Market Strategy Radar Screen Weekly October 15, 2018

Too Much Information

A confluence of factors appeared to overwhelm stocks last week, creating opportunity for those with conviction

This week finds investors around the world pondering if US equity markets will pursue the rally mode they found last Friday or continue down a negative path of price discovery on worries surrounding the US Federal Reserve’s process of normalization (too slow? too fast?), the ongoing trade hostilities between the US and China along with a host of other concerns ranging from the effects of populism on elections and monetary policy abroad to concerns about the outcome of the Q3 earnings season now under way stateside.

The Dow Jones Industrials, S&P 500, the S&P 400 (mid-caps), the Russell 2000 (small caps) and the NASDAQ Composite (over 40% weighted in technology and tech related stocks) respectively fell last week: 4.2%, 4.1%, 4.9%, 5.2% and 3.7%.

A rally on Friday provided some relief for frazzled investors as the Dow Jones Industrials, the S&P 500, the S&P 400, the Russell 2000 and the NASDAQ Composite respectively added: 1.2%, 1.4%. 0.24%, 0.08% and 2.3% on the day.

International equity benchmarks suffered for most of last week as well with the MSCI EAFE index (Developed Markets ex-US and Canada), the MSCI Emerging Markets and the MSCI Frontier Markets respectively sliding 3.9%, 2.1% and 1.7% on the week.

Friday saw rallies in a number of regions around the world outside of the US which saw MSCI EAFE close near flat while the MSCI Emerging Markets and the MSCI Frontier Markets respectively advanced 2.7% and 1.2% on the day.

Gold caught a bid

Turmoil in equity markets sent at least some investors into gold last week, driving prices higher by 1.3% and producing the shiny metal’s biggest gain since 2016 last Thursday after having posted six straight monthly losses this year (see figure below).

The question for gold bugs is for how long can gold stay strong with the Federal Reserve committed to normalizing interest rates in the US as well as a normalization process—albeit still relatively nascent—about to begin outside the US (Europe, Japan and elsewhere around the globe).

Last week’s jump in the price of gold appeared to occur in response to a drop in the yield of the 10-year Treasury last week (from 3.23% to 3.16%) reflecting in some part a surge in volatility in the stock market. The VIX (a gauge of volatility as it relates to the S&P 500) jumped from a level of 14.82 at the start of the week to a level of just under 25 on Thursday before it eased somewhat to a level of 21.3 on Friday as stocks rallied (see figure below).

Investors likely will be watching gold to see if it can follow through into this week to find the strength it found in the middle of last week.

In our view the direction of the yield on the 10-year Treasury could provide a clue as to how gold’s price moves in the near term. Even with last week’s rally at Friday’s close the price of gold was down 6.5% from where it began the year.

Oil Prices Retreat after Strong Run This Year

Oil prices fell over 4% last week as a decline in stock prices along with more worries about the risk of a protracted trade war with China and cuts in global growth estimates from the International Monetary Fund cooled investor sentiment for the black gold with West Texas Intermediate oil falling from $74.34 bbl. at the start of the week to a closing price on Friday of $71.34 bbl.

That said, last week’s drop in the price of oil didn’t put much of a dent into the performance of the commodity as WTI remains up some 19.6% from the start of 2018 through last Friday.

Last Week’s Game of Musical Chairs

We might describe the last few days in the market as a week of nasty musical chairs played with diverse asset classes and driven by machine selling powered by bearish quantitative analytics.

Technical factors appeared overall to outweigh fundamentals, which in our view remained pretty much intact and in fact became more attractive as valuation multiples declined. (See page 5 of this report for more detail on the effect of last week’s market action on forward price to earnings multiples).

A confluence of diverse and troublesome factors took markets lower last week. Among the factors we sighted that served to drag the market and raise concerns among investors, traders and observers were:

• Valuations (particularly among the so-called FAANG stocks);
• Technical factors affecting the equity and bond markets (including concerns that the S&P 500 would trade under its 200 day moving average);
• The potential damage to the economy and corporate earnings should the trade war between the US and China become protracted;
• Q3 earnings season worries tied to company guidance and lowered analyst community consensus expectations for this reporting period;
• Market fears about Fed monetary policy;
• President Trump’s criticism of Fed policy and market concerns that he might try to fire the Fed Chair whom he ironically praised and appointed to the position just months ago;
• Implications of election outcomes that favored populist candidates in Italy and Brazil as well as issues facing the UK tied to populism and the “Brexit” process;
• Investor trepidation about the age of the economic recovery and the bull market;
• A tendency among some investors and observers to take things out of context when evaluating occurrences affecting the market and in the process paint a much darker picture than the one that exists;
• The nature and tenor of last week’s market declines and investor fears about how long the descent in asset prices might run rattled market participants and shook positive sentiment.

By Friday it appeared that the market downturn had run its course and a rally ensued. Should Friday’s upward swing persist over the course of the next few days (give or take some testing) it could restore investors’ confidence and result in what has come to be known as yet another “buy the dip” opportunity in a long series of the same since the markets began their recovery in March of 2009.

From our perch on the Market Radar Screen, Friday’s move to the upside revealed the persistent resilience of the market, the power of positive earnings surprises and evidence that bullish conviction prevails to large extent supported by economic and corporate fundamentals even as a myriad of challenges remain on the landscape.

Downside action this week looked to us less like the 2011 selloff cited by a number of observers over the course of last week and instead more like the equity market downdraft we saw in August 2015 and again in January 2016 when the markets stateside and worldwide reacted to two successive devaluations by China of its currency.

This year’s decline of the yuan (around 6%) likely played a part in creating the sensitivity that the markets felt before becoming overwhelmed by the confluence of aforementioned factors that fed last week’s volatility and move to the downside.

Curiously enough taken in context the market’s rally on Friday may in no small part signal that the yuan’s most recent decline is less to worry about than when considered at first glance. In fact we’d argue that it’s been similar to the yuan’s declines in 2015 and 2016, each of which proved less troublesome to the US economy and markets than what was initially expected.

For now we continue to believe that if investors know what they own in their portfolios, know why they own it and have an idea how what they own might be expected to perform under different economic and market conditions, they will be better positioned to navigate periods of volatility like last week’s.

As a result, they should be in good shape to judge the risk and opportunities that emerge on the investment landscape as they look for “the babies that got thrown out with the bath water.” Carpe Diem.

For the complete report, please contact your Oppenheimer Financial Advisor.

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