Fund Managers Are Bullish On American Stocks

Fund Managers - Bearish Emerging Markets, Bullish On America

The Chinese economy seems in a tailspin. Fund managers surveyed by Merrill Lynch expect global growth to fall in the next 12 months.

As you can see from the chart below, the September z-score on American stocks is the highest at 1.3. The recent sell off in tech stocks has caused the tech z-score to go negative.

Emerging markets are the exact opposite of America as their z-score is -1.3. While it’s easy to claim American stocks are overbought and emerging markets are oversold, there’s a reason for this action.

There are few catalysts outside of the Fed raising rates too quickly.

A trade war that could end this bull market in American stocks in the next few months. I just discussed weak sales results from 4 firms. Clearly that doesn’t determine where the market is headed.

I still expect good results in Q3. I’m watching Facebook, Netflix, and Tesla’s earnings the closest.

Fund Managers - Rising Rates Aren’t A Problem

The chart above shows bonds have a slightly negative z-score, but the American treasury selling is much worse as the 2 year has the highest yield of the cycle and the 10 year is near the cycle peak.

Don’t get confused between the Fed increasing the funds rate too much and treasury yields increasing. Fed rate hikes occurring too quickly could invert the yield curve, while the long bond yield increasing steepens the curve.

It has recently been steepening as the 10 year yield has stayed above 3%. The chart below shows the 10 year yield rising with the stock market. The key is for the 10 year yield to rise more because of improved growth expectations than because of increasing inflation expectations.

Fund Managers - Slight Weakness In The Empire Fed Report

In August there were mixed regional Fed manufacturing reports, a ridiculously strong ISM PMI, a weakening Markit PMI, and moderate growth in the hard data industrial production report.

To summarize, growth wasn’t as weak as some of the regional Fed reports suggested, but the average of the five reports was more accurate than the ISM report.

With that in mind, let’s review the Empire Fed manufacturing report from September. As you can see in the chart below, general business conditions fell from 25.6 to 19.

This missed the consensus for 23 and the low end of the range which is 20. The 6 month forward looking index also weakened as it fell 4.5 points to 30.3. To be clear, the Empire Fed report wasn’t one of the weak ones in August and this report isn’t bad.

The new orders index fell 0.6 to 16.5. Because of weakness in demand, the supply chain looks better.

Unfilled orders index fell 6.2 points to 4.9, the delivery time index fell 3.9 points to 6.5, and inventories increased from 0 to 8.9. Inflation was still hot despite the improvement in the supply chain as the prices paid index increased 1.1 to 46.3 and the prices received index fell 3.7 points to 16.3.

The future expectaions showed similar declines as the current indexes as the new orders index fell 2.7 points to 33.3, shipments fell 2.5 points to 35.2, capital expenditures fell 7.2 points to 19.5, and technology spending fell 2 points to 10.6.

Fund Managers - Sales Results Look Weak

The meat of Q3 earnings season won’t start for a few weeks, but we already have a few earnings reports to decipher. Q3 earnings growth was supposed to be the highest in 2018 because of easy comparisons and the positive trend, but the quarter hasn’t started out great in terms of sales.

The table below shows the results from the first 5 reports. We also got Red Hat’s report after the close on Wednesday. As you can see, 4 of the 5 firms beat EPS estimates.

Since Red Hat reported 85 cents in EPS which beat estimates for 82 cents, the updated record is 5 beats out of 6 reports.

However, since Red Hat missed revenue estimates, 4 out of 6 firms have missed their revenue estimates.

Red Hat’s revenue was up 14% year over year to $822.7 million which missed estimates for $830 million. Because EPS estimates are usually beaten, stocks often react to sales and guidance.

This explains why Red Hat stock fell 4.44% after hours on Wednesday and why General Mills stock fell 7.6% on Tuesday. Red Hat also missed guidance as it expects 87 cents in EPS next quarter while analysts expected 92 cents.

Obviously, this is only 6 firms, so we can’t make any sweeping judgements, but if this trend continues in the next few weeks, the stock market won’t be able to move higher.

Fund Managers - Redbook & Housing Stats

Last week’s Redbook same store sales report which was released this Tuesday saw year over year growth fall from 6.3% to 5.4%. This is far from a tragedy as growth is still strong and the back to school season is over, so the results aren’t as important.

These growth rates are relatively similar to the year over year growth in retail sales which was 6.6% in August and 6.7% in July.

The September housing market index was 67 which met the consensus and was the same as August. This is the lowest reading since September 2017.

Consumers believe the economy is great for home buying, but affordability is a problem. The latter point is reflected in the housing market index as traffic hit 49 which is the lowest reading since October 2017. Traffic is hurt by lack of affordability and lack of interest.

The best parts of the report were sales indications increasing 1 point to 74 and future sales increasing 2 points to 74.

The MBA mortgage applications composite index was up 1.6% week over week. That’s up from the 1.8% decline in the previous week. The purchase index was up 0.3% week over week and the refinance index was up 4%.

The refinance index was down 6% last week, hitting the lowest point since December 2000 because of rising rates. As you can see from the chart below, mortgage interest rates adjusted for PCE have been increasing rapidly on a year over year basis.

Mortgage rates are the highest since April 2011 as the average 30 year fixed rate is 4.88%. Purchase applications are now up year over year after declining in the summer.

 

 

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