At the end of August, we noted a disconnect between the news flow and the markets performance:
“The often-cited adage is that the stock market climbs the wall of worry. I would suggest that the current market is instead climbing the wall of “whatever”, because no one seems particularly worried about anything. The global supply chain and trade agreements are all in flux, not only with China, but also with the EU and NAFTA as well. “Whatever”. The Fed is raising short-term rates and unwinding its massive multi-trillion-dollar balance sheet. “Whatever”. The 10-2 Year Treasury spread (historically a good predictor of recessions) is at its lowest level since right before the financial crisis. “Whatever”. Italy, Turkey, Argentina, Venezuela, Greece, to name a few countries, are all experiencing significant economic difficulties. “Whatever”. The “axis of evil” is alive and well and expanding, with President Donald Trump directing Secretary of State Mike Pompeo to delay a planned trip to North Korea, citing insufficient progress on denuclearization. “Whatever”. The legal problems for the White House keep intensifying, as Cohen pleaded guilty to bank and tax fraud, including campaign finance violations, and Manafort was convicted on eight felony counts. During an interview on Fox & Friends, President Trump said “If I ever got impeached, I think the market would crash. I think everybody would be very poor”. “Whatever”. At North Star, we remain believers in the stock market, recognizing that corporate profits are surging, consumer sentiment is high, while unemployment and interest rates are low. Our enthusiasm remains tempered by all the event risks identified above, as well as the “whatever” attitude that most market participants seem to have adopted. In short, with the market trading at an all-time high, we think it is a good time for investors to be prepared for a moment when the complacency of the crowd gets tested.”
Turn the calendar forward 4 months, and unfortunately that “moment” is upon us. The recent downtrend intensified last week, with the S&P 500 and Russell 2000 both posting their largest weekly losses in a decade of 7.05% and 8.42% respectively.
It might get worse before it gets better, but the stock market at approximately 14.7 times 2018 earnings seems very reasonably priced, particularly with the Ten-Year Treasury rate at 2.79%. In other words, the earnings yield at 6.8% is an attractive 4% higher than the risk-free rate. Nevertheless, panic has set in, with record outflows from equity funds being registered over the past few weeks, and the level of bearishness amongst individuals at its highest level since the financial crisis. It seems particularly curious that concerns over Fed policy have been largely responsible for the recent downdraft. News flash: The Fed is almost done raising rates, with the target Fed Funds rate at 2.5%, up from 0% a few years ago, and likely to top out at between 2.75% and 3%. Trading algorithms have made matters worse, as on a very basic level they simply exacerbate the trend. For the past few weeks there has been an imbalance, with a wave of more natural sellers than buyers, with the sell-off motivating investors to take year-end tax losses to offset gains realized earlier in the year. The computers race to beat the natural sellers, creating additional downward pressure. In the face of declining prices, buyers have stepped to the sidelines waiting for better entry points.
U.S. markets close early on Monday and will remain closed on Tuesday for the Christmas holiday. The economic calendar is very light for the remainder of the week, although the December Consumer Confidence Index on Thursday might be interesting given the recent turmoil. Hopefully the tax loss sellers and algorithmic traders will be on vacation.
Stocks in the News:
Except for one day in 1987, and the six months during the financial crisis of 2008-2009, I have never witnessed such widespread selling pressure without any regard to valuation in my 35 years in this business. The following companies all posted double digit declines without any specific related news:
A.H. Belo, Corp. (AHC), Arc Document Solutions, Inc. (ARC), Build-A-Bear Workshop, Inc. (BBW), 1-800- Flowers.com, Inc. (FLWS), LSI Industries, Inc. (LYTS), Orion Energy Systems, Inc. (OESX), Superior Group of Companies, Inc. (SGC), U.S. Auto Parts Network, Inc. (PRTS), BG Staffing, Inc. (BGSF), CatchMark Timber Trust, Inc. (CTT), Consolidated Communications Holdings, Inc. (CNSL), National CineMedia, Inc. (NCMI), Westwood Holdings Group, Inc. (WHG), The York Water Co. (YORW), Advanced Micro Devices, Inc. (AMD), AMC Entertainment Holdings, Inc. (AMC), Celgene Corp. (CELG), CVS Health Corp. (CVS), PetIQ Inc.(PETQ), Under Armour, Inc. (UAA).