The following is an excerpt from the commentary of Jeffrey Saut, chief investment strategist and managing director of equity research at Raymond James & Associates, for Monday, Oct. 29. To read the full commentary, click here.
“Unseasonably mild and clearing” was the weather forecast going into the Ides of March back in the year of 1888. And it was true, as temperatures hovered in the 40s and 50s along the East Coast. However, torrential rains began falling, and on March 12th, the rain changed to heavy snow, temperatures plunged, and sustained winds of more than fifty miles per hour blew. The “Great White Hurricane” had begun! In the next 36 hours, some 50 inches of snow would blanket New York City, and the winds would whip that snow into 40- to 50-foot snowdrifts. Telegraph and telephone lines were snapped, fire stations were immobilized, New Yorkers could not get out of their homes, 200 ships were blown aground, and 400 people would die before the storm was over. The resulting transportation crisis led to the construction of New York's subway system.
I revisit The White Hurricane this morning because it potentially looks like another 100-year storm is heading pretty close to Manhattan. While in modern day it shouldn't cause the horror seen in 1888, it is still a force to be reckoned with. If, by chance, the storm heads up the Hudson River it could cause the partial evacuation of New York City. So in addition to dealing with the Benghazi scandal, Syrian atrocities, Euroquake, the “fiscal cliff,” a stalled U.S. economy, softening earnings momentum, waning revenues, a dysfunctional government, the nastiest campaign I have ever seen, and who Taylor Swift should date next, Wall Street now has to contend with the potential of being flooded out. What is fascinating, at least to me, is how well the equity markets have held together despite the deluge of dour news. Indeed, while I was laid up with the flu most of last week, the S&P 500 (SPX/1411.94) was also “laid up,” locked in a trading range between roughly 1407 and 1420 the past three trading sessions. As stated in my daily reports (The Morning Tack):
“About the most constructive thing I can say concerning the recent action is that the SPX has been trying to hold around the intraday lows (@1407). The quid pro quo is that it has not been able to travel decisively above the 1418 'pivot point' I was using as a downside 'energy level' for three weeks (read: on a short-term trading basis we should have held above 1418).”
Unfortunately, studying the attendant SPX chart shows that the downside consolidation pattern of closing prices are clustered near the weekly “lows,” which is not suggestive of an imminent rebound (see chart on page 3). Instead, this looks like it could lead to a temporary breakdown below the often mentioned 1390 – 1400 support zone. While it may not happen, if it does I think it would be a “false breakdown,” like the one we identified last year on October 4th (@1075). That expectation is because while the stock market's internal energy is no longer fully charged, it is also not used up. Further, the McClellan Oscillator is still moderately oversold, the number of SPX stocks above their respective 50-day moving averages (DMAs) has fallen from 85% to Friday's 44.2% (approaching oversold levels), many of the market indices tested (and held) their respective 200-DMAs last week, the bearish sentiment is pervasive, the NASDAQ is fully oversold, and we saw buying on weakness last Friday.
Clearly, slowing earnings have been the overriding boogie man. Yet while the earnings season remains sketchy, with only 60.7% of all stocks reporting beating estimates and 44.8% bettering revenue estimates, the economic reports have been strengthening for the past few weeks. Last week, of the 14 economic reports released, eight were above expectations, five below, and one was in line. Such metrics lifted Bespoke Investment Group's Economic Diffusion Index to its highest level since March 2011 (see chart on page 3). The highlight of the week was Friday's GDP report, which caused our economist Dr. Scott Brown to write:
The headline figure was a bit better than expected. Consumer spending growth was moderate, but a bit less than expected. Business fixed investment was weak, but less than anticipated (structures down and equipment and software flat). Inventories failed to add, and net exports subtracted only modestly. Government spending surprised to the upside and was concentrated largely in defense. Real personal income growth was weak. Core PCE price inflation remained below the Fed's 2% target. These figures will be revised and revised again.
Of particular interest to me was that Nominal GDP rose 4.8%, versus the estimate of +3.9%, driven by a 2.8% reading from the Price Deflator (vs. +2.1%E). That was the second biggest gain since 3Q08! This is not an unimportant point, for our economy actually needs more inflation. Last week, however, that higher inflation rate was not reflected in the three major commodity indices I monitor, nor was it reflected in gold prices. Nevertheless, our Canada-based precious metals analyst, Brad Humphrey, thinks an inflection may be near and writes:
For investors looking for an attractive entry point into Gold and Gold Equities, historical patterns, the current macro backdrop and a more positive view towards gold equities suggests the next strong rally in Gold and Gold Equities is just around the corner (following the quarterly reporting period). Although approaching a US election we doubt any asset class will be trading in its “typical” fashion, given gold is off some $90/oz since October 1 and heading for its first down month since the beginning of the summer. We felt it was worth reviewing where gold may be heading based on the historical rally/retreat patterns. As we have experienced over the past several years, we continue to expect gold to trade in a -/+$200/ozpa range for the next several years, so the recent move is not out of character. We continue to view the current macro backdrop as supportive for gold prices and we do not anticipate any significant pullback as long as real rates remain at low levels (currently negative - and will likely remain low until at least 2015/2016).
While there are many mutual funds, closed-end funds, and ETFs that play to the metals theme [one of my favorites is the Van Eck International Investor Gold Fund managed by my friend Joe Foster (INIVX/$19.18)], for individual stock ideas please refer to our Canadian research reports.
This week we are treated to a plethora of economic releases punctuated by Friday's employment report. The consensus unemployment number for October is 7.9% (vs. last month's 7.8%) with nonfarm payrolls estimated to rise to 124,000 from the previous month's 114,000. Of course to me it really doesn't matter what the numbers are, for while many whine the numbers are being manipulated for political reasons, I have opined that the government's numbers are always wrong, which is why the subsequent revisions have such a wide variance to the original reports.
The call for this week: It's been said when you get a headline, a picture, and a lead story about “anything” appearing on the front page of a major newspaper, the end of that theme is near. Over the weekend the front page of Barron's had all three of those metrics along with the byline, “Money managers turn surprisingly bearish.” Moreover, the only sector that has been smashed in this pullback has been Technology, while most of the other macro sectors merely consolidated. Hence, if technology can bottom (its seasonally strong period is October – December), it could set the stage for decent tech price-performance into year-end, potentially carrying the stock market along for the ride. This morning, however, the markets will be closed due to the hurricane. If they were open, based on the current preopening futures, it looks like the 1390 – 1400 support level would come into play with the potential of a breakdown below 1390 a possibility as hurricane Sandy heads to town, so batten down the hatches and rig for heavy weather…