Switzer on Saturday

Feels like a correction and not a crash!

Founder and Publisher of the Switzer Report
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Well, the good news is that Wall Street has tried to put the last couple of days behind it and came out of the gates like a neddy in the Everest today, or maybe like a Sydney racing official being chased by irate Opera House fans, who don’t like horse ads on their beloved sails!

With daylight saving here and America going returning to ‘normal’ time (it’s an 8am close at the NYSE), I’m flying blind with this Report on where the indexes finished.

The Dow was 414 points higher but with two and a quarter hours to go, anything could happen. The Dow is now up only 94 points and, as Kath (from Kath and Kim fame) would say: “I feel it in me waters…” that the ‘weight-enhanced opera singer’ (to be politically correct) hasn’t come on stage yet at the New York Stock Exchange, or at the Nasdaq at Times Square.

And I’m not alone.

“I don’t see evidence of what you’d like to see in a bottom,” said Willie Delwiche, investment strategist at Baird on CNBC.

There’s a lot of stuff going on but the biggest two issues driving the stock slump were the prices of US tech stocks and the fact that interest rates in the States are on the rise. It’s hard to see the kinds of people and institutions that influence the direction of stock prices simply saying: “Well that’s enough for now, so let’s get back to buying.”

On Thursday’s close, the US tech sector was down a big 6.8% but it has been tearing higher and higher for years. At this stage, the falls in the major indexes have been around 5%, so that’s a pullback. But I reckon a 10% correction is likely before positivity makes a comeback. I hope I’m wrong but history doesn’t help me think the worst is over.

Reporting season, which started in earnest overnight, will be important to where stocks head, with J.P. Morgan Chase, Wells Fargo and Citigroup coming in with pretty good results. It was a good start, considering the experts expect a 19% rise in overall US company earnings across the show-and-tell season.

I’ve been alluding to an overdue pullback for the Yanks for some time. The reasons for it are totally understandable but it always feels like we’re in another “here we go again” GFC-style market slump, until we resume the upward march of stocks again.

It was nice for our market to end on a positive note but it doesn’t erase the 4.7% that was wiped off over the week.

We closed at 5895 on the S&P/ASX 200 index, which means we have a much harder task even getting to 6600 this year, which plenty of my technical experts said was on the cards only a month or so ago.

I made the point in Switzer Daily that Donald Trump’s fingerprints are all over this sell off, for good and bad reasons.

US interest rates are rising because of Trump’s tax cuts, his bigger budget deficit and reduced regulation.

This US growth has pumped up world growth and the demand for raw materials is pushing up commodity prices and, in turn, inflation. And his tariffs are also adding to inflation, which puts more pressure on for higher US interest rates.

Meanwhile, the Trump’s trade war is adding to costs, which could hit profits in the upcoming reporting season. So those traders and fund managers in the money are taking precautionary profits.

And then there’s the fact that in July it was reported that 100% of the gain for the S&P 500 year-to-date was due to the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google – plus Microsoft). When they sell off, they slug the big market indexes.

I was fascinated to learn that Netflix was down 21% since its highs on Wednesday but was still up 71% for the year! All this screamed a correction was coming and the continued great growth of the USA, which has taken unemployment to 3.9% (the best rate since 1969), explains why fears of more and faster rate rises are spooking stocks.

So now it’s a waiting game to see how much the key drivers on Wall Street think is needed for stock price reductions, before they start buying again. Both Charlie Aitken and I have been suggesting that growth stocks were due to lose out to neglected value stocks and that argument is getting a lot more supporters.

AMP Capital’s Shane Oliver has summed up the many threats to stock market optimists’ sleep: “Given the ongoing worries around the Fed, inflation and bond yields, threats to tech stocks, the intensifying US/China conflict, rising oil prices, problems in the emerging world, the upcoming US mid-term elections, risks around President Trump and the Mueller inquiry and tensions in the Eurozone regarding the Italian budget, further weakness is likely,” he observed. “And given the usual global contagion, most major share markets, including the Australian share market, will be affected.”

That said, he’s not seeing a plethora of bears heading this way. “However, we doubt it’s the start of a major bear market because history tells us that they invariably require a US recession, and with US monetary conditions still far from tight, fiscal stimulus still impacting and no signs of the excess (in terms of overinvestment, debt growth, etc) that normally precedes a recession, a US recession still looks a long way off and this in turn suggests that the trend in earnings and hence share markets is likely to remain up beyond the near-term pull back.”

Gotta hope Shane is on the money with his history lesson!

Certainly, private equity is not seeing a recession and bear market happening, with Navitas up 21.9% to $5.29, after a bid from BGH Capital, while  MYOB spiked 18.1% to $3.52, following a KKR $2.2 billion takeover offer.

In a week of shocks, this from Fairfax Media would have knocked the socks off a few investors: “On the downside, Nine Entertainment shares lost 18.9 per cent to $1.84, Fairfax, the publisher of The Australian Financial Review, dropped 19.3 per cent to 67¢ and Domain fell 19.7 per cent to $2.77 after the merger partners released trading numbers.”

Who saw that coming? But it makes you treat old media with a fair bit of suspicion, doesn’t it?

What I liked

  • The RBA’s Financial Stability Review, which virtually told everyone to stop stressing about house prices, household debt, the safety of the banks and the financial system and even those worrying us about borrowers coming off interest only loans. As experts on the monetary system, they told the ‘bush economists’ out there making bold predictions based on little data to shut up!
  • The Westpac/Melbourne Institute survey of consumer sentiment index rose by 1% to a reading of 101.5 in October. The sentiment index is in line with its long-term average of 101.5. A reading above 100 denotes optimism.
  • The NAB Business Confidence Index rose to +6.2 points in September, from an upwardly revised 25-month low of +5.2 points (previously +4.4 points) in August. The long-term average is +6 points.
  • The NAB Business Conditions Index rose to a three-month high of +14.8 points in September, from a downwardly revised +14 points (previously +15.2 points) in August. The long-term average is +5.8 points.
  •  The employment component of the NAB Business Conditions Index rose from +9.5 points in August to +11.9 points in September – the third highest level in 12½ years. And the 12-month moving average of +10 points is a record high. The long-term average is +1.9 points.
  • In the June quarter, a record $74.3 billion of residential and commercial building work was yet to be done (completed).
  • The IBD/TIPP economic optimism gauge in the US rose from 55.7 to 57.8 in October (forecast 54.6).
  • The International Monetary Fund expects the global economy to grow by 3.7% in 2018 and 2019, down from earlier forecasts of 3.9% for both years. Australia is tipped to grow by 3.2% and 2.8% respectively. The number has been Trump-affected but it’s still a good growth number.
  • China’s international trade surplus rose by US$3.8 billion to US$31.69 billion (forecast: US$19.40 billion) in September. Over the year to September, exports rose by 14.5% (forecast: +8.9% and imports increased by 14.3% (forecast: +15%). China’s imports from Australia rose by 2.9% to US$8.8 billion.
  • European banks rose on an easing of concerns about the Italian budget situation.

What I didn’t like

  • The overreaction to rising bond yields. These higher rates are a response to a better US economy. Remember a few months ago, when the fear was that a recession was looming because long-term bond yields were not rising? Be fearful of short-term market overreactions, like what we saw this week! It’s my job to spot them.
  • Despite authorities wanting to slow down the housing sector, I can’t be happy about the number of loans (commitments) by home owners (owner-occupiers) falling by 2.1% in August. Loans are down by 10.2% on the year – the biggest fall in 7½ years.
  • The number of dwelling starts fell by 5.9% in the June quarter, after an upwardly-revised 11.8% lift in the March quarter. Currently, 230,573 homes are being built, which still looks pretty good.
  • Concerns about US-China trade relations re-intensified after a “fundamental disagreement” between US Secretary of State Mike Pompeo and his Chinese counterpart in Beijing.

An interesting indicator

For years, I’ve shared with you what I liked and didn’t like over a week of economic and market data. I now believe that when the “don’t likes” outnumber the “likes”, it will be a useful indicator of when we should get worried about being long stocks. Even with the big sell off this week, today’s count, is, wait for it, 10 likes versus 4 dislikes! That makes me feel OK, despite the fear and loathing this week!

The Week in Review:  

Top Stocks – how they fared: 

What moved the market?

  • Rising interest rates and bond yields saw US share markets drop, with falls spreading to the local market as well as Asia and Europe.
  • The trade war between the United States and China continues to affect both countries, with Chinese markets particularly impacted by the 10% duty on US$200 billion goods introduced last month and the looming 25% tariffs expected in January.

Calls of the week:

  • Charlie Aitken said that the chances of a genuine growth stock correction are increasing by the day.
  • Scott Morrison is planning to cut the tax rate for small and medium businesses from 27.5% to 25% in 2021/22, five years earlier than expected.
  • The Australian Cricket team restored (a little of) the country’s faith by hanging on to a draw in the first Test against Pakistan in Dubai.

The Week Ahead:

Australia

Tuesday October 16 — Leading finance (August)
Tuesday October 16 — Reserve Bank Board minutes
Wednesday October 17 — Overseas arrivals and departures (August)
Wednesday October 17 — Speech by Reserve Bank official
Thursday October 18 — Employment/unemployment (September)

Overseas

Monday October 15 — US Retail sales (September)
Monday October 15 — US Empire State Manufacturing (October)
Tuesday October 16 — China inflation (September)
Tuesday October 16 — US Industrial production (September)
Tuesday October 16 — US JOLTS job openings (August)
Tuesday October 16 — US NAHB housing market (October)
Wednesday October 17 — US housing starts (September)
Wednesday October 17 — US Federal Reserve Minutes (September)
Thursday October 18 — US Philadelphia Federal Reserve (October)
Thursday October 18 — US Leading index (September)
Friday October 19 — US Existing home sales (September)
Friday October 19 — China activity data (September)
Friday October 19 — China Economic growth (September quarter)

Food for thought:

What has a bank with no money, and a bed but doesn’t sleep?

Send in your answer to subscriber@switzer.com.au

Stocks shorted:

ASIC releases data daily on the major short positions in the market. These are the stocks with the highest proportion of their ordinary shares that have been sold short, which could suggest investors are expecting the price to come down. The table shows how this has changed compared to the week before.

Chart of the week:

As AMP Capital’s Shane Oliver highlighted using the chart below, period corrections in the share market are not unusual:

Source: Bloomberg, AMP Capital

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