Market Strategy Radar Screen Weekly October 29, 2018

Gimme Shelter

With stock markets worldwide seeing downdrafts, the Glimmer Twins’ title would appear to apply

With just three trading days left in the month, October 2018 has given investors a “month to remember” (for at least for as long as institutional memory can persevere).

October has provided plenty of drama this year. However, In future hindsight, in our view it could prove to be the best buying opportunity investors have had in some time.

Valuations haven’t been this good in years (see page 4 of this report for details). Consider that the S&P 500 as of last week sported a forward P/E multiple of just over 15X earnings.

With some 240 of the S&P 500’s member companies having thus far reported, Q3 earnings results appear resplendent with earnings growth up over 23% on the back of revenue growth near 9%. It’s the forward guidance—when some company managements look at what might lie ahead tied to the trade/tariff skirmish with China—that has produced concerns among the analytical community. A key problem is that projections of the outcome to a trade war tend toward the darker side of things.

Businesses in the US and China are not shy about expressing their concerns about the risks to revenues and earnings should the trade war become protracted. Notwithstanding the considerable amount of rhetoric produced by both sides, the voices of powerful constituencies comprised of business owners, managers, labor and consumers of both countries are likely to be felt by the two countries’ respective leaders whether their power is derived by mandate “for life” or provided by national election.

Negative projections by bearish market participants and a market tantrum to rival the most spoilt child’s outcry shouldn’t deter investors from staying the course and riding out what has been thus far (and may continue for at least a few more days—or weeks) a perfect storm based not so much on fundamentals but on market “technicals,” impatient leveraged players’ distress and what seems to be market bears’ determination to get even with a bull market that has shown significant resilience and recovery capabilities for longer than most ever expected.

We believe that cooler heads are likely to prevail as they have in the recent past (i.e. in 2016, 2015, 2014, 2013, 2012, 2011, 2010 and 2009) whenever the market got cranky about nearterm news and too negatively projected the future.

Fasten Those Seatbelts…

We’re hearing other commentators begin to suggest what we have long recommended—build shopping lists, stay diversified, look for babies that have gotten thrown out with the bathwater and remember that around 99.9% of the time when the pilot on a commercial flight reminds passengers to keep their seat belts fastened because there’s turbulence ahead—it doesn’t mean the plane is about to crash.

Any downside move that is dramatically (even breathlessly) commented on by market observers tends to feed the flames of a pullback and cause those prone to panic attacks to extrapolate negatively into the future. “Consider the source” is advice that we have come to practice at times like these.

Multinationals are showing some strain and forward concerns about the effects of a strong dollar and the impact of tariff regimens that are already increasing their costs and weighing on stock prices. In most cases reported so far as we can see the effects of the trade dispute appear manageable if not without causing inconvenience and cost to companies affected.

We’d also consider that while US multinationals are feeling discomfort as the trade/tariff dispute ramps up, their foreign counterparts (particularly in China) are likely experiencing or about to experience even greater pain should the tariff fracas become protracted.

Consider that for many US companies the disruption and cost will come from efforts to find new sources to replace Chinese supply and production lines. The problem for China is likely to be two-fold as there are countries likely all too eager to take China’s place in the global supply chain in developing, emerging and frontier markets. China for all its potential— realized and future—is simply “not the only crayon in the box.”

For China’s multinational corporations the challenge coming from a trade war with the US appears to be substantially greater as they will need to replace what has become their best customer base in the world (the US consumer) with China’s domestic consumers, who have on average much lower disposable and per capita incomes compared to their US counterparts. Other alternative consumers for China’s products elsewhere in the world may already be customers and are not likely to be a source for additional demand for China’s products.

Why can’t we be friends…?

The impractical nature of a trade war has raised the hackles in the barnyard. No longer “a standoff at the OK Corral” but now an engagement of hostilities with global economic consequence, the cost of one party losing face has got to be taken into consideration to arrive at a suitable resolution of the tariff conflict.

Until then the markets could stay prone to acting out their fears on a day to day basis or at least until a cathartic moment occurs when capitulation becomes evident and sellers are exhausted.

The good news is we might be close to that moment of market capitulation (if it hasn’t come already) as the fundamentals both economic and corporate indicate to us that the distress the markets have been reflecting is more about some point in the future that may not come to pass and less about the fundamentals.

About Those Earnings…

We’d say the distress the market has shown through much of the worst selling has run counter to what is revealed by economic and corporate data points.

Consider Q3 earnings season which thus far is proving to be in actuality not a disappointment but rather another quarter of results beating consensus analyst expectations.

The third-quarter earnings season for the S&P 500 doesn’t look to us as much as a “swan song” for revenue and earnings growth, but rather as a resilient if not resplendent earnings season disregarded by negative extrapolation around the potential of a protracted (lengthy) trade war with China, compounded by overblown fears about the potential for the US Federal Reserve policy mistake.

Ironically, so far the Fed has shown over the past nearly ten years a sensitivity both for strengths as well as vulnerabilities within the US economy that has contributed not only an economic recovery from the depths of the worst financial crisis since the 1930s, but an economic expansion that has delivered sustainable growth and appears to have the potential to improve from here.

The Trade War Isn’t Bloody

Though there’s been some discussion on corporate earnings calls this season showing concerns about the effects of a strong dollar on US multinationals’ global competiveness as well as about trade war costs (and whether they are passed on to consumers or absorbed) the trade war has yet to become a protracted mechanism resulting in systemic damage.

While October 2018 has thus far provided plenty of drama and angst for investors, what has come to pass may well in hindsight prove to have been the best buying opportunity for investors’ consideration in some time.

Isn’t it a Pity?

We can’t help but think that it’s a pity that when stocks go “on sale” as they have in recent weeks that too many investors haven’t been able to make it to the “store” and jam the doors trying to get in to buy quality items that appear to us to have been drastically reduced in price.

We’re reminded that it’s the classic reaction of so many market participants to opt for a “deer in the headlamps” or a “run for the hills” mode when stocks are falling.

Our investment mantra in these weeks besieged by market sentiment full of “trial and trepidation” continues to be “know what you own, why you own it (relative to your goals and objectives) and have reasonable expectations as to how it will perform in varied investment scenarios.”

At times like this we say it’s important for investors to right size their expectations for the near term, build shopping lists of sensible stocks that they may have found too pricey to spring for just a few weeks ago and seek out “babies that get thrown out with the bath water” while others are busy overreacting to the drama du jour. Carpe diem.

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