WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

Key points inside this issue:

  • The Fed, Trump, tariffs and the data bring uncertainty back to the market
  • What it means for investors
  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.
  • What to watch this week

The Fed, Trump, tariffs and the data bring uncertainty back to the market

Between the number of S&P 500 companies reporting last week to the Fed’s FOMC meeting and the pieces of economic data coming at us, we knew it was going to be a busy and potentially volatile week. What few saw coming was the attempt by Fed Chairman Powell to give the market the 25 basis point rate cut it was expecting and regain the position of the market not knowing exactly what the Fed’s next move might be. But then we received the July ISM Manufacturing Index and the July IHS PMI data for the four global economic horsemen (China, Japan, the eurozone and the US). In aggregate those data points signaled the continued slowdown in the global manufacturing economy.  

Granted, the sequential pick up in the July ADP Employment Report fostered the view the domestic economy hasn’t frozen over just yet, but Friday’s July Employment Report reveled slower job creation month over month. 

Normally, economic data like we’ve received in the back half of last week would be enough to ignite the market doves and stoke the view that another rate cut by the Fed was more likely before we exit 2019. And it was that view that led the major market indices higher on Thursday, that was until President Trump did something that arguably next to no one saw coming – announced another layer of tariffs on China that would go into effect on September 1. The implications of that move, which would likely lead to yet another trimming of forecasts for both the economy and earnings, pulled the market lower on Thursday afternoon. 

And on Friday morning, China responded by saying while it does not want a trade war, its not afraid to fight one. Soon thereafter, President Trump is “open to delaying or halting the 10% tariff on September 1” if China were to take action between now and then. Remember, we shared our concern that trade talks could devolve into playground taunting and fighting. Well, we are there and sticking with the analogy, it’s likely going to keep the stock market on the uncertainty teeter totter for the next few weeks. 

If some were hoping for a more normal August for stocks following this week’s Fed meeting, we’re sorry to say that’s not likely to happen. In the past we’ve shared several analogies about investing – it’s not crock pot cooking, you can’t fix it and forget it or investing is not a like a photo, i.e. snapshot in time, but much like a good film it’s an evolving story. As this latest chapter begins to unfold, it will be mean assessing and re-assessing expectations as new developments are had and their ripple effects determined.

What it means for investors

Odds are this will uncertainty will result in the usual back and forth for the market in the coming weeks, which will also see the usual end of summer low trading volumes. While a good chunk of Wall Street is at the beach, I’ll remain vigilant and continue to leverage our thematic lens.

More than likely, we will see the herd once again focus on domestically focused as well as inelastic business models as it looks for ports of safety. We’ve have a number of these among the Thematic Leaders and the Tematica Select ListChipotle Mexican Grill (CMG), Dycom Industries (DY), Costco Wholesale (COST), Axon Enterprises (AAXN), AT&T (T), and USA Technologies (USAT). Unlike the shoot from the hip go to choice of the herd that tends to zero in on electric utilities that group of six have the added benefit of thematic tailwinds propelling their respective businesses.

As August drips by, I’ll continue to look for thematically well positioned companies that offer favorable risk to reward tradeoffs in terms of share prices as I look to position us for what lies ahead. In the meantime, I would recommend subscribers catch the August 5, 2019 issue of Bloomberg Businessweek as the cover story focuses the coming streaming video war that I’ve talked about both here and on the Thematic Signals podcast. The author likens it to “The Hunger Games”, and in many respects I can see why that is a good comparison.

While we were recently stopped out of Netflix (NFLX), I’ll remind you that among the Thematic Leaders and Tematica Select List we have several companies — Disney (DIS), Apple (AAPL), Amazon (AMZN), and AT&T in particular – that are focusing on this market. Each brings their own particular set of strengths ranging from content to addressable customer base, but all three have other businesses besides streaming video to drive profits and cash flow that can fund their respective streaming businesses.

  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.

What to watch this week

After all the happenings for last week that I described above, this week looks to be yet another frenetic one for corporate earnings with more than 1,100 reports to be had, but the pace of June quarter earnings begins to slow and we face a lighter economic data schedule as well. And to be clear, even though we will face a plethora of June quarter reports, let’s remember that exiting this week roughly 78% of the S&P 500 has reported and next week another 13% of that group will be doing so. What this means is the vast majority of reports next will have far less of an impact on the market. This doesn’t diminish them from an ownership of data and information perspective, but rather a smaller impact is likely on earnings revisions and trading ranges. 

Corporate earnings to watch

In terms of which reports I’ll be focusing on this week, it should come as little surprise that they are the ones touching our various investment themes. Here’s my short list:

  • Monday, August 5: Tyson Foods (TSN), International Flavors & Fragrances (IFF), Insulet (PODD) and ShakeShak (SHAK). 
  • Tuesday, August 6: Tenneco (TEN), ADT (ADT), AMN Healthcare (AMN), Comscore (SCOR), LendingClub (LC), Disney (DIS), 
  • Wednesday, August 7: CVS Health (CVS:NYSE), CyberArk (CYBR), Physicians Realty Trust (DOC), Darling Ingredients (DAR), Skyworks (SWKS), Tivity Health (TVTY), 
  • Thursday, August 8: Activision-Blizzard (ATVI:), Alarm.com (ARLM), Dropbox (DBX), Synaptics (SYNA:Nasdaq), Uber (UBER) 
  • Friday, August 9: US Concrete (USCR)

Economic data to watch

Before we tackle the coming week’s economic data, I’ll mention GDP expectations from the Atlanta Fed and New York Fed started last week off between 2.0%-2.2% and as we exited the week those expectations sat at 1.6%-1.9%. As I touched on above, the employment data we received last week pointed to a still growing economy but the take on the manufacturing economy per the July ISM Manufacturing Index and the July US IHS Markit PMI data pointed to a slowing domestic manufacturing one. 

We have only a handful of meaningful economic data coming at us this week in the form of the July inflation reports and ISM’s July reading on the US service economy. Given our pension for looking at other data set in addition to the formal economic data, we here at Tematica will be on the lookout for the last Cass Freight Index and other truck tonnage figures as well as the weekly railcar loading data. Those have been signaling the slowdown we’ve seen in the government produced economic data, and as such we’ll keep a close watch on them in order to stay one step ahead of the herd. 

Should the coming economic data be continue to disappoint relative to expectations and signal the vector and velocity of the domestic economy is down and even slower than recent revisions suggest, odds are the market will increasingly expect another Fed rate cut sooner than later. Our concern, however, is the intended effect of this week’s rate cut and another one should it come to pass on business investment could be muted by the continued trade uncertainty and weakening global economy. As we’ve seen with falling mortgage rates that didn’t stimulate demand earlier this year, in the near-term businesses may stay on the sidelines given the trade and economic uncertainties despite more favorable interest rates.


Surprises From Market Breadth with Record Margin Debt

Surprises From Market Breadth with Record Margin Debt

As we discussed earlier, heading into the third quarter earnings season, we have above average level of positive guidance in terms of both top line sales and earnings as well as lower-than-average negative earnings guidance. We  pointed out yesterday, however, that an uncomfortable portion of that guidance is driven by gains from a weak dollar and we are seeing signs that may be reversing course.

 

In the last quarter, companies that delivered on or beat expectations didn’t get much of a reward for their efforts. We looked at the current market conditions to get a feel for what the earnings reactions could be this reporting season.

 

Margin Debt

Margin debt has reached $550.9 billion, a record high for the second consecutive month and the sixth record high in the past eight months.  Anyone who recalls just a tad bit of market history can see that rapidly rising margin debt has preceded the beginnings of both the March 2000 and July 2007 bear markets. However, nearly one in four monthly margin debt readings since 1959 have been record highs, so to assume that a pullback is imminent based on a record high is folly at best. Instead, we like to look at the rate of change over a 12-month period. Here we can see that the rate of change recently hasn’t been nearly as dramatic as the wild moves we saw around the 2000 and 2007 crashes. This metric does not indicate a market that has been wildly laying on the leverage, despite reaching yet another record high.

Market Breadth

Another measure of the health of the market is the Advance/Decline line which has been well above its 50-day and 200-day moving average. This indicator is showing a market that appears rather robust, but the value of this indicator may lessened by the rapidly rising use of ETFs. When an investor puts money into an ETF, those funds are used to buy all the companies in the ETF indiscriminately, which can give the appearance of greater robustness than would otherwise exist.

 

To further assess breadth, we look at the ratio of equal weight versus market cap weighted for the major market indices. What we found is the S&P 500 and the Russell 2000 equal weight indices underperformed their market cap weighted indices by a material amount year-to-date. This metric indicates that the indices upward moves have been driving by larger cap high-flyers, which indicates weaker breadth than we’d like to see.

 

High Fliers Losing Some Altitude

Amazon (AMZN) tried to carve out a head and shoulders pattern this week, down by over 2% during the week, but closed the week back in the black by Friday. If it moves below the neckline where it is currently perched rather precariously, the shorts will go for the jugular and this is one of those mega cap stock that has been helping to keep the indices up. Another high flier that has driven a good portion of the market’s gains, Apple (APPL), has dropped below both its 50-day and 100-day moving averages and is now down in 13 of the last 18 days as the new product line doesn’t exactly have consumers busting down the doors.

 

Facebook (FB) is also feeling the pain with all the bad press surrounding is ad platform that Ivan and his Russian buddies have been abusing to stir up domestic strife here in the U.S. Who knew Putin’s team may not play fair! The stock suffered its worst day this week since last November, falling over 5% at one point during the week and closing below its 50-day moving average for the first time since July 6th. By week’s end the shares had moved back to neutral territory in this Teflon market, but the warning flares have been fired. Netflix (NFLX) joined in falling as much as 5.5% this week to waver right arounds its 50-day moving average.

 

With the performance of the equal weight indices below that of the market cap weighted, weakness in the big guys are cause for concern. The end of the week saw a rebound in most, such as Alphabet (GOOGL) but we’ll be watching to see if the rebound holds.

 

Another Breadth Indicator

We then looked at the percent of companies above their 50-day moving average in the S&P 500, Nasdaq and the NYSE Composite. We found that the number of stocks trading above their 50-day moving averages has been rising, so from this metric, the markets are looking to have decent breadth, which limits the damage from those high fliers weakening.

 

When assessing either the markets or a stock we always want to find confirming or discordant data points to increase our confidence. While we have conflicting indicators here, our assessment leans more towards a bullish view based on this data for the near term.

 

Volatility

 

What about that wacky VIX that appears to be on a IV drip of some sort of powerful sedative? No matter what gets thrown at it, the index continues to be like Fonzi. The recent Commitments of Traders report from the CFTC revealed that the net speculative short position on the VIX has once again reached a new record high at 171,187 futures and options contractions, taking out the prior 158,114 peak in early August. This is a 63% increase! Talk about the calm before the storm. Yeah, we know, been saying that for a while. This has been a seriously impressive run!

 

Of all the days the VIX has been below 10 since its inception, 70% those have been in 2017. We can’t help but shake our heads, (and remember to stock up on Alka Seltzer) when we consider the likely impact on the markets when the reversion to the mean rule kicks in.

 

Given the lack of volatility, investors seem to be going all in. The last week’s Market Vane report found that the bullish share has reached the highest level in the current bull market. The last time it was this high was in June 2007.

 

The bottom line is while equities are clearly expensive at these levels, the market breadth looks decent and volatility is still hitting the snooze button. The disconnect between fundamentals, historical norms and the current market is likely to at some point result in some seriously dramatic moves.  However, we’ve all seen that expensive stocks can get even more expensive and for at least the near term, we are not seeing any clear catalyst for a pullback that would get the attention of this seemingly Teflon market.

Markets Reach New Highs, But Why?

Markets Reach New Highs, But Why?

At Tematica, we separate our politics from our analysis to be able to provide objective assessments, which means that we need to call out an error we see in the prevailing narrative. Thursday the Dow hit its 7th straight record close, despite the news that Special Counsel Mueller has impaneled a grand jury in the Russia election tampering probe. While many are attributing the market’s gains to president Trump’s administration, this divergence calls that into question. As does the reality that President Trump’s approval rating has hit new lows with disapproval ratings reaching new highs while the market has continued to rise.

Apple (AAPL) and Boeing (BA) collectively have been responsible for 70 percent of the Dow’s gains the past 6 weeks while the FAANG stocks – Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Alphabet (GOOGL) – which account for just 11 percent of the S&P 500 market capitalization have generated 26 percent of year-to-date return. Juicing up those returns has been leverage, with margin debt up 20 percent on a year-over-year basis in each of the past 5 months and is today over 60 percent HIGHER than at the 2007 peak.

The reality is that in the past 6 weeks, the median stock price and median sector price haven’t actually moved. What has happened has been a falling U.S. dollar, which is on track for the weakest annual performance in 14 years. That’s really something in light of the prevailing narrative that assures us the U.S. economy is going like gangbusters. Ignore that recent ISM report which saw Services experience the biggest drop since November 2008 – same goes for the Composite Index. Amazing to have a falling dollar and the U.S. Treasury 10-year yield right around where it was during the depth of the Great Recession while the Fed is tightening and yet we are to believe the economy is firing away, hmmm.

The top three stocks in the Dow for foreign revenue, Apple (APPL), Boeing (BA) and McDonalds (MCD) account for 50 percent of the Dow’s year-to-date gains, hmmmm.

So what’s going on here?

Euro to US Dollar Exchange Rate Chart

Euro to US Dollar Exchange Rate data by YCharts

In euro terms, the S&P 500 is actually down 1.9 percent year-to-date. In Mexican peso terms it is down around 4 percent and even in the polish zloty it is down roughly 5 percent.

In fact, when President Trump was elected, the U.S. stock market capitalization represented 36 percent of total global market capitalization. That ratio rose to nearly 38.5 percent but has since fallen to 35 percent where it was all the way back in June 2015. On a relative basis, the U.S. stock market has significantly outperformed. What we are seeing here is more a function of a falling currency that a rising stock market reflecting a robust economy.

What could go wrong? The Intercontinental Exchange now has a net short position for the U.S. dollar for the first time since May 2014 and after that time the greenback gained 5 percent within 3 months. If the market has been rising on a falling dollar….

Then there is that debt ceiling debate that, when taking into account recent dynamics in D.C. between various members of Congress and the White House, could make Game of Thrones appear rather tame. This coming at a time when the tax reform debate is set to kick off. Oh and there are those November elections to really bring out the softer side of politics. With the Chargers no longer playing in San Diego this Fall, (What the hell?) I think I’ll have more than enough games to watch coming out of Washington.

With 2017 Poised to be the Year of Ransomware, More Cyber Spending is on the Way

With 2017 Poised to be the Year of Ransomware, More Cyber Spending is on the Way

With headlines swirling following the WannaCry attack that hit more than 230,000 computers across more than 150 countries in just 48 hours, on this episode of Cocktail investing we spoke with Yong-Gon Chon, CEO of cyber security company Focal Point to get his insights on that attack, and why ransomware will be the cyber threat in 2017. Before we get into that Safety & Security conversation, Tematica’s investing mixologists, Chris Versace and Lenore Hawkins broke down last week’s economic and market data as well as the latest relevant political events. With all the controversy in D.C., there was a lot to discuss concerning the likelihood that the Trump Bump, which was based on assumptions around tax reform, regulatory roll-back, and infrastructure spending is evolving into the Trump Slump as investors realize the anticipated timeline for such was decidedly too aggressive. With mid-term elections looming, we expect the Trump opposition will be emboldened by the controversy surrounding the administration and will put in best efforts to appeal to their constituents. For the market, it’s another reason to see the Trump agenda likely slipping into late 2017-early 2018, and that realization is likely to weigh on robust GDP and earnings expectations for the balance of 2017.

The markets on May 17th suffered their biggest losses in 2017, with the Nasdaq taking the biggest one-day hit since Brexit, as the turmoil in Washington dampens investors’ appetite for risk while raising questions over GDP and earnings growth. While some Fed banks are calling for 2Q 2017 GDP as high as 4.1 percent (quite a jump from 1Q 2017’s 0.7 percent!), the data we’re seeing suggests something far slower. We continue to think there is more downside risk to be had in GDP expectations for the balance of 2017, and the latest Trump snafu is only likely to push out team Trump’s reforms and other stimulative efforts into 2018. If 2Q growth is driven in large part by inventory build, which is what the data is telling us, expect the second half to be significantly weaker than the mainstream financial media would lead you to believe.

While the global financial impact of the WannaCry ransomware attack may have been lower than some other high profile attacks such as ILOVEYOU and MyDoom, the speed at which it moved was profound. We spoke with Yong-Gon Chon, CEO of Focal Point Data Risk about the incident to get some of the perspective and insight the company shares with its c-suite and Board level customers. While many are focusing on WannaCry, Yong-Gon shares that as evidenced by recent content hijackings of Disney (DIS) and Netflix (NFLX), ransomware is poised to be the cyber threat of 2017. Those most likely to be targeted are those organizations that prioritize uptime and whose businesses tend to operate around the clock, making backups and software updates extremely challenging.

While in the past IP addresses may have been scanned once every four to five hours, in today’s increasingly Connected Society, IP addresses are scanned one to ten times every second. As consumers and businesses in the developed and emerging economies increasingly adopt the cloud and other aspects of Connected Society investing theme, we are seeing an explosion in the amount of data as more and more of our lives are evolving into data-generating activities. From wearables to appliances to autos, our homes, offices, clothing and accessories are becoming sources of data that goes into the cloud. With the Rise of the New Middle Class in emerging markets, we are seeing the number of households participating in this datafication grow dramatically, exposing new vulnerabilities along the way. That increasingly global pain point is fodder particularly for cyber security companies, such as Fortinet (FTNT), Splunk (SPLK) and Cisco Systems (CSCO) that are a part of our Safety & Security investing theme.

During our conversation with Yong Gon we learned that companies need to understand that breaches must be viewed as inevitable in today’s Connected Society, network boundaries are essentially a thing of the past. Security can no longer about preventing nefarious actors from gaining entrance, but rather is now about managing what happens once a company’s network has been invaded. From a sector perspective, with all the regulation and reporting requirements in financial services, many of these firms are leading the way in how to best deal with such breached.Uber

For investors who want to understand the potential impact of cybercrime, Yong-Gon Chon suggests looking at how much data a company is generating and how the company is managing the growth of that data, with companies such as Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL) and Uber examples of heavy generators. Investors need to look at a company’s cyber risk as a function of the magnitude of its data generation and the company’s level of maturity in addressing that risk. By comparison, companies not affected by attacks such as WannaCry need to be asking themselves why didn’t they get hit? Was it luck or did we do something right? If so, what did we do right and what is the scope of protection we have given what we’ve learned about the latest attack strategies?

We also learned about the new efforts underway globally to develop attribution of cyber threats so as to differentiate between those threats from professional cyber criminals versus the capricious tech savant engaging in ill-advised boundary exploration. Along with this shift is also a change in the boardroom, where cybersecurity is viewed in the context of its potential impact on the business, rather than as a function of a company’s IT department.

One thing we can be assured of is that hackers are watching each other and the good ones are learning what makes attacks fail and where organizations are weakest. As the Connected Society permeates more and more of our lives, these risks become more pernicious and their prevention more relevant to our everyday lives. The bottom line is we are likely to see greater cyber security spending in preventative measures as well cyber consulting as those responsibilities become a growing focus of both the c-suite and board room.

Companies mentioned on the Podcast

  • Amazon.com (AMZN)
  • Apple (AAPL)
  • CVS Health (CVS)
  • Disney (DIS)
  • Facebook (FB)
  • Focal Point
  • JC Penny Co (JCP)
  • Kohl’s (KSS)
  • Macy’s (M)
  • Microsoft (MSFT)
  • Netflix (NFLX)
  • Nordstrom (JWN)
  • TJX Companies (TJX)
  • Twitter (TWTR)
  • Uber
  • United Parcel Service (UPS)
  • Walgreens Boots Alliance (WBA)

Resources for this podcast: