I hate to be a party pooper, but I have to tell you that that stock market is grossly overbought. According to our friends at Bespoke, over 70.8% of the stocks in the S&P 500 are now overbought, which is the highest level in nearly three years (since March 2016). This 70% overbought threshold has only happened 8 times in the past decade according to Bespoke and the S&P 500 has only risen a median of 2.1% and 5.6% in the next month and three months, respectively. So the good news is that based on historical overbought occurrences, the S&P 500 may continue to move higher, but at a significantly slower pace.
Essentially, the stock market is entering a funnel that I expect will become progressively more narrow because the S&P 500’s earnings in the upcoming months are expected to “hit a wall” due to more difficult year over year comparisons. Furthermore, due to a stronger U.S. dollar, the multi-international stocks that account for approximately 50% of the S&P 500’s sales are now fighting a strong currency headwind and being paid in eroding currencies. As a result, those companies that continue to post strong sales and earnings momentum in a decelerating environment, like my A-rated dividend growth and conservative growth stocks, should continue to exhibit relative strength and emerge as market leaders. Here is a link to my Dividend Grader and Stock Grader databases, so you can see if your stocks are A-rated:
The economic news last week was mixed. The Conference Board on Thursday announced that its leading economic index (LEI) declined 0.1% in January. Ataman Ozyildirim, the director of economic research at the Conference Board said that initial jobless claims and “weakness in the labor market” contributed to the decline in the LEI, which appears to be influenced by the federal government shutdown. Furthermore, 3 of the 10 LEI components, namely, building permits, new orders for capital goods, and new orders for consumer items, were not available due to the federal government shutdown. As a result, the January LEI will likely be revised, since 30% of the LEI components were missing.
The National Association of REALTORS on Thursday reported that existing home sales in January declined 1.2% to a 4.94 million pace and are now at a 3-year low. In the past 12 months, existing home sales have declined by 8.5%. Median home prices rose by 2.8% to $247,500 in January, which is the slowest annual growth rate since 2012. Existing homes are now on the market for 49 days, up from 42 days a year ago, so there are lots of signs that median home prices may finally be cooling. Sales in the Northeast rose by 2.9% in January, while in the Midwest, South & West, existing home sales declined by 2.5%, 1% and 2.9%, respectively. Overall, the housing market clearly remains soft.
The good news is that the Commerce Department reported that durable goods orders rebounded 1.2% in December, due largely to a 28.4% surge in commercial aircraft orders. December durable goods orders were revised to a 0.7% increase, down from 1% previously estimated. Excluding transportation orders, durable goods in November rose only 0.1%. The business investment component in durable goods has fallen for two consecutive months, which may be due to rising uncertainty regarding global economic growth.
Speaking of global growth, there are formidable storm clouds on the horizon concerning Brexit. Specifically, Britain must leave the European Union (EU) on March 29th and this is shaping up to be a disaster! Already, Britain appears to be slipping into a recession over the Brexit mess. As an example, Land Rover Jaguar is now struggling, announced 4,500 layoffs and is short of capital. Another example is that on Tuesday, Honda announced that it would be closing its plant in Swindon, England in 2021 that employs 3,500 workers.
Some EU automotive companies, like Porsche, have warned its British customers that a 10% surcharge may be added after March 29th due to the fact that there is no agreement between Britain and the EU on vehicle tariffs. Economies hate uncertainty, since both businesses and consumers tend to postpone purchases, which causes the “velocity of money” to grind to a halt and trigger recessions.
At the root of the Brexit problem is that Britain was suppose to pay the EU an substantial multibillion pound exit fee to leave, but Prime Minister May has not been able to get the House of Commons or Parliament to approve of any exit fee. As a result, chaos reigns and both the British pound and euro are expected to remain weak due to the Brexit chaos.
Continental Europe may also be slipping into a recession. Italy is already in an official recession after two consecutive negative GDP quarters and rising unemployment. France is still dealing with the aftermath of its yellow vest protests. The infighting within the EU persists and is being masked somewhat by Britain’s impending exit.
Ironically, both the Bank of England and the European Central Bank (ECB) cannot cut interest rates significantly to fix their ailing economies, so more quantitative easing (i.e., printing money) may be their only option. The only problem with quantitative easing it that it further weakens currencies and sparks inflation, since the price of imported goods then rise.
Interestingly, The Wall Street Journal on Tuesday reported that based on two-year government bonds, Finland, France, Germany and Austria all have negative yields due to ebbing confidence. Although money is gravitating to what is perceived to be stable EU countries as the amount of negative government yield grows, that money is looking elsewhere and the U.S. is unquestionably the oasis.
Essentially, the Brexit chaos has caused money to flow into the U.S. and suppress our Treasury yields. This international capital flight is expected to persist through March and possibly beyond, depending on the ongoing infighting within Europe. The insults from the EU bureaucrats regarding Britain’s decision to leave the EU without a transition plan exposed just how bitter the EU is about Brexit, since without Britain, the EU will likely have to implement massive budget cuts. Specifically, European Council President Donald Tusk’s provocative comments that there is “a special place in hell” for the British officials pushing for Brexit was a parting jab at the failure for EU officials in Brussels to extract any significant exit payment from Britain.
Compared to the rest of the world, the U.S. remains an oasis. Thanks to all time record crude oil production, the U.S. is now driving world economic growth. Emerging market economies are expected to recover somewhat due to the fact that they spend a lot of money on energy, so as energy costs decline, consumers in emerging markets have more disposable income. The U.S. control over worldwide energy prices will eventually lead to political changes in Venezuela and possibly Iran as their respective economies collapse. Like China has successfully done, the U.S. is now using its economic might to influence the world. In the end, the ultimate goal is free trade for all, so the world can better prosper, but that is still decades away due to silly infighting as Britain and the EU are demonstrating.
Speaking of using economic might, President Trump last week in Miami delivered a scathing speech that warned Venezuela’s military authorities to that they would “lose everything” if they remain loyal to President Nicolas Maduro and refuse to allow emergency humanitarian aid that is piling up on the Colombian border. The U.S. military continues to fly C-17 cargo planes to Colombia with nutritional supplements and hygiene kits. Venezuelan opposition leader, Juan Guaido, is demanding that the Venezuela’s military allow in the humanitarian aid and has offered amnesty to military officers that disobey President Maduro’s blockade on the Columbian border.
President Trump in his speech was also very critical of Cuba, which is reported to have 1,000 military and intelligence advisors to protect President Maduro. Complicating matters further are approximately 400 Russian security personnel in Venezuela. President Trump called President Maduro a “Cuban puppet” and warned that officials that keep Maduro in power that “the eyes of the entire world are upon you.” Finally, President Trump said that “The twilight hour of socialism has arrived in our hemisphere” and concluded by saying “The days of socialism and communism are numbered, not only in Venezuela, but in Nicaragua and in Cuba as well.” Obviously, by continuing to fly C-17 cargo planes to Colombia, the U.S. is planning to help with a massive humanitarian aid to Venezuela. The best possible solution is for the Venezuela’s military to cede the humanitarian aid blockade and back opposition leader, Juan Guaido.
This chaos in our hemisphere is actually helping financial markets, since international confidence in the U.S. is boosting the U.S. dollar and suppressing Treasury yields. Naturally, a stronger U.S. dollar lowers commodity prices and squelches inflation. Lower energy prices in the U.S. should boost consumer spending, while lower interest rates should eventually help the automotive and housing industries to recover. The U.S. economy has been remarkably resilient and when one sector has faltered, another has prospered. The bottom line is the foundation under the U.S. economy remains strong.
Finally, the Fed released their Federal Open Market Committee (FOMC) minutes on Wednesday that revealed that they plan to announce a plan to stop shrinking their $4 trillion portfolio via asset sales later this year. The FOMC minutes said “Such an announcement would provide more certainty about the process for completing the normalization of the size of the Federal Reserve’s balance sheet.” This is big news folks, since the Fed has been systematically selling government securities and artificially keeping Treasury bond yields a bit higher than then might be otherwise. So when the official announcement comes out that the Fed will stop selling $50 billion per month in government securities, I expect that Treasury bond yields will decline. The FOMC minutes also revealed that several Fed officials lowered their economic outlook due to (1) softer consumer and business sentiment, (2) downgrades in foreign economies’ growth outlooks and (3) tighter financial conditions stemming from the year-end market swoon. Overall, the FOMC minutes were very revealing and very positive for both bonds and stocks.
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