The Other Shoe?
Last night, well after the day's final bell had chimed out loud at 11 Wall Street, the Trump administration pulled the trigger on the next round of tariffs aimed at bringing the Chinese government closer to the U.S. position on trade. On September 24th, which is next Monday, the United States will implement a 10% tax on $200 billion worth of imports from China. If progress is not made, then this 10% tax becomes 25% by year's end. President Trump was frank ahead of the announcement. In reference to the U.S./China trade deficit, he said quite simply "We just can't let this happen anymore."
From the Chinese point of view, these tariffs will go well beyond the point where China can respond in dollar for dollar fashion, as China had done with the Trump administration's original batch of tariffs that amounted to a 25% tax on $50 billion worth of goods. In order to respond in kind, China would have to implement a mixed bag of tariffs and some kind of trade restriction that would deny U.S. access to raw materials or impact American corporate supply lines.
It is safe to say that European equity markets and overnight U.S. equity index futures markets have taken the events of last evening quite well. This comes despite President Trump's threats earlier this month that the U.S. had another $267 billion worth of tariffs versus imports from China ready to go if China still refuses to deal. That number, by the way, would ultimately bring the dollar total of imports from China subjected to U.S. tariffs beyond the total amount of goods that were exported from China to the U.S. in 2017. That number totaled $505 billion. In 2017, China only imported a rough $129 billion worth of goods from the U.S. That, and the alleged theft of U.S. corporate intellectual properties, are the very crux of the matter.
What Is Priced In?
Oddly enough, the sectors within the U.S. equity markets that one might expect to take it on the chin, did not on a day where a move like this on tariffs was telegraphed well ahead of the close. The Industrials were simply not torched in the way that one might think. Highly exposed Honeywell (HON) , though trading lower overnight, actually traded at a multi-year high during the regular session. Perhaps investors had started to price in 25%, and found relief that this opening salvo only included a 10% tax that might eventually roll up to 25%?
One thing is certain, at least to this trader. It may not feel like it, but we have experienced something of a stealth correction across equities and other markets in 2018. Blame trade wars if you want. Blame the methodical drawing down of liquidity by the central bank. Blame the coming, at some point, of an obvious slow-down in earnings growth that may occur alongside a problematic fiscal situation.
The fact is that earnings growth across the S&P 500 has printed well above 20% year over year, and last quarter more like 25%. This, while the S&P 500 itself has gained ground to the tune of a more pedestrian 8%. Why? What is clear to me is that due to the reasons mentioned above, forward looking valuation has been siphoned off quite a bit. As calendar year 2017 came to a close, the broad S&P 500 was trading at a rough aggregate of 18.3 times forward looking earnings. Pundits across TV land screamed about over-valued equities. Poof. Nine month later, the air has come out of those tires. The S&P 500 currently trades at 16.8 times forward earnings, which by the way for those keeping score... is just a smidge above the five year average for the index. Overvalued now? Still, an argument might be made but certainly not such a cut and dried case at this point.
Will tariffs slow confidence? Is the Fed hurting the broader economy? Survey results make me look silly just for asking. The fact is though... that I must ask. Housing Starts are due tomorrow. This data-point has disappointed in each of the last two months, and in three of the last four. The largest slice of the housing pie... Existing Home Sales has now disappointed for four consecutive months. We'll see that one hit the tape again on Thursday. Now, look at Total Vehicle Sales. That line has printed well below its recent norms in three of the past four months. All line items covering sales of expensive items that require for most people the willingness to borrow a lot of money.
Now, there are certainly other factors at play such as household formation, pricing, etc. However, mortgage rates are now also higher than they have been since prior to the economic crisis, and the Fed is whittling down the balance sheet while forcing higher the short end of the curve... this, while the nation is engaged high stakes trade conflicts with key partners. If this isn't dangerous then I guess that I am just unable to recognize danger.
One sector where we did see some major selling pressure yesterday was in Information Technology. Selling continued across the semiconductor space, which is highly exposed to China for revenue. However, the selling was just as intense for the cloud/software space, an industry almost entirely not exposed to China, but perhaps just as exposed to the ruthless magic of passive investment.
Depending on your source, the technology sector trades at a higher valuation than does the broader marketplace, at somewhere between 18.7 times and 19 times next year's earnings. Sliced and diced, one quickly sees the semis, and their suppliers trading around 10 to 13 times, while our beloved cloud names sport valuations in the 20's and even 30's. This is where the perceived overvaluation is. This is where the largest profits are, this is where the money has to come from for those getting skittish ahead of any feared slowdown in growth.
Truth be told, as a trader, I added to my cloud longs as the closing bell rang last night, or at least the ones not trading prohibitively above my net basis at this point. Interestingly, one name jumped out at me after the closing bell... a name that I am already long... for a good while... Microsoft (MSFT) .
Microsoft gave up a little more than 1% on Monday. Ugly? Yes, but still outperforming the Nasdaq Composite, the Information Technology sector, and the software industry. Hmm. What goes on here? Apparently, Five-star Stifel analyst Brad Reback pointed out late in yesterday's regular trading session that Microsoft has announced an increase to the firm's dividend payment on the third Tuesday of September for eight consecutive Septembers. Microsoft has already made plain the firm's intent to return a cool $20 billion to shareholders. Reback placed a price target of $118 on this name. Same day, Oppenheimer analyst Timothy Horan, also five-star caliber... maintained his buy rating on the name, and established a $127 price target.
MSFT trades at something close to 26 times forward looking earnings, expensive for the broader marketplace, but not for the group. Cash on hand and cash equivalents dwarf total debt. Operating Margin is healthy and growing. Cash Flows are enormous. Current and Quick Ratios are robust.
On September 24th-28th (next week), Microsoft will be hosting the Ignite conference in Orlando. The focus here will likely be on Cloud technology, as well as on new innovations across the Microsoft universe involving big data, and artificial intelligence. Wait... there's more.
By the way, the firm will hold it's "Apple (AAPL) style fall product launch event in New York City on October 2nd. (That's in two weeks). Think hardware such as a new Surface in addition to new software. I think that maybe the stock price increases in front of these events as we saw with Apple? Maybe. I'm long the name. I am not always right, but I do not see the current week as good timing for a sale.
Don't Fear The Reaper
One thing that a chart watcher might say is that this is one heck of a nice Pitchfork. Money Flow is strong. Every component of the daily MACD is pulling the right way. Relative Strength is at a nice level, but appears to be waning just a bit.
I placed the second set of Fibonacci levels on the chart just so that the investor my be able to place an effective panic point somewhere. That somewhere for me is the $103 level. However, the stock continues to make higher highs while also putting higher lows to the tape. I interviewed a CEO in an unrelated field for an unrelated purpose the other day. That executive told me that his firm uses the Microsoft Azure cloud for it's business. That did not surprise at all.
My Target Price: $121
My Panic Point: $103
Note: MSFT reports on October 18th. For those looking to scalp some revenue by selling the October 19th 105 puts, they only paid 64 cents last night. Is that worth it? Only you can answer that. However, the November 16th 105 puts went out paying $1.64. An extra hundred buck per contract for an extra month of exposed risk? That one's a definite maybe from my corner.
Economics (All Times Eastern)
08:55 - Redbook (Weekly): Last 6.3% y/y.
10:00 - NAHB Housing Market Index (Sept): Expecting 66, Last 67.
16:00 - TIC Net Flows (July): Expecting $65.1B, Last $-36.5B.
16:30 - API Oil Inventories (Weekly): Last -8.636M.
Today's Earnings Highlights (Consensus EPS Expectations)