First, you’re not seeing things. Volatility is at multi-decade lows, and that can be seen in multiple ways. First, the VIX hit a 23-year low yesterday, falling to the lowest level since 1993.

Second, so far in 2017 the S&P 500 has moved more than 1% on just three separate days, all of which were in March. By this time of year we’ve normally had 19 days where the S&P 500 has moved more than 1%.

Third, with a close at 9.98 yesterday, the VIX now is lower than nearly 99.5% of all the closes since Jan. 1, 1990. Put another way, it’s only closed this low about 0.05% of the time during the last 27-plus years. So, the VIX is extraordinarily low.

But, that doesn’t mean it’s going to bounce back soon.

First, According to a note from ConvergeEx, the all-time low for the VIX 50-day moving average is 10.8, which it hit in Feb. 2007. Right now, the 50-day moving average for the VIX is 12.17.

Takeaway: It’s very unlikely that the VIX will stay at these ultra-low levels for very long, but that doesn’t mean a big rally is looming. It would take several more weeks of VIX at these levels to drag the 50-day MA down towards the all-time lows.

Second, looking at the VIX to measure volatility can cre-ate a bit of an odd picture, because again the VIX is based on options prices and not the actual price move-ments of the S&P 500. Looking at actual stock price movement, it confirms what our eyes tell us.

Going back to the 1950s, the current volatility of stock prices is 48% of its longer-term average. That’s really low. And, this period of historically low volatility has been going on for 78 days (including yesterday). But, that doesn’t mean it necessarily will bounce back.

First, there have been two specific periods of similarly low volatility in the last 20 years. First in mid-2014 (75 days) and second from Nov. ’06 to March ’07 (79 days).

Second, we’re not even close to the record for low volatility. In 1992/1993 and 1995/1996 we saw respective periods of ultra-low volatility last for 179 and 254 days, respectively. That’s double and triple what we’ve seen so far in 2017.

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Earnings Season Post Mortem & Valuation Update, May 9, 2017

May 9, 2017/in Investing/by Tom Essaye

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The S&P 500 has been largely “stuck” in the 2300-2400 trading range for nearly 10 weeks, despite a big non-confirmation from 10-year yields, modestly slowing economic data and political disappointment. Given that less-than-ideal context, the market has been downright resilient as the S&P 500 only fell to around 2320ish. The main reason for that resilience is earnings and valuation.

While it’s true that stocks are at a valuation “ceiling” right now, and need a new macro catalyst to materially breakout, it’s also true that given the current macro environment the downside risk on a valuation basis for the market is somewhat limited. That’s why we’re seeing such aggressive buying on dips.

Here’s the reason I say that. The Q1 earnings season was better than expected, and it’s resulted in 2018 S&P 500 EPS bumping up $1 from $135-$137 to $136-$138. At the higher end of that range, the S&P 500 is trading at 17.4X next year’s earnings. That’s high historically to be sure, but it’s not crazy given Treasury yield levels and expected macro-economic fundamentals.

However, if the S&P 500 were to drop to 2300 on a macro surprise, then the market would be trading at 16.67X 2018 earnings. In this environment (low yields, stable macro environment), that could easily be considered fairly valued.

Additionally, most analysts pencil in any help from Washington (including even a small corporate tax cut and/or a foreign profit repatriation holiday) adding a minimum of $5 to 2018 S&P 500 EPS. So, if they pass the bare minimum of expectations, it’s likely worth about $5 in earnings, and that puts 2018 earnings at $143.

At 2400, and with $143 expected earnings, the S&P 500 is trading at 16.8X 2018 earnings. Again, that is high historically, but for this market anything sub 17X will elicit buying in equities (whether it should is an open question, but that is the reality).

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Last Week and This Week in Economics, May 1, 2017

May 1, 2017/in Investing/by Tom Essaye

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Economic data continued to underwhelm last week and the gap between soft sentiment surveys and actual, hard economic data remains wide, and that gap remains a medium term risk on the markets.

Last week in Economics – 4.24.17

Looking at the headliner from last week, Q1 GDP, it was underwhelming, as expected. Headline GDP was just 0.7% vs. (E) 1.1%, and consumer spending (known as Personal Consumption Expenditures or PCE) rose a mea-sly 0.3%. But, the 0.7% headline met the soft whisper number and that’s why stocks didn’t fall hard on Friday.

That GDP report came on the heels of another underwhelming Durable Goods number. The headline missed estimates but the more importantly, New Orders for Non-Defense Capital Goods ex-Aircraft rose just 0.2% vs. (E) 0.4%, although revisions to the February data were positive.

Meanwhile, inflation metrics firmed up last week. First, the PCE Price Index in Friday’s GDP report rose 2.2% vs. (E) 2.0%, while the Employment Cost Index, a quarterly gauge of compensation expenses, rose 0.8% in Q1 vs. (E) 0.4%. Those higher inflation readings were why you saw the dollar rally pre-open Friday despite the disappointing GDP report.

Bottom line, the economic data over the past several weeks hasn’t been “bad” and it’s not like anyone is worried about a recession. But, the pace of gains has clearly slowed, and until we see a resumption of the economic acceleration many analysts were expecting at the start of 2017, any material stock rally from here will not be economically or fundamentally supported (and remember, it was the turn in economic data back in August/September that ignited the late 2016 rally. Yes, the election helped, but the momentum was positive before that event, so economics do matter).

This Week in Economics – 5.1.17

Economic data this week could go a long way towards helping to resolve the large gap between soft sentiment surveys and hard economic data, given the large volume of economic reports looming this week.

First, it’s jobs week, so we get the ADP Employment Report on Wednesday and the official jobs report on Friday. We’ll do our typical “Goldilocks Jobs Report Preview” on Thursday, but after March’s disappointing jobs number, the risks to this report are more balanced (it could easily be too hot if the number is strong and there are positive revisions, or it could be too cold and further fuel worries about the pace of growth).

Second in importance this week is the Fed meeting on Wednesday. The reason this is second in importance is because it’s widely assumed the Fed won’t hike rates at this meeting (June is the next most likely date for a rate hike), although the Fed has turned slightly more hawkish so there’s always the possibility. We’ll send our FOMC Preview in Wednesday’s report but the wildcard for this meeting is whether the Fed gives us any more color into how it plans to reduce its balance sheet. If the Fed does reference or start to explain how its plans to reduce its balance sheet, that could be a hawkish surprise for markets.

Finally, we get the global manufacturing and composite PMIs this week. Most of Europe is closed today for May Day so just the US ISM Manufacturing PMI comes today, with the European and Japanese numbers out tomorrow. Then, on Wednesday, we get the US Service Sector PMI and global composite PMIs on Thursday. The global numbers should be fine but the focus will be on the US data. In March we saw a loss of positive momentum in these indices but the absolute levels of activity remained healthy. If we see more moderation and declines in the ISM Manufacturing and Non-Manufacturing PMIs in April, that will stoke worries about the overall pace of growth in the economy and that will be a headwind on stocks.

Bottom line, this a pretty pivotal week for the markets. On one hand, if economic data is strong and the Fed a non-event, the S&P 500 could push and potentially break-through 2400. Conversely, if economic data is underwhelming and the Fed mildly hawkish, we could easily see last week’s earnings/French election rally given back, and the S&P 500 could fall back into the middle of the 2300-2400 two months long trading range.

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Jobs Report Preview, April 6, 2017

April 6, 2017/in Investing/by Tom Essaye

For the second month in a row the major issue for tomorrow’s jobs report is simple: Will it cause the Fed to consider more than three rate hikes in 2017? If the answer is “yes,” then that’s a headwind on stocks. If the answer is “no,” then stocks should comfortably maintain the current 2300-2400 trading range.

So, tomorrow’s jobs report is once again potentially the most important jobs number in years, as it has the ability to fundamentally alter the market’s perception of just how “gradual” the Fed will be in hiking rates.

“Too Hot” Scenario (Potential for More than Three Rate Hikes in 2017)

>250k Job Adds, < 4.6% Unemployment, > 2.9% YOY wage increase. A number this hot would likely ignite the debate about whether the Fed will hike more than three times this year (or more than 75 basis points if the Fed hikes 50 in one meeting). Likely Market Reaction: Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

“Just Right” Scenario (A June Rate Hike Becomes More Expected, But the Total Number of Expected Hikes Stays at Three)

125k–250k Job Adds, > 4.7% Unemployment Rate, 2.5%-2.8% YOY wage increase. This is the best-case scenario for stocks, as it would imply still-stable job growth, but not materially increase the chances for more than three rate hikes in 2017. Likely Market Reaction:Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

“Too Cold” Scenario (A June Rate Hike Becomes in Doubt)

< 125k Job Adds. Given the market’s sensitive reaction to the soft auto sales report earlier this week, a soft jobs number could cause a decent sell-off in equities. As the Washington policy outlook continues to dim, economic data needs to do more heavy lifting to support stocks. So, given the market’s focus on future growth, the bottom line is bad economic data still isn’t good for stocks. Likely Market Reaction:Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

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Bond Market Problems (That May Become Stock Market Problems), April 5, 2017

April 5, 2017/in Investing/by Tom Essaye

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One of the reasons I watch all asset classes so closely is because I’ve learned that other sectors often will confirm (or not confirm) a move in the stock market. Right now we are getting a pretty notable non-confirmation from the bond market.

Specifically, when stocks rally I like to see: 1) Bond yields rising, which reflects investors expecting greater economic growth and inflation (two stock positive events). 2) A steepening yield curve, which also reflects rising inflation expectations and increased demand for money via loans (something that has been sorely missing from this recovery). 3) I like to see “riskier” parts of the bond market, specifically junk bonds, rising (or at least holding flat) as investors show confidence in corporate America by lending money to riskier companies in search of greater yield (it’s an anecdotal risk-on signal).

Throughout Q4 2016, that’s exactly what we got. First, the yield on the 10-year Treasury rose from 1.54% in late September, to 2.40% at year end. Second, the yield curve steepened as the 10’s-2’s spread rose from 0.81% on Sept. 29 to 1.25% on Dec. 30. Finally, junk bonds were broadly flat during that period (although with notable volatility).

Since the start of 2017, the opposite has occurred. The 10 year started at 2.44% but now is sitting at 2.35%. The 10’s-2’s spread has decreased from 1.23% on Jan. 1 to 1.11% on Monday (the low for the year). Finally, junk bonds rallied through March with stocks, but have since given back some of those gains. If JNK (the junk bond ETF) breaks $36.19 that will be the first “lower low” of 2017, and a negative technical signal.

Point being, the bond market is reflecting an outlook that is comprised of slower growth, less inflation, and more general concern—which is almost the exact opposite of what we’re seeing in stocks right now.

To be clear, this non-confirmation isn’t a guaranteed death sentence for a stock rally. Bond markets gave non-confirmation signals consistently in 2015 when Europe was on the verge of deflation because of the flood of European money into Treasuries, which sent bonds higher and yields lower despite a stock rally. But, that’s not happening now.

So, the “gaps” in this environment are growing in size and number. The gap between political expectations and likely reality regarding tax cuts is as wide as it’s even been. The gap between hard and soft economic data continues to widen as sentiment indicators continue to surge. Now, the gap between bond market direction and stock market direction is widening.

Bottom line, the trend in stocks remains higher, but there are cracks appearing in the proverbial ledge stocks are standing on, and we better get some positive catalysts soon, otherwise we are in danger of a real pullback.

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

March 23, 2017/in Investing/by Tom Essaye

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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.

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

March 15, 2017/in Investing/by Tom Essaye

Why the Monthly OPEC Report Was Bearish Oil

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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

March 7, 2017/in Investing/by Tom Essaye

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.

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

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.

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