Investors Lose Confidence

Market Summary

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Wall Street sold off for three consecutive sessions as the stock market ended its worst week in over three months. The three major U.S. indexes ended the week down more than 3%, firmly putting the brakes on a fast rally that began in October. The Dow lost 3.7% for the week, the S&P 500 shed 3.6% and the Nasdaq declined 4.3%. Up 4% year-to-date, Nasdaq is the only major index in the black for the year. Wall Street, which enjoyed its best October in four years and started off fast in November, reverted back to risk-off mode. Investors are finding more reasons to hold off on buying stocks, with worries ranging from overvalued stocks, higher interest rates, weak results from key retailers and ongoing angst over the impact of China's economic slowdown. If the Fed hikes rate in December it could mark an unprecedented conflict between a tightening cycle starting at the same time as earnings fall into recession. "We can't think of any instances when the Fed was hiking during an (earnings) recession," said Joseph Zidle, portfolio strategist at Richard Bernstein Advisors in New York. "In the last six months one can point at a lot of different things. But if you think about fundamentals, falling corporate profits and the threat of rising rates" are behind the market stalling, Zidle said.

Investors are grappling with uncertain market conditions due to the first Fed rate hike in nearly a decade, global economic worries, falling oil prices and fears of a weakening retail sector. S&P 500 earnings are on track to close their first reporting season of negative growth since the Great Recession and estimates call for sub-zero growth in the current quarter as well. As reported by Reuters, with more than 90% of S&P 500 components having reported, S&P 500 earnings are down 0.9 percent in the third quarter. Absent surprisingly high numbers from the companies left to report, it will be the first negative growth quarter since the third quarter of 2009. Fourth-quarter estimates are for a 2.4% earnings contraction, according to Thomson Reuters IBES data; that would set up the two quarters of declining earnings, required for a bona fide 'earnings recession.' That already occurred in the second and third quarters, according to FactSet Research Systems, which calculates its quarterly results slightly differently than does Thomson Reuters. Furthermore, the decline in revenue has been steeper than that in earnings, a bad sign for investors who like to put money into companies that are growing sales and not just cutting costs or buying back their own shares. Last quarter's sales are seen falling 4.3% and estimates for the current quarter are for a 2.7% decline. Last week was the first down week of the fourth-quarter. As seen in the graph below, quarterly results remain solid for equity indexes. Interest rate sensitive asset classes such as bonds and precious metals remain depressed ahead of the Feds December interest rate announcement.

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Last week’s analysis “…a pending change in the market trend…indicators point to declining momentum while the trend has converted into a trading range. This supports our contention that the grossly overbought strength indicator needs to be resolved before the stocks move much higher…” This analysis is confirmed in the updated chart as investors aggressively selling off stocks have started a price downtrend. Momentum indicators have turned bearish to confirm the downtrend

Investment Analysis

The updated graph below reflects investors’ expectation of a December rate increase. The S&P Financial sector is soaring because financial institutions normally benefit from higher interest rates that they can pass on to their customers. Other S&P sectors are starting to wane ahead of the Feds December rate announcement. Utilities sectors is getting smashed because similar to bonds, these stocks perform better in a low rate environment. According to the Stock Trader’s Almanac, the week before Thanksgiving has an overall bullish history. The DOW was up 16 of the last 21 years the week before Thanksgiving with losses in 2003(-1.4%), 2004 (-0.8%), 2008 (-5.3%), 2011 (-2.9%) and 2012 (-1.8%). Next week is also an options expiration week. Monday of expiration week has been down 9 of the last 16 years for the DOW, but Friday is up 11 of the last 13 years with an average gain of 0.7%. S&P 500, NASDAQ and Russell 2000 have not been as bullish as the DOW around or on November option expiration. S&P 500 has advanced only 14 times during options expiration week while NASDAQ and Russell 2000 have climbed only 12 and 11 times respectively over the past 21 years. Any weakness next week could be a good entry point for new longs ahead of the usually bullish Thanksgiving holiday. There is usually solid strength during the week after options expiration since 2001. The worst blemish on the recent 14-year history is 2011.

By Gregory Clay

Investment Strategist

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