Weekend trade headlines have spiked the futures 13 points on Sunday.
The Shanghai composite rose 2.64% on Monday with the Shenzen composite up 3.52%, the HSI up 1.16% and the Nikkei up 1.12%. The WSJ reported that the US and China are in the "final stage of completing a trade deal." Beijing has reportedly offered to lower tariffs on US products in order to sweeten the negotiated deal.
Earlier in the week NEC Secretary Larry Kudlow and Treasury Secretary Steve Mnuchin both said they were very pleased with the fantastic progress being made in the trade talks. The market turned briefly positive on that news but closed flat for the week. With the futures up 13 points late Sunday evening it looks like Monday could be off to a good start.
However, we only need to look at the intraday chart of the Dow from Friday to realize how quickly those futures gains can be erased. The Dow spiked 227 points at the open but gave it all back to trade flat by 11:30. Fortunately, the dip buyers were waiting.
With the major indexes at critical resistance levels we could easily reach a point where a futures triggered short squeeze could catapult us over those levels and cause an even bigger squeeze.
The China trade agreement is approaching completion and President Xi will meet with President Trump at his Florida resort for a photo op signing party. That could create a major market spike that could also turn into a sell the news event. With 10-weeks of gains since Christmas, we are very overdue for some real profit taking.
The last half of February was true to the historical trend. The Dow closed at 25,882 on expiration Friday and 26,027 this Friday for a whopping two week gain of 145 points. Trading was volatile but the peaks and valleys were minimal. The major indexes did not decline over the last two weeks, but they also made no forward progress.
The S&P has gained 11.8% in 2019 and that is the best start for any year since 1991. The Dow is up 11.6%, Nasdaq 14.5% and Russell 17.9% since the December 31st close. They are up even more if you count backwards to the December 26th low.
Unfortunately, all the major indexes are at critical resistance and it will be tough to produce a major breakout from here. The main reason is that the expectations for a China trade deal have already been priced into the market. When Kudlow and Mnuchin both praised the fantastic progress in the negotiations early in the week, the market barely moved. A couple months ago that would have produced a 400-point rally in the Dow. This is clear evidence the good news has already been discounted.
Since the Christmas bottom the S&P is up 19.5%, the Dow 19.9%, Nasdaq 22.7% and Russell 25.3%. That is two months and four days of gains. Most years don't see gains that big. With declining earnings growth, the odds are extremely high we are going to see some significant profit taking after the Chinese trade agreement and possibly ahead of it as cautious investors try to exit ahead of a sell the news event.
Also positive is the fact that analysts are expecting Q1 to be the trough in earnings with gains the rest of the year. They are not expecting big gains, but small gains are better than any loss. If we do get a China trade deal, the USMCA is approved by Congress and Britain has a peaceful and coordinated exit from the EU, the earnings estimates should rise along with the markets.
For the S&P the key level remains 2,815 and resistance from Oct/Nov. I believe if we can punch through that level on decent volume the next target will be the prior high at 2,930. This close to the old high that level becomes a self-fulfilling target. That does not mean we will simply blow through it to new highs because there is a better than 50:50 chance that it could turn out to be a double top.
The Dow missed extending its streak of gains to 10-weeks by 6 points. The index struggled for the week thanks to Apple, UnitedHealth, Home Depot and Walgreens. Baird added WBA to its "negative" list and shares fell 6% on Friday. Constant chatter about "Medicare for all" crashed the medical stocks and UnitedHealth shares fell -$25 in two days to knock roughly 175 points off the Dow.
If a trade deal appears in a couple weeks, we could see gains in CAT and MMM but even those tariff sensitive stocks have been struggling despite the positive news on negotiations.
We are right in the middle of the post earnings depression period and it will take some new headlines to lift us back to the highs.
The Nasdaq is holding right at resistance at 7,600 and has the best chance for a breakthrough. The next soft target would be 7,932 followed by 8,115. Two of the FANG stocks posted gains and two of them posted losses for the week. This kept the Nasdaq from advancing but the intraday dips were bought.
The Russell 2000 failed to decline materially for the week. The loss was only 0.42 of a point. The index is trapped between the 200 and 300 day averages and round number resistance at 1,600. I believe a breakout is imminent but until it happens, we are stuck at resistance.
This is payroll week with the ADP forecast at 195,000 and the nonfarm guesstimate at 180,000. Analysts have been missing these numbers by tens of thousands and anything close to 200,000 will be considered a success. On the nonfarm report the average for the last four months is right at 250,000. Employment is very strong and now that spring is just ahead the job numbers will rise as hiring for outdoor jobs accelerates.
The construction spending report will be ignored because it covers December and is a lagging number. The ISM nonmanufacturing for February is expected to rise slightly but after the drop in the manufacturing report, I am concerned we could see weakness here as well.
The Fed's Beige Book report on Wednesday should show there is no material decline in the economy. This is a detailed report of conditions in each of the Fed regions and should show continued expansion in most.
We are only two weeks out from another Fed meeting with the decision on March 20th. There is a 98.7% chance there will be no rate hike at that meeting according to the Fed funds futures.
The Brexit is now less than 30 days away. Parliament will get to vote again on March 12th on a plan for the exit. This plan is expected to look almost exactly like the plan that failed by a record 230 votes in January. If that vote fails, there will be a vote on the 13th to "crash out" of the EU with no plan in place and suffer the consequences. If that vote fails, there will be another vote on the 14th for a short-term extension of the Brexit date.
If the first two votes fail as expected it is almost a guarantee that the date will be extended. Crashing out of the EU would be extremely damaging to the British economy. However, the EU would also have to agree to extend the deadline. March is going to be a rough month for Thresa May.
If Britain ends up with a hard Brexit it will impact our market as well because of the severe economic disruptions in Europe.
The pace of earnings continues to slow but there are some big names reporting next week. SalesForce.com, Costco, Target, Dollar Tree and Ross Stores are the highlights.
With 484 S&P 500 companies already reported the earnings expectations are now 16.7% growth. Q4 revenue is expected to rise 5.1% with 69.2% of companies beating on earnings and 60.2% beating on revenue. For Q1 there has been 70 guidance warnings and 31 guidance upgrades. The current PE is 16.6. There are 10 S&P companies reporting this week.
The earnings estimate for Q1 has declined from 5.3% as of January 1st, 2018, 8.1% as of October 1st to -1.1% as of Friday's close. Q2 growth estimates are now 3.2%, Q3 2.9% and Q4 9.3% growth. The early quarters have huge comps of more than 20% in 2018 and that is proving to be a monster hurdle. ANY earnings growth in the first three quarters of 2019 would be positive given those huge comps.
I believe we are going higher simply because the China trade deal has not yet happened and there is still some hope for a miracle rally. Add to that the gravitational pull from the prior highs and that is prompting investors to put more money at risk. However, with roughly 20% gains since Christmas, there will be profit taking. The only question is where and when. Reaching the prior highs on a China trade agreement could be the trigger for a meaningful decline.
I had a very tough time finding a recommendation this week. Stocks were either at new highs like ADP but with $15-$30 LEAP premiums or they are crashing from post earnings depression. With the markets testing critical resistance and futures up 13 on Sunday evening, any momentum stock is going to gap open on Monday. I had to go through my entire 700 stock screen before I could find something where the risk/reward was somewhat balanced. I hate to recommend a stock at new highs, but the strong employment is showing no signs of fading and that is ringing the cash register for ADP.
I want to thank everyone for their thoughts and prayers for my son last week. He is now out of the hospital and recovering nicely after a serious scare.
Enter passively and exit aggressively!
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