By Pete Biebel, Senior Vice President

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There’s a new item to add to the list of factors that are sucking the bullish enthusiasm out of the stock market.  It’s no secret that over the years there’s been a tendency for new IPO (initial public offering) stocks to rip higher when they are initially made available to the public.  However, the recent wave of IPOs has had more than the typical share of stinkers.  Several of those were highly anticipated, big-name “disruptive technology” companies.  In every case the stock prices soared in the minutes following the opening of the stock for public trading, but in too many cases the euphoria died relatively quickly, and the share price slumped back below the IPO price.  This is not an encouraging development for the market.  When something that has “always” worked in the past shows signs of faltering, it’s a hint that things may not be as wonderful as they seem.  So, in addition to rising trade tensions, a less dovish Fed, threats of impeachment and an apparently the stalling of a major infrastructure spending bill, “IPO-suction” has recently been responsible for trimming some of the fat off stock prices.

Like many occasional dieters who go through cycles of eating, overeating, then dieting, the market has a tendency to go through a similar cycle with respect to political, economic and earnings news.  It reacts, overreacts, then corrects.  Like the foodie cycle, the market’s binges are enjoyably satisfying, and the inevitable corrections are uncomfortable if not painful.

Following the market’s crash diet in December, stocks quickly put the poundage back on through the first quarter of the year, digesting better than expected earnings and stronger than expected economic growth.  The averages continued to plump up through April, though at a noticeably slower pace, feasting on headlines that suggested progress was being made in the trade talks with China.  The S&P 500 Index (SPX) was looking particularly pudgy at its May Day mayday, when (allegedly) comments from Fed chair Powell caused the index to reverse down from a new high and close with a loss for the day.

Since then, the averages have trended lower, shedding a bit of the excess.  Several of the less corpulent sectors like Consumer Staples, Financials and Communication Services haven’t needed much of an adjustment in their diet.  Several others like Consumer Discretionary, Industrials and Technology have undergone the market’s version of a tummy tuck.

A quick look at the recent performances of the various sectors suggests that the one factor that has outweighed all others has been the deterioration of progress in the trade talks.  The threat of a trade war and the likely subsequent slowdown in global economic growth have caused interest rates to decline steeply along with the prices of raw materials like industrial metals, timber, crude oil and other commodities.  They have also caused stock prices in emerging market countries to be considerably weaker than the more developed markets.

The yield on the benchmark Ten-Year Treasury Notes, which peaked a bit above 3.2% late last year, spent most of the first quarter of this year between 2.6% and 2.8%, largely based on the Fed’s more dovish stance.  Since late-April, that yield has skidded even lower, last week falling to 2.32%, its lowest level in nearly a year-and-a-half.  Lower rates helped to support interest rate-sensitive sectors.  Utilities and Real Estate were among the better performing sectors last week.  The lower rates also helped to hold up prices of emerging market bonds even as stock prices in those countries sank.  Indices of Chinese stocks and emerging market stocks as a group have declined 10% to 12% in the past five weeks.

Over the past five weeks, the three poorest performing of the U.S. equity sectors have been Industrials (-5.9%), Basic Materials (-7.0%) and Energy (-8.4%).  Those last two aren’t any surprise; they were a couple of the more conspicuous laggards in the market’s rally through the first four months of the year.  The recent weakness in the Industrials sector, which had nearly climbed back to its all-time high by late-April, is a different story.  That sector’s change in character is a testament to how much the swing in the trade-talk optimism/pessimism has impacted the market.

Another sector that has been a big loser due to trade war fears is Technology.  The S&P Technology Sector Index has dropped about 8% since its May 1st high.  It hit its lowest level in about two months last week but is still about 3% above its 200-day moving average.  One significant contributor to the weakness in Tech has been the sudden softness in the values of semiconductor stocks.  The PHLX Semiconductor Index charged up by nearly 50% from its December low to its late-April high.  But then, as trade war fears rose, those stock prices sank.  That PHLX index has lost about 18% in the past month; it ended last week at its 200-day moving average and near its lowest level in three months.

While the recent market action has been noticeably negative, so far there hasn’t been too much damage.  This recent slide could still turn out to be just a timeout in a continuing uptrend.  But, “too much damage” is not too far away.  The Dow Jones Industrial Average (DJIA) looks the worst of the big three.  It tagged its 200-day moving average at its low last week.  The NASDAQ Composite Index (COMP) ended the week less than 1% above its 200-day.  SPX has a little more breathing room.  Its 200-day is hovering near 2777, nearly 2% below SPX’s Friday closing level, 2826.06.

The broad index that has been on a more severe diet this month is the Russell 2000 Index of small-cap stocks (RUT).  It didn’t plump-up as much as its larger-cap brethren through early-2019, so for it to be shedding a lot of weight now is not a healthy condition.  It briefly poked above its 200-day moving average in April, but barely got above its February high and was still well short of its Summer 2018 high.  By the end of the first week of May it was already back below its 200-day.  If it falls much more, it will take out its February and March pullback lows.  That would be a very negative development for the overall market.

Until that happens, there is still hope for higher highs.  It wouldn’t take a lot to be convinced that the market has reverted to its gluttonous ways; just climbing back above 2900 on SPX would indicate that the short-term timeout was over, and that SPX could be heading to the low-3000s.

The critical area for SPX is just a percent or two below Friday’s closing level.  To keep the bulls salivating for higher prices, SPX needs to hold in or above the 2775 – 2800 range.  That index has already held at 2800 twice in the past two weeks.  Its 200-day moving average is near 2777.  Sustained trading below that level would likely be followed by an acceleration in the downtrend.  After a nearly uninterrupted rally from Christmas Eve to May Day it might be time for the market to take an extended holiday.  My guess is that if the 200-day moving average fails, SPX would likely be headed for the 2650 area, roughly the midpoint of the year-to-date rally.  So, no reason to panic, but no rush to buy the dips.

Perhaps we should be thankful that the market was closed yesterday.  The reason is that this month of May has not been very merry for Mondays.  Each Monday morning this month has been greeted with a significant gap-down opening, usually the result of news suggesting that any near-term resolution of the trade talks was becoming less likely.

As has been the case, we should expect markets to be atwitter over trade talk headlines through the week ahead.  This week brings a full economic report calendar, but not much of significance.  The GDP report on Thursday should be fun to watch, but more as a curiosity than a catalyst.

Date Report Previous Consensus
Monday 5/27/2019 Memorial Day Holiday – Markets Closed
Tuesday 5/28/2019 S&P Case-Shiller Home Price Index, M/M +0.2% +0.2%
Consumer Confidence 129.2  129.8
Dallas Fed Manufacturing Survey, General Activity 2.0 7.0
Wednesday 5/29/2019 Richmond Fed Manufacturing Index 3 6
Thursday 5/30/2019 Real GDP, Q/Q, SAAR 3.2%  3.0%
International Trade in Goods, Trade Deficit $71.4B  $72.0B
Jobless Claims 211K 215K
Pending Home Sales, M/M +3.8%  +0.3%
Friday 5/31/2019 Personal Income & Outlays, Income, M/M +0.1% +0.3%
Personal Income & Outlays, Spending, M/M +0.9% +0.2%
Chicago PMI – Business Barometer Index 52.6  53.7
Consumer Sentiment 102.4  101.0

 

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