Assessing the action, even to one's immediate rear, can sometimes be a tough read. Day over day, Friday looked kind of tough. The narrow scope of the Dow Jones Industrial Average is one reason why you will almost never catch me covering that index in great detail. That "blue chip" index under-performed on Friday largely because two constituent stocks suffered daily losses of greater than 6% for very different reasons. For those still a little sleepy, those two names would be Boeing (BA) , who reports this week, and Johnson & Johnson (JNJ) (who reported a solid quarter last week).
So, how tough is it to successfully track a stock market. How tough is it to track anything? Off trail? The condition of the vegetation offers clues. The state of mind of whatever it is being tracked. Panicked? Wounded? Better throw something ahead in the direction you're headed. Make some noise, just to let 'em know you're around. On trail can be easier, or tougher, depending on the soil itself. Hard-pack, or rocks offer little help. Wet mud, pretty much the same, if the prints immediately fill with water. Clay? Now clay is perfect. Makes figuring weight and stride a whole lot easier. Might even tell you what exactly it is that you're following, and how far behind you might be. Might even tell you if something is hunting you.
Friday's stock market action was quite nasty when isolated. The S&P 500 surrendered just 0.4%. However, the Nasdaq Composite, tech heavy as it is, took a quiet drubbing of 0.8%. Trading volumes better illustrate the sector rotation. Volume directly attributable to these two indices finished the day for both just above their respective 50 day SMAs. That said, when broken out by exchange. Volume at both the NYSE and Nasdaq Market Site increased from Thursday to Friday, but not spectacularly so. At the Nasdaq, losers beat winners by less than 3 to 2, while downtown, losers just barely edged winners (51-49).
So, there probably was some mild but targeted professional distribution on Friday. As many of you know, I do a lot of my chart work on Sundays. This work is kept separate from all of the rest of my notebooks, and to be honest, the week over week charts, though I knew they would look pretty good, really do paint a picture of some awkward fractured optimism, if that seems possible.
There are several drivers behind what is certainly a reshuffling of allocation. First there is the tepid optimism around the sort of "Phase 1" trade deal between the U.S. and China. It's not about the content of that deal, which is admittedly less than impressive, but about forward progress. That idea that progress had in fact been made has now been cemented by rare comments made over the weekend by Chinese Vice Premier Liu He from Nanchang. Liu said, "Stopping the escalation of the trade war benefits China, the US and the whole world. It's what producers and consumers alike are hoping for." More importantly, Liu also said, "The two sides have made substantial progress in many fields, laying an important foundation for the signing of a phased agreement." Does this mean much by itself? No. What it does mean though, is that the Chinese side also feels that something has been accomplished with more to go. It means that the nature of these negotiations is warmer than it has been. It means that the Trump and Xi administrations are at least looking at the same page. That's more than nothing.
Though financial markets had started to price in a negotiated exit for the UK out of the EU last week, that short-lived benefit appeared to have been withdrawn somewhat on Friday as it became clear that the path forward was still quite messy. UK Prime Minister Boris Johnson, despite losing what was seen as a crucial vote in Parliament on Saturday, is expected to try again at some point today if he feels that he has a legitimate shot at 320 MPs. If this were to occur, then the British government could still deliver Brexit, at least in theory, with a deal in place by the October 31st deadline.
This is more important in terms of the condition of global trade, and economic growth than a lot of folks realize. Algorithms that trade in U.S. markets will react should negative Brexit headlines seep into the news cycle throughout the day. Stay alert.
Late on Friday, the probability of a reduction being made to the Fed Funds Rate on 30 October climbed to 91% as priced in by futures markets trading in Chicago. From a macro-economic point of view, the data is painting September as a pretty tough month. Though this weakness supports the idea, that's not why the Fed needs to move forward with this cut.
The Fed is now purchasing $60 billion worth of T-Bills per month, meaning that while yes... the increase in the size of the balance sheet will accommodate the needs of overnight money markets, the more discreet yet just as important focus of this program is the suppression of short-term yields. Still with me?
I take no issue with this program. In fact, I applaud this action as precisely what the doctor order for the environment provided. (Not to mention that we have called for nearly this precise plan for months here at Market Recon.) The Fed may have caused these issues, but they do seem to understand that, and are making what appears to be a sincere effort at implementing a remedy.
Folks have to understand that the Fed is staying out of the business of controlling long-term interest rates, and a Fed Funds Rate that targets 1.5% to 1.75% (currently 1.75% to 2%) is far more appropriate relative to a yield curve that pays 1.703% for 30 day T-Bills. The cut on October 30th is a technical necessity. There is talk of taking a pause after this next cut. I really have no issue with that unless the $60 billion in monthly purchases reduces 30 day yields below that of overnight interest rates. This stuff really is not that hard. Then another technical cut would be necessary, but I do feel that it is safe to say that in the absence of economic contraction that the U.S. might justifiably be able to plan the end of this rate cutting cycle as long as the bulk of the yields curve (3 month through 10 year) remains positive.
Let's not forget that this Thursday, Mario Draghi runs his last policy meeting as top dog at the ECB before handing leadership over to Christine Lagarde. Yes, the ECB kick starts it's QE program in November to the tune of E20 billion per month. (That's $22.4 billion). When the reinvestment of maturing assets is factored in, the ECB will be pumping E35 billion ($39.2 billion) into the European economy through member nation sovereign debt purchases. Inevitably, that causes some money to chase yield as European debt becomes even less desirable to hold for anything other than preservation of capital at a discounted return. A portion of this artificial demand will find safe haven in the longer end of the U.S. Treasury curve. Fortunately, this rebirth in European quantitative easing is less aggressive than what we have seen from Brussels in the past, and with the Fed target at $60 billion per month, the U.S. central bank may be able to stay ahead of what could be a problem for at least a little while.
Keep in mind that while the European plan is open-ended, and the U.S. plan is expected to last just six months or so, that there is indeed a new sheriff in Brussels, and that local leadership at the German, Austrian, Dutch and Estonian central banks openly opposes this relaunch in the first place. Lagarde's strength as politician is seen as that of a consensus builder. Her talents will be tested from the start.
What This Means To Me
For one, as readers know, while maintaining some level of exposure across the spectrum of potential allocation, I have been working my way from extremely defensive to a more value-based bias. The market for it's part, seems to be trying to price in a warmer environment for global trade, and a less angry yield curve.
Clearly the software/cloud space had been awarded a multiple based on more than growth. That group has not ever been highly exposed to Chinese trade, and the stocks were really only exposed in the broadest of tech ETFs. On the flip-side, semiconductors, and semiconductor wafer providers are extremely exposed to China, and thus have been punished beyond that of just a slowing business. As my Real Money colleague Eric Jhonsa pointed out in his piece on Saturday, there is a repricing taking place within the tech sector.
Beyond that, the reordering of sector valuations remains quite sloppy. As the yield curve behaves, Utilities seem to have lost some luster, though real estate remains quite beastly. The Financials appear to be positioned well, and very cheap should the yield curve remain sloped appropriately. Forget lower headline rates, the shape of the curve is what matters there.
As for growth, both Industrials and Materials remain in limbo. That's not a bad thing. These two groups generally offer some kind of dividend, and are really cheap at least in spots... the Industrials in particular. Energy? At least they pay us to stick around. For me that and regular net basis reduction through sales of both calls and puts is enough to keep me in place.
Sarge Fave Beat-Down
Lockheed Martin (LMT) reports tomorrow. Tuesday. Last week was a doozy for one of your old pal's all-time favorite stocks. First, Raytheon (RTN) wins an important contract from the U.S. Army to build out a new radar for the Patriot Missile Defense System. The deal pays $346 million up front, and could end up worth a rough $5 billion. Raytheon, a firm that currently has a merger agreement in place with United Technologies (UTX) , beat out both Lockheed Martin and Northrup Grumman (NOC) for this award. By the way, UTX also reports on Tuesday, while RTN and NOC both report on Thursday.
The news got worse for Lockheed Martin on Friday. I have been asked by readers over the weekend if I thought the recent dip in the share price for LMT was a buying opportunity ahead of earnings. This is my answer.
Lockheed hit a new problem on Friday. The F-35 apparently will now not be cleared by the Department of Defense for full rate production at any point this year due to delays in the aircraft's integration with simulation technology. The expectation had been that this clearance would be granted in December and the fact that full rate production pays a whole lot better than low-rate production had been at least somewhat priced into the stock.
There is now talk that full rate production may not be granted until January of 2021, despite the fact that U.S. Air Force and U.S. Marine Corps pilots have already flown this aircraft in combat. 91 F-35s were delivered in 2018, The plan had been to deliver more than 170 per year by 2022. A new schedule for delivery as well as for revenue generation and cash flow now has to be priced in.
I am not running for the hills, but I do have a lot to protect here. This has been one of my best performing positions for 2019, even with recent declines. I am willing to hear CEO Marillyn Hewson out tomorrow. That said, my panic point for this name is $370. The shares traded below that level on Friday, but closed above. I am not afraid to take a little something off of the fast ball should I see another test.
The short answer is that while I have not recently reduced my LMT long, I am not adding at these levels going into earnings.
Economics (All Times Eastern)
14:00 - Federal Budget Statement (Sep): Last $-200B.
The Fed (All Times Eastern)
11:40 - Speaker: Reserve Board Gov. Michelle Bowman.
Today's Earnings Highlights (Consensus EPS Expectations)