As we head into the final month of summer, we head into Wall Street’s traditional slow season. Statistically August and September are two of the worst months of the year as traders partake in their annual migration to the Hamptons.  Add in questions surrounding the strength of the economy and be prepared for the “Bears” to come out with their stock market crash predictions.

However, computers running AI programs ripping off trades that round trip in nano seconds, don’t take vacations. I’m not so sure that their AI programmers accounted for tradition and have programmed in a slow period just because the calendar has turned to August. I’d rather look at some facts. And assume that whatever happens over the next couple of months, some rationality will return in the fall to correct any excess over the next couple of months, whether positive or negative.

The Market

A poplar talking point when election talk heats up, is that the market is not the economy. While stock prices aren’t much of an indicator, company earnings are. If businesses have strong earnings, and expectations that future earnings growth will remain strong there is little chance of an imminent recession, baring the infamous “Black Swan” event, (something completely unforeseen at this time). If you have read this blog or any of my writings prior, you are aware that earnings are everything when it comes to stock valuation. While we use multiple resources for overall money management, Zacks is my go-to for earnings reports and outlooks. Zacks main investment thesis is that companies that beat expectations with their earnings will see the greatest price appreciation. Earnings is their bread and butter. They must be pretty good at it. So, what is Zacks saying about 2nd quarter earnings? Remember the background here is that GDP came in at a tepid 2.1% growth rate, albeit slightly above expectations.

From the www.zacks.com Earnings Trend Report 7/24/2019 (subscription required):

While most companies are beating estimates, the tone and substance of management commentary is on the cautious side, with uncertainty about global trade a notable headwind. 

Total earnings for the 138 S&P 500 members that have reported Q2 results already are up +2.8% on +3.4% higher revenues, with 79.0% beating EPS estimates and 59.4% beating revenue estimates.

The earnings and revenue growth pace for these 138 index members is unsurprisingly very weak relative to other recent periods. The proportion of these index members beating EPS estimates is about in-line with historical trends, but positive revenue surprises are modestly on the low side.

I have two positive take aways from the report. First, comparisons are to 2nd quarter 2018 when GDP came in at 3.!% boosted by the Trump tax package. Seeing an earnings decline is not a surprise. 2. Much of the current softness and expected 3rd quarter declines are being attributed to the trade war with China. Transportation and large exporters like Caterpillar have most definitely been affected. The positive? Most naysayers were saying it would be much worse. Between the trade situation and the economy facing a restrictive Fed for the first time in a decade, 2.1% growth was pretty solid.

The Economy

Every week, every month, every year some entity is producing some statistic that market pundits spend a day or two interpreting their meaning in terms of the economy’s direction. Not only are we overwhelmed by the shear number of statistics but determining what is actually predictive and what is not keeps many an economist employed. My go-to for a quick look at the economy is www.econpi.com

They take many of the most meaningful statistics and create a “Mean of Coordinates” (MoC) indicator which is plotted weekly along with its components. They also plot the Leading Indicators average. LD theoretically pulls out only the economic statistics that show some predictive ability as most indicators fall into the “hindsight is 20/20 category”. Finally, this is all put together in a very nice and intuitive graph.

The most recent update from 7/26/2019 is below. You can go to their website for a complete explanation and historical graphs (no subscription required).

BaR Analysis Grid - 7/26/19 Update

Each quad is labelled as to where each indicator lies in the economic cycle. A quick look shows:

  • The red square MoC is in the decline quad – meaning overall the indicators have been slowing. However, it is well above the baseline, meaning the MoC is still showing growth above a baseline or average level. It is well above the larger red rectangle that is labelled as to where the MoC has been during the start of the last two recessions. This is consistent with positive and modest GDP growth.
  • The Green LD box, the leading indicators is still in the expansion quad. Meaning the forward-looking indicators are still leaning toward further economic growth

What’s it All Mean?

As the saying goes, “Hope for the best, but prepare for the worst”. While I don’t expect “the worst” I do expect volatility, primarily in the wrong direction over the next few months. There is little chance of a trade truce with China until after the 2020 election. The Chinese are hoping for a Democratic win and hopes of a reversion to our old policies; remove tariff’s on Chinese imports, while they maintain their tariff’s, illegal trade practices and intellectual theft of our U S goods. There is potentially too much for China to gain from a Democratic win to cave in to Trump now. 

Economic indicators and earnings are both showing enough strength to keep this expansion on track. Third quarter economic growth and earnings will likely be anemic. Earnings may dip into negative growth territory, but economic indicators should stay positive. If business outlook turns positive for the fourth quarter expect a solid fourth quarter rally. 

What is not being talked about, in terms of the affect on our economy, is our debt. With interest payments rising to the second largest category of Federal expenditures, our economy is being choked off by such a large amount of unproductive spending. In addition, the lack of qualified labor is further choking economic growth. This gets worse as more and more baby boomers leave the work force with fewer unemployed willing to step into the openings. Labor shortages in in transportation, retail and skilled trades are very real. 

Steps to Take

For 401k investors, definitely stay the course. But if you are not using our service at www.FundTraderPro.com or through our office www.401Advisor.com do be aware, Fidelity and potentially other Target Date Fund providers have gotten more aggressive in this rising market to capture more gains. Sounds ok except last time they did this was prior to the 2008 – 2009 crash which resulted in some large losses. When the “Pro’s” start doing what they say you shouldn’t do – change your long-term strategy based on short term market conditions, then it could be a sign to worry!

For other investors, now is the time to stress test the portfolio. How is it likely to hold up if the market does crash? If you’re currently an aggressive investor, it may be time to be more prudent and think of the long term. No one ever went broke taking their profits!

Good luck and enjoy the rest of your summer. And for our clients, relax while we watch the markets for you.

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