"The Truth must dazzle gradually or every man be blind." -- Emily Dickenson
Fresh record closing highs. Oooh!! New intra-day highs. Ahhh!! The S&P 500? Try 2,690 out for size. The Dow Jones Industrial Average? 24,792. Remember that book Dow 36,000, by James K. Glassman? We used to laugh at the thought. The Nasdaq Composite? 6,994, after kissing the hand of 7,000. All this as optimism piles upon optimism. Like the proposed tax plan or not, there is no denying that what appears before us is incredibly friendly toward business, and that changing environment is not lost on the investing public.
The U.S. House of Representatives is set to vote on the compromise tax bill on Tuesday, and the U.S. Senate vote will come after the House vote, perhaps as late as Wednesday. If they are sure they have the votes, then vote they will; and it becomes increasingly likely that President Trump will have something to sign, if not prior to Christmas Day, then at least in 2017. The Santa Claus Rally is usually a post-Christmas phenomenon. Will there be anything left in the tank by then?
Valuations are too high, they said? Often, those making comparisons forget that historical norms are meaningless when the rubber hits the road, unless the road is the same, the rubber is the same, and the driver is the same. Well, my students of the marketplace, all three, especially the driver, have been different this time from all other bull markets. I am not blind to the fact that all things that rise, must indeed, fall someday. The one valuation metric that I think far more significant that all others is forward-looking PE ratios (next 12 months projected earnings). We do not price in past performance, mind you.
The S&P 500 is now trading at 19.8 times 2018 earnings. The Dow Transports just 18.8 times. The Nasdaq 100? A whopping 21.2 times. Guess what happens when the corporate tax rate drops from the headline of 35% to 21%? Estimates are for an increase of $1.40 in aggregate S&P 500 earnings per percentage point cut. Gang, there will 14 of those. Many models were pricing in S&P 500 earnings well into the mid-$140s at the old rate. Wait 'til the Sun shines, Nelly.
What do you think those P/E ratios will look like when those models allow themselves to run the new corporate tax rate? Not so absurd now, is it? Ooh Freakin' Rah.
Is increased deficit spending ethical? Has monetary policy been perverse? May we even travel down the path of fiscal reform after this? I argue none of these points, and I hear your cries loud and clear. Now, let me be clear. We must separate our thoughts on the purity of forward-looking balance sheets, and understand the environment provided. It is only when we understand and adapt to the conditions provided that we may excel. That is our challenge. That is where the joy of the fight becomes one with the individual once engaged.
If you must, set aside a portfolio that prepares for darker times, then make this part of your discipline. Discipline is a necessary part of excellence. Excel, we must.
Pride and Prejudice
Spending the better part of my career waving paper in the air and shouting at others on the trading floor of the New York Stock Exchange, I was perhaps too prideful. We considered stocks that traded at the big board to be the corporations that had made it to the majors. The Nasdaq? We still referred to that market as the "over the counter" market, even though that had not been true for quite some time.
Now, when trading stocks, rarely do I even check to see where a name is domiciled. The Dow Jones Industrials are no longer "us", and the Nasdaq Composite is no longer "them". Most folks use the S&P 500 as their benchmark for U.S. equity markets now, and have for a long time. In fact, information technology has long been the pony that I rode in on, and for as long as I can remember, one of my favorite sectors when asked by various television hosts what I like right now. With that in mind, let's travel down a path that we have not traveled in a while, and take a look for our home-gaming crowd at the PowerShares QQQ Trust Series 1 ETF (QQQ) .
For the new kids, this investment vehicle is an ETF (exchange traded fund) that seeks results that in general correspond to the performance of the Nasdaq 100 index. As a stock picker, I generally do not love ETFs all that much, but find no fault in their use to reach a specific goal, or to line a targeted portfolio as a benchmark.
The Nasdaq Composite hit the 7,000 levels yesterday. The Nasdaq 100, with many of the same components, is actually comprised of the top 107 (bet you did not know that) non-financial names listed at the Nasdaq stock market.
QQQ runs at a market cap of $60 billion, pays a yield of 0.84%, and went ex-div yesterday. That dividend is payable next Friday. The expense ratio is an extremely affordable 0.2%. For those looking for exposure to the tech space without picking individual names, this is one way to go. Tax reform may treat the tech space less kindly than others, if only because that group's effective tax rates are already very low. The group dodged a bullet with the elimination of the corporate AMT. I personally doubt that equity markets will succeed if tech does not. I doubt that U.S. consumers will very likely forego technology en masse. I see, and we have experienced the rotation, and it is something to contend with. Occasionally.
Still, for the most part, when I trade out of tech and get back in, it tends to be at a higher price in many of my names, thus reducing my overall profit, even though I have often obeyed my time-tested disciplines. Still learning.
A Pinch of Salt
What's inside? The top ten holdings of the QQQ ETF are like a "who's who" of the technology sector. I am long several names myself, as I prefer to be my own ETF. Action Alerts PLUS charity portfolio holding Apple (AAPL) leads the way, at a 12.2% weighting. AAPL, by the way is still cheap in my book, trading at just 14.5 times 2018 projected earnings. That stock also just hit my price target again yesterday, though it has indeed come in overnight. I think that this time I will wait for a take and hold at the $176 level rather than just sell half, which is what I have done with this name in the past.
Included in the fund's top seven holdings as well are many of your favorites, such as Microsoft (MSFT) , Amazon (AMZN) , Facebook (FB) , Alphabet -- both classes (GOOGL) , (GOOG) -- and Intel (INTC) . Wondering just how well this fund tracks the index? The Nasdaq Composite has run 30% year to date. The Nasdaq 100? 33.92%. QQQ? Oh,33.9% -- pretty darned close.
Danger, Danger!! (I Think)
What about levered funds? Adding leverage increases performance, but also increases the risk in downturns. Margin calls. Like those? Not too much, I guess. There is no denying that levered funds such as the Ultra QQQ (QLD) that seeks two times daily performance of the Nasdaq 100, and the UltraPro QQQ (TQQQ) seeking three times daily performance, have succeeded in 2017. QLD is up 76.8% this year, while TQQQ has run 130%. Still, are you going to hold these long-term?
While I can see the allure of such returns, I really also see danger, especially psychological danger. There may be use here for day traders. I can kind of see that. There is also the danger of slipping into an almost gamblers' mentality, which for some might be best left untouched. I do not, and have no intention of using levered or inverse funds in my portfolios. I have enough on my plate as is, thank you. Maybe when we're down by six at the fifty with time for one play left on the clock. Not 'til then.
Charts of the Day (QQQ)
This decade-long monthly chart is just for show and tell, because it is awesome. Just look at the technically overbought condition that both relative strength and the moving average convergence divergence (MACD) convey to the viewer in this snapshot! That is basically a year-long condition. Incredible. Tech. Oh yeah.
The one below is a more useful chart for folks actually trying to trade the space. What jumps out here is the sudden pop for the MACD, coming out of another failed attempt at a rotation away from info tech. Relative strength is also in jive with this theme. What to do? Long? Ride the wave. Want to be long? That's a horse of a different color.
I have imposed a Fibonacci Fan on the model that assumes the trend stays intact and stretches into the future. The panic point for a trader protecting gains looks to be around $150 right now, and will likely be $151 by New Year's Day.
Add an unbroken month, and this level would become $154. See how that works? By the way, if you're the kid looking for entry, you can chase if you want to. I don't. One man's panic point is another's opportunity. Bang.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2714, 2702, 2695, 2688, 2679, 2672
RUT: 1569, 1562, 1551, 1543, 1535, 1529
Today's Earnings Highlights (Consensus EPS Expectations)