Update Of Market Meltdown & Game Plan For Bottom Fishing
The Inflation/Higher Rates Camp Is the Winning Camp
Glad we closed out 77% of our risk capital and 90% of our massive profits starting in early September yet? Yea me too. We are obviously getting the technical correction--the market event NOT an economic event-- that we have been expecting and cautious about for a handful of reasons I have shared (why we took profits on most positions and did not jump into richly valued Enterprise Cloud leaders for instance). Look, September and October are always seasonally weak, to begin with. We are in the 4th quarter "stock buyback blackout" period before earnings where the big stock buyback players (FB, Apple, MSFT, Micron etc) cannot buy back stock (which takes that very important marginal buyer bid out of the big indexes). The market assumed that after NAFTA was resolved, the Tariff-Maker-In-Chief would turn to a "deal" in China and get that done BEFORE the midterm elections. Now we are turning up the bellicosity and China has taken the yuan down 10% this year to offset the 10% tariffs--so we must assume we are headed to 25% tariffs or China cries "Uncle." (FYI: My experiences in China tell me that assuming the Chinese to capitulate and lose "face" aka pride is a losing assumption--they negotiate to the death is my experience and they NEVER EVER lose face).
I always say, once you have rewired your mind to get CALM in these HEALTHY corrections--you can see the data and correlations cleary. Next, we need to work on our list of the BEST secular 3-5 growing companies riding waves of transformational change that are NOT priced for perfection. This is a healthy re-set for expectations, earnings growth,
What do I see? I see a much different world today than on Jan 2, 2018.
1) Remember, we started the year in "synchronous global growth." Now those same global synchronous global growers have stock markets in -20% bear markets or big-time corrections so that market action says that story is over. This is the Great Divergence I've talked about--how the US with our corporate tax rate cut doubled EPS and the rest of the world sat on the EPS sidelines.
2) When we started the year we had 20%+ year-over-year EPS growth purely from the first 4 quarters of corporate tax cuts. Now in Q1 2019, that story is over (meaning the rate of growth of the rate of EPS growth or "second derivative" for you nerds) has peaked.
3) The second derivative for after inflation GDP growth in 2019 is flat or slightly negative (when you remove corp. tax cuts and 3/4% GDP ding from 25% China tariffs).
4) When we started the year growth stocks lead value stocks for 10 years in a row--and momentum stocks outperformed regular growth. Now those same momo stocks are a source of funds and profits are being locked in. When all the profits that have to be taken are taken, we will bottom.
5) When we started the year we had no trade war with China and no tariffs with our two largest trading partners. Now we have settled Canada and Mexico but have fallen into a full-on trade war with the 2nd largest economy.
6) Long-term hyper-growth stocks without significant earnings and no dividends led the market higher risk and higher volatility.
7) We were a liquidity-driven market (lots of free money needing a home). That worldwide liquidity incoming tide is now receding.
8) We started the year with gross and net profit margins expanding. This week we got warnings from major industrial materials players PPG, Fastenal, and now Flower Corp. and others that input costs "oil prices, transportation and tariffs" have cut their margins 10% or more ( so we assume that they will raise THEIR prices to their business customers).
9) And of course, we started the year with 2.5% 10-year and now have a 3.25% 10-Year rate (which discounts future earnings at a 40% higher rate) AND we have a new Fed Chairman who is an old bond trader who told the market "We may very well raise rates beyond the neutral monetary stimulus point."
10) Semiconductor demand and prices were riding long-term growth--that wave peaked in late May/June and y-over-year growth (again the second derivative) peaked.
The FIRST question you have to answer is "Is this it? Did the double top on the Nasdaq Composite and QQQ and is this the end of the bull market or is this the run of the mill bull market correction? Our answer is our Transformity Investor MacroMarket index at 17.8--no recession in 4-6 months. Therefore, this is a good old correction aka a market event not a Main Street economic but it is also a risk reduction market. IF I am right, we should see the small caps and microcaps get killed. Check the IJE Microcap Index--check!
Next question: Is this a 50-day/100-day or 200-day moving average correction (meaning where is the support and oversold place where all the profits that will be taken have been taken and we hit a bottom in this bull market?) Here are the charts--notice the RSI or relative strength indicators--under 30 is oversold region. Answer: it is a 200-day moving average correction. Notice the EVEN weighted Nasdaq 100 Index (all members at the same weighted value) has broken the 200-day ahead of the market cap weighted index (that holds the 100 top market cap stocks by their percentage value of the 100--so if Amazon's $1 trillion market cap is 10% of the overall market cap of the QQQ 100, it is weighted 10%).
Then we look at the Transportation Index.
High growth areas of the stock market have stretched valuations simply because of how we discount the present value PV of those future forecast earnings. When you discount the present value of a stock's earnings you use the 3 or 5-year bond (which represents the future inflation rates) and means that the no-EPS hyper-growers should get whacked. The Dow Jones Internet Index HAS been whacked--yet the Software index is the healthiest chart I follow--which means that I have to believe there is more of a "pain trade" ahead:
IF this chart breaks its 200-day, then I will get excited. WHAT a run for DJ US Software companies--wow!
Are we at the bottom? Let's look at Transport and VIX volatility index tell us--breaking 25 is for sure--but like last January we won't see a 50 spike (that was 100% caused by huge imbalance from VIX day traders). Let's give it a few more days. Transports had a HUGE sell signal back when they rolled over earlier this year.
Actions to Take: #1 WE already TOOK the correct portfolio de-risking actions starting with selling semiconductors and semi-equipment in late August and early September (in addition to other sales earlier in the year in OLED and Data Center etc.). AMD NVDA and XYLNX are being sold since they are such big winners--"margined shareholders in highly volatile MOMO (price momentum) stocks sell what they can!" Earnings season starts Friday. They SHOULD hold their key support--so far so good. AMD has farther to go before it's oversold--IF you did not follow our SELL 2/3rs at $28 I'd protest profits but be ready to BUY with a swoosh down below its 200-day. If you bought AMD at $4.25 who ignored out SELL..I'd take your profits and sell something you have losses in to wash those profits. IF we really are shifting to a higher GDP growth/higher bond yield world, we have to stand aside and let ALL these "long duration" hyper growth stocks find a washout bottom. IF capital moves to "value" then the first stock we will buy is MICRON--now down just 10% from where we sold. But look at LRCX and AMAT--they are down 30-40% from where we sold...they have to be on "value investors" radar.
Final point ... Energy looking good, corporate turnarounds looking good, and cannabis stocks are living in their own world.
Breath deep...look at all that cash we have as an amazing opportunity. Our $10k a Month Portfolio sends us dividends every month and quarter that we are reinvesting and building value.
There are going to be some GREAT leaders of our Transformational Super Sectors come back into reasonable valuations. Let's wait for 10-year to hit 3.5% and see what happens--if that is the real signal for a shift to value we have a long list of value-priced plays on transformation sectors--starting with 5G players ATT and Verizon.