Battle Over Trendline Support Continues
Here is a brief update of our recent series of observations on the stock market. First of all, the SPX has just tested its major trendline for the third time after making yet another lower high – it is back below the 38% retracement level after a failed attempt to break through the 50% level. The same applies to NDX, DJI and NYA as well, but the RUT (Russell 2000) continues to outperform all the big cap and broad-based indexes noticeably.
SPX, daily: another downturn from a lower high, but the major trendline – and incidentally the 200-dma, which is situated very close to it – continues to hold so far. This chart, as well as those of the other major indexes, continues to look dangerous. The danger is mitigated by the outperformance of the RUT, as funds slosh around from one corner of the market to another (there doesn’t seem to be enough liquidity to keep all the plates in the air concurrently).
It is fair to say that the market hasn’t tipped its hand yet, but as we noted previously, a number of things differentiate this correction from previous ones. All the problems we discussed in our last update (see: “Happy Days Are Here Again? Not so Fast…” for details) continue to persist – except for the fact that the charts look even worse now. Since nothing has materially changed with respect to our signals, there is no need to update them at this time.
Narrative Failure?
There is however one thing worth commenting on. As we inter alia pointed out in our last update, we felt that there was a danger that the market reaction to earnings may not be “business as usual” this quarter. We argued that both valuations and expectations are by now so extremely stretched, that good news may no longer suffice to boost stock prices.
Although we did not say so explicitly, we did not want to indicate that companies would necessarily fail to “beat expectations” for the quarter as such. Rather, we thought that this might simply not be enough to trigger another round of valuation expansion. The market has in the meantime given some initial indications that may indeed be the case.
As usual, the big banks were the first major companies to report – and as far as we could see, their reports were good, but their stocks sold off after the perfunctory gap up open prints, a first hint that things may not go as smoothly in this earnings season as they normally do. This week things got even more interesting though.
GOOGL, CAT and MMM are three rather important stocks – the former two reported solid beats, the latter was merely “in line” (woe!) – and all of them sold off. Apparently a luxury miracle is urgently required at this stage.
Obviously, it is not a good sign when stocks start plunging on what superficially appear to be excellent news. We would note though that a recent analysis by Bernstein Research shows that the gap between “adjusted” operating earnings and GAAP earnings has begun to widen rather noticeably, which they mentions is a typical late cycle phenomenon. Interestingly, GAAP earnings remain solid, but “earnings without any of the bad stuff” are rising much more strongly. Here is a chart from their report illustrating the situation:
Do “investors” (we use the term loosely at this stage of the cycle) care about any of this? We would argue they don’t. We think the reasons why stocks are selling off are:
1. The slowdown in money supply growth over the past 18 months,
2. The fact that everybody got long up to their eyebrows into the late January peak (the mutual fund cash-to-assets ratio has plunged to a new all time low of just 2.9%, while NYSE margin debt is currently off by just $20 billion from a recent all time high in nosebleed territory of $640 billion) and
3. Interest rates are rising almost every day lately.
Short term interest rates continue to streak higher, day in, day out. We would note that treasuries have recently failed to catch a safe haven bid, which is bad news for “risk parity” funds and could become a problem for the market as a whole if it forces them to deleverage.
Conclusion
As we write this, stock market futures are trading up after FB’s report beat expectations as well – since it was the subject of lots of concern ahead of its earnings, the effect is likely to be more positive. Will it be enough to turn the tide? We doubt it.
As an aside, note that several AAPL suppliers have disappointed rather noticeably of late. Given that this stock (which is actually not overvalued based on trailing earnings, contrary to practically every other market darling) is also very important to the market, this is something worth keeping in mind.
One thing has been confirmed by the recent action: this correction is indeed different.
PS: 3M Details
We thought this press report on 3M’s earnings contained a few interesting tidbits, which we highlight below:
The company, which brands include Post-it, Scotch and Thinsulate, reported before Tuesday’s open first-quarter results that were in line with expectations. But the company trimmed its full-year guidance ranges for profit and revenue, citing softness in its automotive aftermarket, oral care and consumer electronics businesses.
That sent 3M’s stock MMM, -0.12% tumbling 6.8%, enough to pace the Dow Jones Industrial Average’s DJIA, +0.28% losers, as it heads for the lowest close since Sept. 5, 2017. The price decline of $14.75 was subtracted about 102 points off the Dow’s price, which dropped 423 points. The selloff was the biggest one-day post-earnings percentage decline since Oct. 19, 2007, when it tumbled 8.6% following 3M’s third-quarter 2007 results.
Obviously, “softness in the automotive aftermarket, oral care and consumer electronics” seems to be at odds with the “strong economy” meme. And it may be an omen that MMM last time suffered a similar one-day tumble right after the 2007 high in the SPX (an all time high at the time) – when everybody insisted that the economy was going gangbusters and the budding sub-prime crisis was still widely deemed “well-contained”.