Monday, March 26, 2018

Melt Up Runs Out of Steam

Monday, March 26, 2018 - Surprises from Washington continued to drive down stocks last week as investors seek a respite from Trump. While the lack of control over user data at Facebook  and the newly appointed Fed Chairman Jerome Powell’s aggressive fed tightening move clearly hit the market hard, we think that fear of a new trade war with the imposition of tariffs on certain Chinese imports and China’s counter imposition of tariffs targeting US exports to China factored heavily into the plunge. All of these factors are certainly contributing to a slow build of a crisis of confidence in the ability of the GOP to govern with Trump in the WH. It is amazing how quickly investors’ perceptions changed after the State of the Union Address. It was if someone promptly threw cold water on the “Melt Up.”

Investors drove down key US indexes last week with the S&P 500 and the NASDAQ Composite dropping to 2,588.26 and 6,992.67 respectively for a weekly loss of -5.95% and -6.54%. More impressively the Large Cap S&P is down YTD -3.19% while the NASDAQ Composite is still up 1.29% YTD.

We are not ready to abandon that the odds favor US equity markets going up, albeit at a slower rate. Why?  First, economic growth continues to accelerate worldwide and that is good news for businesses, workers and investor profits. The US, Europe and Japan are on an upward economic trajectory.  Evidence of the pickup in economic activity can be seen in the recovery of spot oil prices which are now hover around $66 (US Light Sweet). This is a far cry from the depressed prices some 24 months ago. The move in oil prices has come from increased buyer demand – which is evidence of increased economic activity, not supply constraints which generally foreshadow inflation.

Secondly, let’s consider the effects of the fiscal stimulus of the corporate tax cuts. The new found money in corporate coffers will find its way either to Shareholders in the form of increased dividends and stock buybacks, to employees in the form of wage increases and one time bonuses (i.e., Walmart, VISA, Apple), business expansion (capital investments and R&D) and lastly and most importantly, in the short term, for investors, M&A. Additionally, one cannot underestimate the economic stimulus from relaxed regulation particularly on small to mid-sized businesses. Excess regulation acts as a friction on the economy as it does not generally add tangible value to GNP. To date, the Trump Administration has significantly rolled back many Obama-era executive orders. Recent relaxation of financial regulations around banking should benefit regional banks and small to mid-sized businesses.

The risk is that if Trump suddenly abandons his business friendly policies that characterized his first 12 months in office and starts to pursue his campaign populist policies to a degree that a real trade war develops. That ultimately would affect corporate profits and the economy in a negative way. Intellectual property rights however are a serious issue for American businesses doing business particularly in China and need to be addressed.

If indeed we are in a Bull Market, investors should be prepared to buy on any pullbacks but keep a cautious eye on interest rates. Keep in mind, that markets lack the liquidity that used to be the case some 10 years ago due to changes in market structure. ETF investors in particular should be mindful that in periods of high volatility since some thematic, fixed income and strategy ETFs could suddenly see widened spreads particularly in the smaller funds. Hence, investors should keep reserves and be prepared to take advantage of such opportunities.

Our Select List and Risk and Reward Ratings should be used to evaluate the vast set of opportunities in the ETF marketplace. Investing in ETFs requires a new approach to macro investing, one in which investors are just beginning to realize. Investors and traders are advised to check the ETFG Quant Movers daily for revisions to our ratings to gain insights into the latest news developments.

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