As traders and chartists obsess about the key 2800 level on the S&P 500, drawing and regressing all sorts of statistical studies to predict where it is headed, it is useful to take a step back here and really study the facts around us. Algorithms may be tricked by regular Trump and U.S. official tweets to get the market to grind higher, but even they seem to be running out of ammunition as the market still remains trendless.
Machines do not have all the answers, it still boils down to actual fundamental risk vs. reward. Fundamentals exacerbate trends, not the other way around.
So let's talk facts.
The drop in earnings per share (EPS) in the first quarter of 2019 has been quite severe -- down 7% (one of the lowest going back to 2014), with 74% of S&P 500 companies lowering guidance and Informational Technology being the worst (~70% of them lowered), and Healthcare (~88%). There are no upgrades to come, as they did in 2017 after U.S. tax reforms that boosted year-on-year EPS for companies.
Treasury yields seem to have broken their downward trend, with the U.S. 10-year shooting higher towards 2.75%. Given the Fed's dovish tilt possibly letting inflation run higher as they are worrying about the "uncertain economy," inflation seems to be picking up, with higher raw material prices and strong labour markets. The bond and forward swap markets seem to be pricing this in. Equities rallied when bond yields fell, as the Fed u-turned in January. They can't rally when yields are moving higher as well. We all know that as the "r" moves higher, it generates a lower DCF for equities.
China jump-started its economy with a record injection in January. The economic data there theoretically should be getting better around the Fed and into March, as asset prices improved. We have yet to see that, as it comes out in the next few weeks.
But so far, globally there seems to be little improvement to the data, as seen by the Taiwan Manufacturing PMI for February, which sits below 50 (a three and a half year low), and South Korea's new export orders, which fell at the fastest pace in almost four years. Given the trend in China's PMI, there seems to be more downside for new orders.
The Eurozone has always been an issue, but it seems to be getting worse. German Manufacturing PMI is at 47.6, with Italy and Spain contracting as well. U.S. manufacturing has slowed even further in February, at 54.2 vs. 55.8 expected. The Citigroup U.S. Economic Surprise Index fell further as a result of weaker ISM, automobile sales, consumer sentiment and spending.
The Fed, being a backward-looking institution, reacts, it does not pre-empt. It was the reason why it stayed its course back in the fourth quarter of 2018 during its rate-hike cycle. And now it is suggesting a pause as it is petrified and unsure how bad the data really is. A lot is blamed on the trade wars, but there was an underlying slowing in the economy irrespective of the Trade Wars that made matters worse. If markets reach back to all time-highs, and inflation starts getting to be a problem, what do you think the Fed will do? Perfect timing to start raising rates or continue with balance sheet normalization. Bond markets already know this. Equities, as usual, are late to the party.
For the market to break higher from 2800, it needs new incremental positive economic or earnings surprise. Trump is pressured to do any deal as he gets closer to re-election, and China knows it. They are masters of out-thinking their opponents and buying time. Yesterday at the National Party Congress, China cut its economic growth target to 6%-6.5% for 2019, down from 6.5%. These numbers are not particularly important, as China is skillful at fudging the official data to make it look what it would like to -- the trend is more important, and it is lower. Despite the record injection that boosted Chinese markets higher, which perhaps was a ploy going into the trade talks to show "strength," they are still in the mindset to delever. Xi Jinping said they need to brace for a "tough" battle, which does not imply a deal is close, well at least not the one Trump expects, anyway.
It seems the computer algorithms are tired of holding the baton to lead the market higher. We have so many moving factors in March, algos would be best to sit this one out, as it will be volatile and trendless as markets digest the news.
The Fed FOMC meets on March 19. Will they start to be more hawkish, given where asset prices (aka the stock market) are trading? The Brexit vote is on March 29, what happens is anyone's guess. We have huge derivative exposure cleaning up on March 15, which is technically important as day traders influence markets by hedging their delta, keeping the market quite pinned, rather than letting it flow freely.
It eludes me why we feel the need to invest always. Sometimes it is best to be in cash and observe. But then how can Hedge Funds justify their management fees. This is where proprietary trading desks overrun the Hedge Funds -- at the end of the day, it is about making money, not how you make it or over what time period.
Chase the opportunity, not the market.