Published by Raymond James & Associates Jeffrey D. Saut, Chief Investment Strategist, (727) 567-2644, Jeffrey.Saut@RaymondJames.com Scott J. Brown, Ph.D., (727) 567-2603, Scott.J.Brown@RaymondJames.com Andrew Adams, CFA, CMT, (727) 567-4807, Andrew.Adams@RaymondJames.com July 31, 2018 A Monthly Chart Presentation and Discussion Pulling Together the Disciplines of Economics, Fundamentals, Technical Analysis, and Quantitative Analysis What If This Is As Good As It Gets? In our recent travels we keep getting asked, How can the economy and stock market get any better? That brought back memories of a scene from the 1997 movie As Good as It Gets starring Jack Nicholson. The scene is where Nicholson s character (Melvin Udall) is walking out of his psychiatrist s office, he turns to the other patients in the waiting room and says, What if this is as good as it gets? It is a reasonable question given the improvement in the economy and a 300%+ move in the S&P 500 (see page 3). Yet, the history of secular bull markets is that they typically last 14+ years and tend to compound at 15% per year. Most investor believe the secular bull market began in March 2009, but the majority of stocks bottomed on October 10, 2008. On that date, 92.6% of traded stocks made new annual lows. Our notes on the equity markets go back to the 1960 s and we have never seen such a reading before. It is a seven or eight standard deviation event, meaning it is not supposed to occur in your lifetime. So, in our opinion, the secular bull started in October 2008. We can even make a cogent argument that the bull didn t begin until the major averages broke out of the 2000 2013 trading range in April of 2013. Indeed, nobody measures the 1982 2000 secular bull market from the nominal price low of December 1974 (March 2009 was this market s nominal price low). They measure it from when the major averages broke out of the 1966 1982 trading range in August 1982, but we digress. So, most use March 2009 as the starting point; okay, fair enough. Using that as a starting point implies this bull should last at least until 2023 (14 years). Some pundits actually believe this will be the greatest bull market of all time. In our lifetime, 1982 2000 was the longest secular bull we have experienced. If, by chance, this one equates to that one, it suggests a target date of 2027 (18 years), yet few individual investors believe it. Speaking of big bases that stocks break out of, it has been proven that the longer the base (1966 1982 or 2000 2013), the greater the subsequent bull market. To this point, the Value Line Geometric Index definitively broke out above a 19-year base in September 2017. If one uses that as a starting point, well you can run the numbers. It has also been said that an investor will experience three secular bull markets in their lifetime. For the first one, you will not have much money to do much with it. In the third bull market, you will be too old to take enough risk to really capitalize on it. Therefore, you better take full advantage of the second bull market in your lifetime. For us, this is the second secular bull market of our lifetime and we are investing accordingly. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863
Contents Market Review with Jeffrey Saut... 3 Economic & Market Update... 9 Stock Trends/Quantitative Analysis with Andrew Adams... 10 Economic Review with Scott Brown... 20 Important Disclosures... 38 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 2
Jeffrey Saut What If This Is As Good As It Gets Is A Reasonable Question After a ~302% Rally by the S&P 500 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 3
Jeffrey Saut But Secular Bull Markets Typically Last 14+ Years and Compound at About 15% per Year (1949-1966 or 1982-2000) International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 4
Jeffrey Saut The Value Line Geometric Index Definitively Broke Out of a 19-Year Base in September 2017. Such Long Bases Tend to Support Major Secular Bull Markets. The Only Other Such Base We Can Find is in Japan. Source: FactSet. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 5
Jeffrey Saut Obviously it is Earnings That Are Driving the Equity Markets and With Margins Staying Wide, the Strong Earnings Trend Should Continue International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 6
Jeffrey Saut With Earnings This Strong, Valuations Are Not Out of Line International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 7
Jeffrey Saut Returns and Valuation by Sector as of June 30, 2018 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 8
Economic & Market Update Equity Markets/Technical Analysis Monetary Policy, Inflation, FX U.S. Economy Global Economy Market Outlook While the broader market has had a nice start to 3Q, volume has been light and participation narrow. Earnings have been a bright spot to be sure, but trade noise may pick up into Labor Day before easing before the midterm elections. High multiple tech names seem to be taking a breather. All said, we still expect downside to be limited and pullbacks should be seen as buying opportunities. S&P 500 Earnings At the halfway mark of earnings season, 83% of S&P 500 companies have reported positive EPS surprises. The current blended earnings growth rate is 21.3% - would be the highest since 3Q10. Looking forward, analysts currently project earnings to grow at about 20% for the remainder of 2018, but predict lower growth for first half of 2019. S&P 500 Earnings estimates* 2018 - $158.02, 2019 - $175.65 Current P/E: 2018 17.7x, 2019 16.0x Estimates only slightly higher, valuation more so after rally S&P 500 Key support: 2800, 2785, 2770, 2745, 2707-2710 Key resistance: 2850, 2872 Sectors Overweight: Information Technology, Financials, Healthcare, Industrials, Energy Equal Weight: Consumer Discretionary Underweight: Consumer Staples, Materials, Utilities, Real Estate, Telecom Fed Chair Powell Monetary Policy Testimony (July 17 testimony to Congress) Little changed in Fed Chairman Powell s testimony to Congress, but did add for now qualifier with regards to policy, opening up the possibility for a change should conditions deteriorate: the FOMC believes that for now the best way forward is to keep gradually raising the Fed Funds rate. Personal Income and Spending (Bureau Economic Analysis) June figures were in line with expectations. Comprehensive revisions boosted the level of income and savings. The core PCE Price Index rose modestly, leaving the year-over-year increase at 1.9% (just below the Fed s 2% inflation goal). Consumer Price Index/Producer Price Index: CPI (July 12) The CPI was up 2.9% from a year ago (vs. +2.8% y/y in June). Core inflation was in line with expectations, up 2.3% y/y (highest y/y gain since August 2016). PPI (July 11) The PPI rose a bit more than expected in June (+0.3% vs. median forecast +0.2%), reflecting higher prices of energy and trade services. The PPI report tends to surprise relative to the median forecast, so the slightly-strongerthan-anticipated numbers for June aren t (by themselves) a big deal. However, pipeline inflation pressures remain elevated a concern for Fed policymakers. Exchange rates (July 31) EUR/USD $1.173 - GBP/USD$1.315 - unch USD/JPY 111.51 - USD/CAD $1.304 - Real GDP Advance Estimate 2Q18 (Bureau of Economic Analysis) Real GDP came in at 4.1% vs. median forecast of 4.1% and 3.0% in 2Q17. While the headline data met expectations, recent data (durable goods shipments and inventories, wholesale and retail inventories, and merchandise trade) pointed to about 0.5 percentage point less than that. Consumer spending (68% of GDP) rebounded (2.2% vs. 0.5%), with a downward revision to an already-weak 1Q18. With little growth in real earnings, consumer spending likely to slow in 2H. Industrial Production (Federal Reserve) The headline figure was as expected in June (median forecast: +0.6%), reflecting a rebound from the May fire at an auto parts supplier. Retail Sales (Census Bureau) - Headline figures (+0.5%) were as expected, although core sales rose a little less than anticipated however, previous figures were revised higher so, on balance, a somewhat stronger-than-expected report overall. June Employment Report (Bureau of Labor Statistics) Nonfarm Payrolls rose by 213,000 in the initial estimate for June (median forecast: +195,000). The three-month average gain for privatesector payrolls was 205,000 (vs. an average monthly gain of +221,000 in 1Q18). The Unemployment Rate rose to 4.0% (median forecast: 3.8% vs. 3.755% in May). U.S.- EU trade U.S. and EU agreed to de-escalate trade tensions following a meeting between President Trump and EU President Juncker (WSJ, Bloomberg). U.S. and EU agreed to work together toward zero tariffs on non-auto industrial goods. Trump noted EU will almost immediately boost purchases of U.S. soybeans. Also plan to strengthen strategic energy cooperation, set up a working group to carry out a joint trade agenda and reform the WTO. Trump said issue of steel and aluminum tariffs, as well as retaliatory tariffs, will get resolved. Juncker noted as long as talks are ongoing, U.S. and EU will hold off on further tariffs. ECB Policy Statement ECB left its key policy settings on hold. The meeting was largely uneventful after it set out plans for monetary policy for 4Q last month. Biggest area of contention since June decision has been around rate guidance and whether it could raise rates before summer 2019. President Draghi said the English version of ECB statement is only one conveying Governing Council message of unchanged rates through summer 2019. Source: FactSet, Bloomberg, Raymond James Research. S&P 500 earnings estimates are bottom-up operating earnings as of 7/19/18 market close, provided by Standard & Poor s. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 9
Andrew Adams S&P 500 Back in Middle of Channel Since bottoming in early 2016, the S&P 500 has mostly stayed confined within a clear rising up-trend channel. Early this year the index did experience a bit of a blow-off move that took it up above the top of that channel, a sign that it was getting overheated, but now the multi-month consolidation has helped to make the market less extended. The S&P 500 now sits about right in the middle of that up-trend channel, in mostly neutral territory. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 10
Andrew Adams Near-Term Zones of Interest The S&P 500 continues to move in a pattern of higher highs and lows over the short term (that s good), but recently entered a zone of likely resistance near the January all-time high (that s bad). There should still be decent support in the 2760-2800 area, however, and considering not much trading volume was done near the high earlier this year, we continue to think the S&P 500 should eventually muster enough strength to break out to the upside. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 11
Andrew Adams Advance-Decline Line Not Yet Flashing Danger We have recently put a lot of emphasis on the NYSE Advance-Decline Line and have repeatedly mentioned that it s one of the main reasons we are not overly concerned right now. The reason for this is that the A-D Line has made new highs over the last couple of months even as indices like the S&P 500 and DJIA have not. We would much rather see this happen than have it be the other way around, since a rising A-D Line means that more stocks are still going up than are going down. The NYSE A-D Line was a reliable signal prior the 2000 and 2007 tops in the S&P 500, as it peaked well in advance of both of those highs. It gave an almost two-year warning back in the late 1990s, as the A-D Line rolled over and started going down in 1998, while in 2007 it gave several months notice that not all was right under the surface. Considering it just hit a new all-time high on Thursday, July 26 th, it is not yet flashing warning signs. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 12
Andrew Adams Breadth Not Great, But Not Breaking Down Either Recently, the market breadth readings haven t been spectacular, but we re also not seeing a worrying breakdown either. The five-day total of U.S. stocks making new highs continues to be greater than the number making new lows, and the overall breadth picture seems to be consistent with the sideways consolidation that has occurred since the January high in the S&P 500. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 13
Andrew Adams Technology Tries to Weather the Storm The Technology sector has had to deal with some notable breakdowns in a few individual stocks over the last week, but so far it appears to be remaining fairly resilient overall. The long-term uptrend is not even close to being in danger, though it is worth mentioning that Technology may see some near-term pressure vs. the broad S&P 500 thanks to the current negative sentiment. Technology has led the S&P 500 for most of the last five years, but it may be due for a bit of a pause against the broad market. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 14
Andrew Adams U.S. Dollar Has Paused The U.S. Dollar Index shot up in April and May, likely because global investors poured into U.S. assets for safety due to fears about a trade war, but since the start of June, the index has mostly been range-bound. Until the dollar breaks out to the upside or breaks down to the downside, we won t really have much technical help on which direction it s next significant move may be, but it is worth noting that it still looks to be making higher highs and higher lows, perhaps making it more likely we ll see an eventual upward breakout. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 15
Andrew Adams Crude Oil Also Taking a Breather Meanwhile, the price of crude oil remains contained within its own trading range. The area around $75 looks to be the resistance zone to watch, while the commodity should have quite a bit of support in the $60-$65 zone. Until a breakout of breakdown comes, we have to assume it will remain range-bound. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 16
Andrew Adams World Stocks Looking Better The U.S. stock market has held in there better than the rest of the world throughout the trade war concerns, but now it does appear the MSCI World (ex-usa) Index may be reversing to the upside. After what looks to be a false breakdown in late June/early July, global stocks have rallied to break the downtrend line that contained them going back to the January high. There is still work to do, including getting back above the 40-week (roughly 200-day moving average; orange line), but the recent action is promising. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 17
Andrew Adams Emerging Markets Still Offer a Good Risk/Reward A similar move has been witnessed in the MSCI Emerging Markets Index, which bounced off support around the 38.2% Fibonacci retracement level of the 2016-2018 uptrend. We continue to think emerging markets offer a pretty good riskto-reward trade for more aggressive investors as long as they stay above the recent low. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 18
Andrew Adams Gold Nearing a Bottom? The technical action in gold has been nothing short of horrible over the last several months, as the metal has broken down through several support levels during its downtrend. However, gold is nearing a $1200-$1225 support zone that should bring in some bottom-feeders. If the metal is going to turn around in the near-to-intermediate term, this would be the zone we d expect to produce the reversal. Source: Stockcharts.com. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 19
Scott Brown The Economy in Brief Real GDP rose at a 4.1% annual rate in the advance estimate for 2Q18, following a 2.2% pace in 1Q18, reflecting a rebound in consumer spending growth and a surge in agricultural exports (which should reverse in 3Q18). Consumer spending (68% of GDP) rose at a 4.0% pace vs. +0.5% in 1Q18, averaging a 2.2% annual rate in the first half. Business fixed investment rose at a 7.3% annual rate vs. +11.5% in 1Q18, with the rebound in energy exploration accounting for more than a third of that gain. Research and development spending rose. Spending on industrial machinery and transportation equipment fell. The White House imposed tariffs on $34 billion in Chinese goods in July, which invited Chinese retaliatory tariffs on U.S. goods. The U.S. and the European Union agreed not to raise tariffs on each other while negotiations continue. Progress is reported on NAFTA negotiations. The Federal Reserve is still on track to raise short-term interest rates again in late September and (most likely) mid-december. Fed officials view the recent pace of growth as beyond a long-term sustainable pace. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 20
Scott Brown Trade Policy The U.S. runs large trade deficits because we consume more than we produce (or equivalently, we do not save enough) not because we are getting ripped off on trade deals. If tariffs were zero, the U.S. would still run a sizable trade deficit. While there is an aggregate benefit from foreign trade, there are dislocations (job and industry losses) and the U.S. has not done a good job of easing the transitions. About half of the manufacturing jobs lost since 2000 have been due to technology. Focusing on bilateral trade balances is misguided. For example, China imports parts and materials from around the world and exports assembled goods to the U.S. Focusing on unilateral agreements (such as the TPP) would produce better results. Tariffs are a tax paid for by U.S. consumers and businesses. Tariffs raise costs, invite retaliatory tariffs, disrupt supply chains, and discourage international investment. To date, while increased tariffs have had a significant impact on certain sectors, the aggregate impact has been small. However, the risks of broader trade conflicts are a key downside risk to the growth outlook. Manufacturers in all districts expressed concern about tariffs and in many districts reported higher prices and supply disruptions that they attributed to the new trade policies. Fed Beige Book (July 18) The recently announced and anticipated tariff increases by the United States and retaliatory measures by trading partners have increased the likelihood of escalating and sustained trade actions. These could derail the recovery and depress medium-term growth prospects, both through their direct impact on resource allocation and productivity and by raising uncertainty and taking a toll on investment. Financial market conditions remain accommodative for advanced economies with compressed spreads, stretched valuations in some markets, and low volatility but this could change rapidly. Possible triggers include rising trade tensions and conflicts, geopolitical concerns, and mounting political uncertainty. IMF World Economic Outlook (update, July 16) International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 21
Scott Brown 2Q GDP Growth Was Led By a Rebound in Consumer Spending, Which Followed a Weak 1Q18 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 22
Scott Brown Comprehensive Revisions Left Some Residual Seasonality International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 23
Scott Brown Underlying Domestic Demand Growth Remains Strong International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 24
Scott Brown The Current Expansion is the Second Longest on Record International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 25
Scott Brown While Flatter, the Yield Curve is Not Signaling a Recession International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 26
Scott Brown Job Growth Has Remained Strong International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 27
Scott Brown The Unemployment Rate is Trending Lower International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 28
Scott Brown Real Wage Growth Has Been Flat International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 29
Scott Brown Pipeline Inflation Pressures Are Elevated International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 30
Scott Brown Little Flow-Through of Goods Inflation to the Consumer International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 31
Scott Brown The Fed is Near its 2% Inflation Goal International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 32
Scott Brown Fed Officials Are Divided on Three or Four Rate Hikes in 2018 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 33
Scott Brown The Market Sees Slower Rate Increases in 2019 International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 34
Scott Brown Fed Policy Outlook it is difficult to predict the ultimate outcome of current discussions over trade policy as well as the size and timing of the economic effects of the recent changes in fiscal policy. Overall, we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate... With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that -- for now -- the best way forward is to keep gradually raising the federal funds rate. We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary policy will be appropriate. As always, our actions will depend on the economic outlook, which may change as we receive new data. -Powell Monetary Policy Testimony (July 17) International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 35
Scott Brown Economic Indicator Growth Employment Status Comments Following a strong but uneven first half, the pace of growth is likely to moderate in the second half of the year, partly reflecting labor market constraints. Trade policy is a downside risk. Labor demand should remain strong in the near term, but supply constraints are expected to become more binding. Consumer Spending Business Investment Manufacturing Uneven in the first half and a mixed bag. Tax cuts have helped at the high end. For the typical worker, inflation-adjusted earnings have been flat over the last year. Sentiment remains strong, although there is concern about the negative impact of tariffs. The energy recovery is contributing, but should moderate at some point. New orders and production have been mixed, but the pace has been generally lackluster-to-moderate. Trade tariffs are a concern. Housing and Construction Inflation Monetary Policy Long-Term Interest Rates Fiscal Policy Builders continue to note supply constraints (lack of skilled labor, higher costs). Demand remains strong. Home prices have continued to rise, making affordability an important issue. Increased tariffs add to commodity price pressures. Wage gains are moderate. Consumer price inflation is at the Fed s goal, but officials have indicate a tolerance for somewhat higher inflation. Fed policy remains accommodative (according to the June 13 FOMC statement), but is nearing neutral. The Fed is expected to raise rates further, but should be gradual. A strengthening economy and increased government borrowing would normally send bond yields higher. However, trade policy concerns and geopolitical risks have led to a flight to safety. Tax cuts and added spending are providing support for the economy in the near term, but budget deficit projections have risen sharply. The Dollar Trade policy conflicts and concerns about global economic risks have led to a flight to safety into U.S. Treasuries and the dollar. Rest of the World The global economic outlook was strong at the start of the year. However, supply chain disruptions and Fed rate increases have negative impacts on emerging economies. Nationalistic tendencies and Brexit are concerns in Europe. International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 36
Scott Brown Key Calendar Dates August 3 August 9 August 10 August 15 Employment Report (July) Producer Price Index (July) Consumer Price Index (July) Retail Sales (July) Industrial Production (July) August 16 Building Permits, Housing Starts (July) August 22 FOMC Minutes (August 1) August 24 August 29 September 3 September 7 September 26 November 6 November 8 December 19 Durable Goods Orders (July) Real GDP (2Q18, 2nd estimate) Labor Day (markets closed) Employment Report (August) FOMC Policy Decision (Powell press conference) Election Day FOMC Policy Decision (no press conference) FOMC Policy Decision (Powell press conference International Headquarters: The Raymond James Financial Center 880 Carillon Parkway St. Petersburg, Florida 33716 800-248-8863 37
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