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  1. Home
  2. / Investing
  3. / Stocks

It Isn't Time to Sound the All Clear in the Equity Space Just Yet: Market Recon

Market participants are smart enough to know by now that when one must venture across thin ice, one does not linger.
By STEPHEN GUILFOYLE
Jan 08, 2019 | 08:19 AM EST
Stocks quotes in this article: HELE, KSHB, MU, NVDA, INTC, KSS, HD, XOM, BP, RDS.A, PCG, TME

Measured Steps

Equity markets did benefit from some follow through on Monday. Tempered somewhat, but still a follow through. Equity index futures appear to offer more of the same here on Tuesday morning. There is plenty to feel better about, and I think most of us can feel something of a shift in sentiment. That said, all of us are smart enough to know by now that when one must venture across thin ice, one does not linger.

The immediate optimism is still related most to the U.S./ Chinese trade talks in Beijing. Attendance by China's Vice Premier Liu He added to investor enthusiasm. My feeling is that this may have been merely by design. The U.S. demands action first on increased agricultural purchases already promised by China, as that is an area of need and perhaps is the easiest area to make progress on reducing the trade imbalance between the two nations without costing anyone anything significant.

The additional boost here on Tuesday is coming from an agreement that the two sides will keep talking and will move that discussion to Washington later in January. Most investors seem to feel that as long as the two sides stay in close contact that the increased hostility in the U.S. posture regarding tariffs aimed at China may not be triggered on March 1. The most robust gains made across the U.S. equity space in recent days have been in retail, semiconductors and energy. A lot of reliance on China there. We have taken these type events lightly before, I think. Stay disciplined. 

The More Things Change...

Even if the U.S. and Chinese delegations seem to be getting along out of necessity, there are still enough monsters under the bed. Some of them not under the bed, perhaps, but brazenly showing themselves.

Causal observers may not have noticed. Those who watch everything with a keen eye certainly did. Atlanta Fed President Raphael Bostic spoke on Monday afternoon. Bostic, for those who watch Maury Povich in the afternoon, is considered more dovish than most at the Fed. Atlanta does not vote on policy this year. Bostic said on Monday that he expected one rate increase in 2019. Very quietly, the dollar found support. Very quietly, US Treasury yields started working their way slightly higher. Unfortunately, short-term yields expanded just a bit faster than did the long-term variety, which explains why the banks badly under-performed the broader markets in Monday trade.

As the creatures of the night crawl past my office window on Tuesday morning, futures markets in Chicago are now pricing in a slightly higher probability of one rate hike in 2019 than they are one rate cut (13% to 12%). While there remains a roughly 75% chance of no change, according to this market, that is a slightly more hawkish view than this same market offered traders late last week.

There are no Fed speakers on Tuesday's docket. I would keep my helmet and body armor within arm's reach, however. Traders will be up against three speakers from the central bank on Wednesday and an incredible six on Thursday, including both the chairman and vice chairman. On top of that, Chairman Jerome Powell testifies before Congress next week as earnings season gets under way. What could go wrong?

In addition, the president will address the nation tonight on the government shutdown and border security. Obviously, this presents both political risk and perhaps opportunity, though that vision is more difficult to see. My thought is that, should this market move into the regular session with any kind of strength resembling what we are seeing overnight, I will shave what have been my book's best names over the past two weeks. To act in any way that might be considered more than light profit-taking, I would need to see the S&P 500 open above the Monday high of 2566, and move into the 2570s. I am talking about semiconductors such as Micron Technology Inc. (MU) , Nvidia Corp. (NVDA) and Intel Corp. (INTC) here, as well as some of my favorite retailers such as Kohl's Corp. (KSS) and Home Depot Inc. (HD) . That said, instinct demands that I exclude my energy longs from such a haircut.

What About Oil?

Six days in Heaven. Unless I am new to you, then you know that I spent the later weeks of 2018 getting longer my favored oil names as they were hitting what now looks like a bottom (knock wood).

There is a real battle going on here. A stronger dollar, which we'll have if the Fed talks tough, is obviously our enemy. Where do we go from here? There will be an overt effort made by OPEC in general, and more specifically by Saudi Arabia, to rebalance this market. The kingdom indicates forward production of 7.1 million barrels per day, down from 7.9 million just six weeks ago.

This has occurred while Goldman Sachs cut its quarterly and semiannual outlooks for West Texas Intermediate (WTI) crude to projections in the mid $60s (which I would take in a heartbeat) based on new pipeline access that will un-bottle the Permian. This may be true. In the meantime, producing oil rig counts in the U.S. printed toward their recent lows last Friday at 877. That equaled their second-lowest print over a nine-week span.

How do I feel? Stay with the bigger names with the fat cash flows. Should corporate debt markets hit a major pothole, highly indebted smaller energy names will be hit the hardest. As for the bigger names in the space, in the event of continued tough times across the pace, they'll at least pay the investor a handsome dividend.

Should economic growth be restored to planet Earth, this is where, in my opinion, it will be most visible. You already know my faves are Exxon Mobil Corp. (XOM) , BP plc (BP) and Royal Dutch Shell (RDS.A) .

Attention, Discount Shoppers!

Two alerts for discount shoppers. The first is obvious. It's Pacific Gas & Electric Co. (PCG) . Will the California utility be forced to seek bankruptcy protection? It is facing a mountain of liability in the wake of a spate of wildfires that tore through the state. The company already has acknowledged a need to add to or change the board. S&P Global Ratings here on Wednesday cut its rating for PCG from BBB- to B. For clarification, this labels PCG's debt as junk.

Obviously, I would not suggest an equity play in this name. However, I will price the options market going out six months after open. An limited directional play, such as a bull call spread or a bear put spread, could present value in a risk-averse way for a trader willing to go there.

Now, for my new secret weapon. I likely will implement a long in the coming days in Tencent Music Entertainment (TME) . The Chinese streaming music service has struggled lately after its December initial public offering (IPO). This name peaked at $14.75 on Dec. 12 after the deal had been priced at $13 the night prior.

Sure thing? Not even close. Trade-related name? No, but definitely a name dependent on the Chinese economy, so yes, in a roundabout way. I noticed on Monday that KeyBanc initiated the name at Overweight with a $19 price target. Then I notice that Bank of America had initiated the name at a Buy with a $17.10 price target. Both of those firm were involved either as joint book-runners or co-managers on deal day, so I don't get all that fired up about their opinion.

However, what I do get fired up about is that Tencent Music is the largest streaming music service in China. The population of China is estimated to be close to 1.386 billion. Tencent Music boasts 800 million active monthly users. This indicates to me both deep penetration and substantial room for growth. On top of that, such broad usage could allow for eventual pricing power. Put in perspective, U.S. streaming television service Netflix Inc. NFLX boasts about 137 million active users, 58 million of which are in the U.S.

At these prices, it appears possible that risk-reward could play well for going long the shares. Keep in mind, not a lot of data is yet available. There is no consensus view for earnings or revenue. Levered cash flow is admittedly negative, and the lockup expiration looms on June 10. There is a chance some investors may look to liquidate come summer regardless of where the shares are trading. This must factor into the timing of the exit of any entry-level position. 

Economics (All Times Eastern) 

06:00 - NFIB Small Optimism Biz Index (Dec): Expecting 103.8, Last 104.8. 

08:30 - Balance of Trade (Nov): Expecting $-53.9B, Last $-55.5B. 

08:55 - Redbook (Weekly): Last 9.3% y/y. 

10:00 - JOLTS Job Openings (Nov): Last 7.079M. 

15:00 - Consumer Credit (Nov): Expecting $17.1B, Last $25.4B. 

16:30 - API Oil Inventories (Weekly): Last -4.5M.

Today's Earnings Highlights (Consensus EPS Expectations) 

Before the Open: (HELE) (2.36)

After the Close: (KSHB) (-.03)

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At the time of publication, Guilfoyle was long MU, NVDA, INTC, KSS, HD, XOM, BP and RDS.A equity; short BP, MU and NVDA calls; and short NVDA puts.

TAGS: Federal Reserve | Interest Rates | Investing | Oil | Stocks | Digital Entertainment | Energy | Retail | Semiconductors & Semiconductor Equipment | China | United States | Real Money |

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