Major stocks such as GE (the third largest manufcaturing firm in the US) are not playing the game and have broken down, usually the sign of an impending recession.
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Equities opened flat, traded lower to take out last week’s North Korea induced market lows, but has since rebounded slightly. Stocks are on track for their second consecutive weekly loss in a row since May amid a confluence of factors including: weak quarterly retail earnings, record-setting markets due for a pullback, potential futures rate hikes by the Fed after a bout of strong economic indicators, as well as heightened questions about President Donald Trump's ability to pass a raft of pro-growth policies amid the corporate backlash of his reaction to a white-supremacist rally. Throw in the North Korea geopolitical fears and the recent terror attacks in Spain yesterday – amid low volumes for summer trading and you get weak stocks and a rebound in defensive bonds (10-yr drops under 2.17%) and gold (trades above $1,300 an ounce for first time this year). Small Caps continue to underperform as the Russell 2000 falls further below its 200 day MA support (traded below its 200-day moving average for the first time since June 29, 2016 yesterday of 1,375). Transports also extend losses as index drops below its 200 day support for first time over the last year.
Treasuries, Currencies and Commodities
Sector Movers Today
· Transports extend yesterday decline of more than 2% drop, falling below 9,100 briefly – the index closed below 200 day MA yesterday (first time since July 2016); airlines dropped yesterday on broader market weakness and terror fears after incident in Spain; Wolfe this morning upgraded DAL and LUV to outperform; MATX top decliner in Transport index after Stephens downgraded rating with $23 tgt following news competitor TOTE is planning to establish a West Coast to Hawaii container service
· Construction and Infrastructure; Citigroup upgraded shares of MTZ and PWR to buy as think visibility in PWR’s core electric power market and continued momentum in oil & gas pipelines is underappreciated; for MTZ, said recent pullback creating a good entry point for an E&C with above average EPS growth potential vs. now lower expectations
· Casino, Lodging & Leisure; boating stocks fall a second day; BC was downgraded to neutral at Wedbush after July SSI data (yesterday) was significantly worse than expected and puts the burden of proof on management to convince investors that the boat cycle is not beginning to peter (shares of MBUU and MCFT were also active)
· Retailers; apparel retailers get good results from: GPS Q2 was ahead of expectations on a higher comp and significantly higher gross margin increase, as in 1Q/comps rose 1% vs. est., marking the third consecutive quarter of positive comps, with Old Navy at a stronger than expected 5% and Gap a stronger than expected -1%; ROST rises on 2Q beat, driven by a 4% comp that was driven by traffic and accelerating merchandise margin gain/raised guidance
· AEM +1%; among the top performing gold miners as gold trades above $1,300 an ounce
· AMAT +3%; beat street estimates for F3Q and guided F4Q to above street estimates
· ATGE +13%; after earnings results
· CPN +10%; to be acquired for $15.25 per share in cash by Energy Capital and investor group led by Access Industries and CPPIB in deal valued at $5.6B https://goo.gl/BSD7ZF
· EL +7%; Q4 EPS and sales top consensus/guidance of $3.87-$3.94 for the year tops $3.77 estimate
· ROST +10%; 2Q beat, driven by a 4% comp on traffic and accelerating margin/raised guidance
· SPWH +19%; posted Q2 EPS and sales beat, though Q3/year sales miss views
· DE -7%; Q2 EPS beat but sales of $6.83B missed estimates while said industry sales for agricultural equipment in the U.S. and Canada will be down about 5% this year
· FL -24%; Q2 EPS missed the lowest estimate (62 vs. est. 90c) and posts negative Q2 comp of (-6%)
· HIBB -15%; slashed its year EPS forecast to $1.25-$1.35 from $2.35-$2.55 after Q2 sales miss
· INFY -8%; CEO Vishal Sikka resigns immediately; Pravin Rao, current COO now interim CEO
· MATX -24%; top decliner in Transport index after Stephens downgraded rating with $23 tgt
· NKE -4%; falls in sympathy with FL weakness/drops below its 200 day moving average
Once upon a time, people purchased books about the stock market. (Now, they read Internet articles instead, about which I will not complain.) Among the most popular of those titles was Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market.
Dow 36,000 differed from other best-sellers in that its authors lacked star power. James Glassman was a former Washington Post columnist who appeared on Sunday morning political talk shows, and Kevin Hassett had worked briefly for a think tank. What the book had, instead, was impeccable timing. Its publication date was October 1999, the height of the New Era.
The first rule of investment advice is that if you wish to help people, tell them what they should do. If you wish to help yourself, tell them what they think they should do. The first approach gathers polite applause, and is forgotten by 90% of the audience 10 minutes after they file out of the auditorium. The second inspires. It sways, impresses, influences. No counsel appears sounder than that which tells a man what he already thinks that he knows.
Whether the authors were cynical, or genuinely convinced by their thesis, is not for me to know. Suffice it to say that there has rarely been an occasion when so many stock investors believed that this time was different. Great bull markets inevitably call into question the possibility of future stock-market failures. The Great Bull Market of the 1990s, accompanied by the breathtaking development of the Internet, cast an even greater doubt. Had the New Era eliminated (or at least greatly reduced) economic recessions? Dow 36,000 was an idea whose time had come.
You know how that played out. Stock prices topped six months later, the NASDAQ Composite Index shed almost 80% of its peak value, and Glassman/Hassett became a parlor joke among economists and portfolio managers. Barry Ritholtz writes that the authors possessed “the audacity of cluelessness” (good phrase, that); a Berkeley economist celebrated a “month-long April Fool’s festival” in their honor; an Internet blogger placed Dow 36,000 on his list of the five worst investment books ever written.
However, as any business school professor will affirm, predictions should not be judged on their accuracy. If two dice are rolled and the outcome is 12, that doesn’t make a forecast that the number was unlikely to be 12 incorrect. Nor does it make a sucker out of the person who was willing to pay $25 on a $1 bet should such an event occur. Glassman and Hassett weren’t disproved because the Dow Jones Industrial Average did not behave as their book suggested.
(Also, the authors didn’t directly claim that the Dow would trade at 36,000. Rather, they argued that if investors were rational, they would bid stocks up to that level. That was where the market should have been. So, technically at least, they could excuse themselves on that account—although their frequent promises of upcoming profits would serve as counterevidence.)
A Kernel of Truth
Such has been the history. Looking back 18 years later, with the benefit of perspective, were Glassman and Hassett onto something, as many (even among the reputable; the book was blurbed by, among others, the president of Kiplinger’s and a Carnegie Mellon professor) believed at the time? Or was the volume entirely, thoroughly hogwash, as later became the consensus?
The short answer: Dow 36,000 is sound at the core. Had the authors contented themselves with that, they would have published something quite different than what emerged. Such a book would have been considerably shorter, theoretical in nature, and lacking pizzazz. The existing publication carries calculations that give the impression that the authors solved a long-standing puzzle—as if, for example, they had determined the stock-market version of the Black-Scholes model.
What the authors were onto was questioning the assumption that stocks were far riskier than government bonds—so much so that they must carry a “risk premium” of seven percentage points. That is, the consensus belief was that stocks should be priced so that they return seven percentage points (roughly) more per year than bonds, to compensate for their additional perils. Glassman and Hackett argued that the premium was too high.
That is a valid claim. Indeed, I believe it to be accurate. As Bill Bernstein discusses in Rational Expectations: Asset Allocation for Investing Adults, stocks aren’t that much more dangerous than government bonds. Yes, stock prices are more volatile than bonds in the short term, and companies go bankrupt and (despite New Era beliefs) companies enter recessions. But over the long haul, across the global markets, stocks have actually been the safer bet. They aren’t wiped out when countries lose wars, or when their currencies implode. Of the two assets, stocks and bonds, the latter is the likelier to go to zero.
Less Would Have Been More
All well and good. Glassman and Hackett identified an important subject, years before Bernstein addressed it. But then they overstepped. Rather than presenting the evidence for a lower equity risk premium, discussing the relevant factors, and coming up with estimates for what the proper level might be, they quickly decided that the correct risk premium was … zero. No half measures for them!
Whether the authors derived correctly from that spot is rather beside the point. (They say yes; some distinguished critics say no.) If the equity-risk premium had moved anywhere near zero, the Dow Jones Industrial Average would have surpassed 36,000 long ago, and nobody would be quarreling over the details. But it has not. And nobody, including Glassman and Hackett themselves, has demonstrated why that event should occur.
Whether Glassman and Hackett made the right call, I leave for you to decide.
John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.
It’s time to prepare portfolios for the remainder of the year. Richard shares investing ideas to consider.
It’s hard to believe that we’re already a few weeks into the second half of 2017. The midway point is traditionally a good time to take a step back and prepare portfolios for the remainder of the year.
We see investing in the third and fourth quarters occurring against a backdrop of sustained and synchronized economic expansion, structurally lower growth and interest rates, and ongoing low volatility. What does this mean for portfolios? We share a few of our investing preferences below, all featured in our Global Investment Outlook Midyear 2017.
Stocks over bonds
The latest earnings season has affirmed our positive view on equity fundamentals, and we see solid equity returns ahead in the second half. At the same time, global economic expansion and monetary policy normalization point to a gradual rise in bond yields over the next five years. Long-term rates are being held down by structural factors including plentiful global savings, providing a favorable backdrop for equities. The earnings yield (earnings per share divided by the share price, or the inverse of the price-to-earnings ratio) still looks attractive versus real (after inflation) bond yields, meaning stocks may be cheaper than they look in a low-rate world.
There are risks to our view. The share of income going to labor (wages) is historically low, and corporate margins are elevated. Any policies that reverse this trend—or labor shortages causing wages to spike—could erode margins and equity valuations. In the final analysis, however, we believe investors are being paid to take equity risk against the backdrop of low rates.
Non-U.S. equities over U.S. peers
We like the U.S. market, but we think higher returns can be found in emerging markets (EM), Japan and Europe, as we note in our new podcast. We see opportunities in EM equities, assuming no sharp changes in currency, trade or other policies. Economic reforms, improving corporate fundamentals and reasonable valuations provide support. Elsewhere, we see a number of positives supporting the Japanese market, including more shareholder-friendly corporate behavior, ongoing ultra-easy monetary policy, low valuations and solid earnings. That said, a stronger yen is a risk.
European equities have done well this year, but they are still trading at a valuation discount to U.S. peers. We believe there’s further scope for this valuation gap to close, given the European economy’s strong fundamentals and a decline in populism. But a stronger euro could slow the pace of earnings growth among European companies, and other risks include politicians not delivering on reforms, the European Central Bank (ECB) winding back its stimulus too soon and renewed political instability in Italy.
Risk-seeking equity style factors over defensive ones
Today’s economic regime favors risk-seeking style factors over defensive ones, we believe. The momentum factor—securities with strong recent price gains—has outperformed in economic expansions, our Factor-based Strategies Group’s analysis of U.S. factor performance since 1990 suggests. It has historically outrun the broader market, but with periodic sharp drops. The biggest dips have coincided with recessions and financial crises.
Today’s low-volatility environment coupled with a sustained economic expansion bode well for momentum, we believe, and we like the momentum factor, even if its performance could be prone to short-lived reversals. A sharp drop in tech stocks in mid-June illustrated the risks of momentum breaks. Momentum drawdowns typically last two months or less, our analysis shows. And they are typically buying opportunities, provided there are no economic or financial shocks to today’s low volatility regime. We advocate tilting style factors throughout the economic cycle, but believe exposure to multiple factors may help provide diversification overall.
Credit over government bonds
We prefer credit to sovereigns, as we believe investors are still being paid to take risk/carry. However, we see more reason to be selective within credit markets than we did at the beginning of the year. Future credit market returns are likely to be more muted than in the recent past, and tight spreads leave little room for error. We prefer U.S. investment grade bonds against this backdrop of reduced compensation for credit risk. We are neutral on U.S. high yield and prefer up-in-quality names. We are underweight European credit, as ECB purchases and negative rates have helped lead to steep valuations. We like selected EM debt, an asset class global growth favors, even if the Federal Reserve is raising rates.
Looking for more investing ideas? Find more in our asset class views table below as well as in our full Global Investment Outlook.
Investing involves risks, including possible loss of principal. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
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