Given
all that is going on, we decided to call upon our friends Jessica Rabe and Nick
Colas at DataTrek to get their insights.
Below is their view...
Markets
have been heavy, so let’s start with a light but brief story before digging
through some of the important issues as we start the week…
In
1973, the editors of British magazine New Music Express put Keith Richards at
the top of their annual “rock stars most likely to die within the year” list. He remained at the top of this stack for the
next decade. It was a logical guess,
given Keith’s hard driving lifestyle. After a decade, however, NME had to face the inevitable: Keith Richards
is immortal.
Plenty
of market observers have the 2009, present bull market on a similar deathwatch,
but that story (courtesy of a 2010 New Yorker article) is a good reminder that
the seemingly obvious doesn’t always come to pass. With
that, three things to know as we kick off what will certainly be another
volatile week in US and global equities:
#1.
Last week’s 3.9% selloff for the S&P 500 notwithstanding, corporate
earnings reports were actually much better than the prior week. In fact, Q3 earnings season is now actually
ahead of the 5-year average “beat” percentage. The numbers (source: FactSet):
Through
October 19th (when just 17% of the S&P 500 had reported
earnings), the average company had beaten their Q3 earnings expectations by
3.9%. The mean year-on-year earnings
growth rate was 19.5%.
Through
last Friday (with 48% of companies reporting), the average S&P company has
beaten expectations by 6.5%, above both the prior week and the 5-year average
of 4.6%. Average earnings growth now
stands at 22.5%, which represents a notable acceleration from last week.
Last
week’s financial reports also showed better revenue growth than the prior
week. The numbers: 7.6% year-on-year
growth versus 7.4% last week.
So
why did stocks sell off if everything is so good? Worries about the Fed, yes. But despite the better beat percentages,
analysts actually cut their Q4 2018 estimates. Last week, they were looking for 16.5% year-on-year growth. Now that
number is 16.1%. Wall Street is also
reluctant to boost their 2019 numbers, which remained unchanged this week
despite the better tone of earnings reports.
Bottom
line: Q4 numbers may continue to come down this week even if last week’s better
beat rates continue, an unwelcomed development. This is something we did not see mentioned anywhere, but it neatly
explains why the pullback has a fundamental as well as macro explanation.
#2.
The market’s game of “I double dare you” with the Federal Reserve
continues. The latest odds on rate
increases (source: CME):
Fed
Funds Futures show a 30% chance the Fed skips the widely expected December 2018
rate increase. A week ago the odds were
16%. If
the Fed does go in December, futures now make the odds of a March 2019 increase
at just 40%, down from 50% a week ago.
Bottom
line: while Fed Funds Futures may be repricing rates, the 2-year Treasury
market isn’t really buying it yet. Yields of 2.81% are the same as at the start of October. That’s
important, since this is the most visible measure of riskless opportunity cost
for equity investors. We’ll need to see
2-year Treasury rates come down further to see equity prices stabilize, in our
opinion.
#3.
Trends in US equity sector correlations explains a large part of why the CBOE
VIX Index remains lower than feels “right” given recent volatility. The numbers and some background:
Back
during the February – April 2018 volatility spike, the average S&P 500
sector was 0.80 – 0.80 correlated in terms of daily price action to the S&P
500 as a whole. (We use 30 day trailing correlations for this measure.)
Over
the last 30 days, the average S&P 500 sector is 0.72 correlated to the
index, even with the recent volatility. That is 14% lower than the vol shock earlier this year. Why the difference? Utilities, Consumer
Staples and Real Estate are decoupling – something they did not do from
February – April.
Bottom
line: to our thinking it is a spike in sector correlations that signals an
investable bottom for US stocks, and this is an underappreciated input into the
behavior of the VIX “fear” Index. Watching correlations worked during the February – April selloff and
accurately tracked the 2-month bottoming process. The current 0.72 reading is
not yet back to the +0.80 readings that signifies the start of an investable
low. In Churchill-ian terms, we’re more
at the end of the beginning than the beginning of the end.
Summing
up: everything here points to more US/global equity volatility and the real
chance for further losses this week. Cuts to Q4 earnings expectations and correlations tell that story well
enough. A sticky 2-year Treasury yield
only reinforces it. Like Keith Richards,
these aren’t likely enough to kill stocks outright. But they are enough where the bearish
deathwatch will continue.
For
a more in-depth commentary, visit www.datatrekresearch.com
_________
Now
let’s look at our ETFG Weekly Select List
To best support the ETF
selection process, the ETFG Weekly Select List highlights the 5 most highly
rated ETFs per Sector, Geographic Region and Strategy as ranked by the ETFG Quant model.
Below we highlight the ETFs that attracted our attention:
For
those looking for defensive sectors the top slots this week went to KXI in
Consumer Staples, IBB in Health Care, KIE in Energy—jumping from 5 to top place
and FUTY in the Utility Group.
For
the more adventurous, check out EFA which jumped from 5 to 1 reflecting a value
play in the benchmark EAFE index, while EMIF continued to stay in the top slot
being a play on Emerging Markets Infrastructure. For those looking for income, PFXF was
ranked top in the Preferred Sector.
Volatility
is likely to return this week however, at some point the markets will find a
bottom which will yield buying opportunities. We suggest keeping a mindful eye on tools like our Select List
and Risk and Reward Ratings that can be used to evaluate the vast set of
opportunities in the ETF marketplace.
Today’s market realities require a new
approach to macro investing, one in which individual investors now have access
to tools via ETPs to customize risk and return profiles in their portfolios.
Use our Scanner to find those funds.
Thank
you for reading ETF Global Perspectives!
ETFG 21 Day Free
Trial: https://www.etfg.com/signup/quick
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