Switzer on Saturday

What me worried? This looks like a correction not a crash!

Founder and Publisher of the Switzer Report
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I’d like to confidently do an Alfred E. Neuman of MAD magazine and look at this market correction and say: “What, me worried?” However, if I did, I’d be lying!

That said, on balance, I’m seeing this as a correction, not a crash and I will be a buyer some time next week, or maybe after the mid-term elections.

The key issues for investors at the start of the week were Chinese economic stimulus, UK Brexit talks and the Italian budget situation. By week’s end, however, it was all about the correction and good old October has done it again, But the bigger question for us gets down to whether this is a correction or a crash.

People with memories know I warned about six weeks ago that a sell off in US stock markets was overdue. I pointed out that Ray Dalio of Bridgewater Associates had reduced his exposure to stocks, especially emerging economies stuff. His pull out looked early but his sound judgment now looks spot on. That’s why he’s seen as a legend.

Our market overreaction looks like a great buying opportunity if this is a correction, which I think it is, though I don’t think the sell down is over yet. The Dow was down over 500 points earlier overnight, then, at 11am, everything turned around. That said, if Wall Street doesn’t rally into the close, our market will start like a wimp on Monday (as we generally do) waiting for a lead from the New York Stock Exchange.

Looking back to Monday, US markets saw technology stocks out-performing, as investors looked forward to a big batch of earnings results over the week. And players were encouraged by a 4.1% lift in China’s Shanghai Composite share index, on the prospect that tax cuts will serve to lift economic growth.

But Tuesday brought a different story, with the Dow Jones falling by 608 points (or 2.4%). The S&P500 index fell 3.1% and the Nasdaq index lost 329 points (or 4.4%).

By Thursday, Reuters noted that “the S&P’s valuation fell to a two-and-a-half year low of 15.3 times profit estimates for the next 12 months from 15.8, according to Refinitiv data.” Meanwhile, bellwether company Caterpillar saw its shares fall 7.67%, after the company didn’t change its earnings forecast, after lifting it the past two quarters. This is a company that reflects world growth.

But it hasn’t been all bad news out of the US and the following partly explains why I see this as an overdue correction, not a crash. Check the following out from the The Earnings Scout, as reported on CNBC:

  • As of Thursday’s Wall Street close, the S&P 500 earnings were up 24.8% so far, against a prediction of 19%.
  • 82% of the companies that had reported had beaten estimates.
  • Earnings growth forecasts of 8.44% in the first quarter of 2019 were upgraded from 8.39%.
  • Next year’s second quarter earnings growth was also increased to 6.48% from 6.36%; and
  • First and second quarters of 2019 earnings per share growth estimates went higher.

You can see that the 19% to 24% boost in earnings always had to eventually tail off but apparently they’re tailing off slower than was expected a week ago. On the other hand, the smaller growth in profit explains why doubts about the valuations of US stock markets might be questioned right now.

Back to overnight action and the S&P 500 moved into correction territory, with the index down more than 10%. However, it then gave up the losses before again giving up ground. An interesting piece of stock market history is that the average correction for the S&P 500 is 13%, so my view that this isn’t over yet is at least backed up by records.

Not helping this negativity has been the generally poor performance of tech companies over reporting season. Not long ago I told you that 85% of the S&P 500’s gain for the year to date was down to the FAANG stocks plus Microsoft. Interestingly, Microsoft and Apple have not been trashed (stock price wise) like Facebook, Amazon, Netflix and Google (Alphabet), which undoubtedly shows that the valuations of the FANGs were excessive.

Another reason why I think this is a correction rather than a crash was a good bit of news overnight that couldn’t settle down market fears. That was an upgrade in US economic growth from a 3.4% estimate to a 3.5% result.

In addition, the rise in inflation was less than expected, which builds a case for those predicting the Fed is set to raise interest rates faster than was expected, when US stocks were defying gravity a few weeks ago.

Also, US consumer spending really spiked in the third quarter – up 4%. That’s the best rate since the last quarter of 2014! This is good for growth potential but does suggest rate rises might be needed to cool down the ‘hot’ consumer. However, if rates rise because the US economy is better than expected, it should be good for stocks. When the rate rises actually start slowing down the economy and money in stocks starts chasing interest-bearing assets, that’s when a crash could come.

Back home and Friday’s failed relief rally set me up for the expectation that Wall Street was set to disappoint overnight. However, after years of watching sell offs, you’re better off expecting the worst and being pleasantly surprised if you’re wrong.

We actually did creep into positive territory, after being down 1.3% at the worst on Friday, with the S&P/ASX 200 index finishing up 1 point to 5665.2. After five days in the red and the big fall on Thursday, that ripped 2.8% off the index and took 4.7% off index players for the week!

However, it means that since August 30, we’ve gone into correction territory. And the latest week of instability was driven by external factors: Trump and trade wars, US interest rates, EU versus Italy, Brexit, China slowdown fears and a Saudi killing of a journalist, potentially having oil price effects.

Previously, we have created some reasons for a sell off too. Like what? Try the Royal Commission and the bank bashing, losing a PM, the Government becoming a minority government and rising bank interest rates. And what about the relentless scaring of owners of property?

Earlier this week we saw a huge 6% fall in consumer confidence and this is how Craig James from CommSec summed it up: “Sentiment dipped by the most in six years last week after the Morrison government likely lost its one seat majority in the House of Representatives, following the Wentworth by-election on Saturday. Consumers (and businesses) don’t like political uncertainty, as also evidenced by the outsized plunge (down 3.5% over the week ended August 19) in sentiment due to the Liberal Party leadership spill two months ago.”

And adding fuel to the fire that burned a lot of our stocks this week was the excessive belief in our tech stocks, which were (like their US counterparts) vastly overbought.

I’d like to think that the turnaround happens next week but we might have to wait for after the Melbourne Cup, when we see how the US mid-term elections do. How President Trump’s Republicans do could have a positive or negative impact on stocks across two months that historically are great for equity markets.

Personally, I don’t know what would be the best outcome but if the Republicans do better than expected and the President seals a trade deal with China, then we’d be off to the races. But the pay off would be much bigger than anyone would expect out of Cup day!

On the other hand, if the Republicans get clobbered and Mr Trump becomes a lame duck President, he still can control trade deals and he might overplay his only significant hand, which could really worry Wall Street. If it plays out this way, then Donald might steal my Santa Claus rally hope!

Could Donald mug Santa? If anyone could, he could!

What I liked

  • In the 12 months to September 2018, the Budget deficit stood at $3,379 million (less than 0.2% of GDP) and down from the $6,890 million deficit in the year to August. The rolling annual deficit is the lowest in 9½ years. Over the same 12-month period to September, the fiscal balance was in surplus by $1.24 billion.
  • Real GDP per capita rose by 1.2% to a record high of $73,267 in 2017/18 (decade average growth of 0.9% a year). Household wealth rose 3.6% in 2017/18 to a record high of $10.37 trillion. Financial assets rose 6.3%, with liabilities up by 4.6%.
  • The CBA/Markit ‘flash’ manufacturing purchasing managers’ index rose from 54 to 54.3 in October. However, the CBA/Markit ‘flash’ services gauge fell from 52.2 to 50.8 in October – the lowest level since the series began in May 2016. But a reading over 50 indicates expansion.
  • Consumers’ inflation expectations over the next two years rose from 4.5% to 4.8% last week, the highest reading since the week ended 29 November 2015. Why do I like this? The RBA wants inflation to show the economy is recovering.
  • Durable goods orders in the US rose by 0.8% in September (forecast -1.0%).
  • The good 3.5% US economic growth number.
  • “Consumer spending, which accounts for more than two-thirds of economic activity, surged by 4% in the third quarter, the fastest pace since the fourth quarter of 2014.” (CNBC)
  • The US Markit ‘flash’ manufacturing purchasing managers’ index rose by 0.3 points to 55.9 points (survey: 55.5 points) in October. The services gauge rose by 1.2 points to 54.7 points (survey: 54 points) in October.

What I didn’t like

  • The Internet Vacancy Index fell by 0.6% in September. The index is 1.6% higher than a year ago – the slowest annual growth rate in 18 months.
  • The ANZ-Roy Morgan consumer confidence rating fell by 6% to 112.3 in the past week – the largest fall since the week ended 20 May 2012. The index is below the average of 114.2, held since 2014 and below the longer-term average of 113 held since 1990.
  • Commonwealth Bank Business Sales Indicator (BSI), a measure of economy-wide spending, rose by 0.2% in trend terms in September – the weakest growth since May 2017. While spending growth slowed in September, it hasn’t declined in 20 months but annual trend growth in sales eased from 9.9% to 9.4% in September, although it remains above the decade-average pace of 3.4%.
  • Moody’s left Italy’s sovereign rating outlook at “stable” but investors were worried about Europe’s response to the Italian budget later in the week.
  • US new home sales fell 5.5% (survey: -1.4%) to 553,000 units in September and this sector is going off the boil.
  • The Saudi cover up and the negative implications it added to the stock sell off this week.

Would Winx have been your best bet?

With the great four-legged mare Winx set to try and win her fourth Cox Plate today at Moonee Valley, which would be her 29th win in a row, I stumbled across this intriguing ‘investment’ fact.

If a punter placed a $1 bet on Winx when she won the Sunshine Coast Guineas in May 2015 and then rolled it over in her 28 victories since, they would now have, wait for it, $44,184.57!

I know it’s impossible to pick out a neddy that can do what Winx and Black Caviar have done but it does say a lot about putting your money into quality assets rather than absolute billy goats. And the lesson applies to companies, property and all assets.

The Week in Review:

What moved the market?

  • Disappointing earnings growth by FANG stocks and US heavyweights Apple and Alphabet (Google’s parent company).
  • Ongoing trade and potential military friction between the US and China.
  • October’s general reputation as a rough month for shares.

Calls of the week:

The Week Ahead:

Australia
Monday October 29 — State of the States (Quarterly report by CommSec)
Tuesday October 30 — Building approvals (September)
Wednesday October 31 — Consumer Price Index (Sept quarter)
Wednesday October 31 — Private sector credit (September)
Thursday November 1 — Home value index (October)
Thursday November 1 — Purchasing manager indexes (October)
Thursday November 1 — International trade (September)
Thursday November 1 — Export and import prices (Sept quarter)
Friday November 2 — Retail trade (September)
Friday November 2 — Producer price indexes (Sept quarter)
Overseas
Monday October 29 — US Personal income/spending (September)
Tuesday October 30 — US Home prices (August)
Tuesday October 30 — US Consumer confidence (October)
Wednesday October 31 — US ADP employment (October)
Wednesday October 31 — China Purchasing manager indexes (October)
Thursday November 1 — US ISM manufacturing (October)
Thursday November 1 — US New vehicle sales (October)
Friday November 2 — US Non-farm payrolls (October)
Friday November 2 — US Trade (September)

Food for thought:

“You will be successful if the people who you hope to have love you, do love you.”

Warren Buffett

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:

AMP’s Shane Oliver said the September quarter profit results in the US have been good so far with 84% of results beating on earnings, 59% beating on revenue and earnings growth expectations moving up to 23% year on year.

Source: Bloomberg, AMP Capital

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 Recent Switzer Reports:

Monday 22 October: Keep calm

Thursday 25 October: Doctor’s orders

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.