Weak Economic Reports Almost Catalyzes The First 5% Correction Of 2019

Weak Economic Reports - Another Down Day

There are several Weak Economic Reports that almost seem to be leading towards a correction. Thursday was another down day. S&P 500 fell 1.19%, Nasdaq fell 1.58%, and Russell 2000 fell 1.97%. 

The market is now at the low end of its recent range. There still hasn’t been a 5% decline this year, but that will likely change shortly. The headlines blamed the decline on trade fears, but I think the weak PMI caused the selloff. Even though I have been slightly bearish this month, I am increasingly open to the possibility of a short term rally. 

As you can see from the chart below, the short interest in the largest S&P 500 ETF is the highest since 2015. Bears are getting too confident. Furthermore, the CNN fear and greed index fell 4 points to 28. That puts it close to the extreme fear category.

Weak Economic Reports - Small Caps Underperform

Weak Economic Reports - It’s worth noting how much the Russell 2000 has underperformed the S&P 500 in the past few months. 

The chart below shows the relative strength of the Russell 2000 versus the S&P 500 just fell below the trough it hit late last year. You would think that the trade war would cause the big caps to fall more than the small caps. Weakness in the Russell 2000 is probably catalyzed by the weak economic reports. 

Weak economic reports explain why the trade war ending won’t be a panacea for the stock market. A trade deal would cause a big pop in the short term, but there is still cyclical weakness to work through.

Weak Economic Reports - Market Dynamics Support Slowdown Narrative

We know the economy is weak because of the economic reports I review, the strength in treasuries, and the rally in the utilities sector. The 10 year yield fell 9.7 basis points on Thursday to its lowest yield since October 2017. This was its biggest daily decline in January 3rd. It is now at only 2.33% which is 9 basis points below the Fed funds rate. 

2 year yield fell 10.1 basis points to its lowest level since February 2018. That was also its biggest daily drop since January 3rd. Its yield of 2.16% means the market is anticipating multiple rate cuts in the intermediate term.

It’s good to see the 10 year yield 17 basis points above the 2 year yield. But there can easily be an inversion if the Fed stays with its guidance for zero rate cuts this year. I think the stock market will fall sharply if the Fed maintains its guidance at its June 19th meeting. Fed funds futures market now shows there is a 77.6% chance of at least one rate cut this year. 

When stocks fall, rate cut odds go up. 

Weak Economic Reports - Odds of a cut in June went back up to 10% which goes against my forecast and what the Fed recently said in its Minutes.

Only 2 sectors increased on Thursday. It’s no surprise the utilities did the best as the sector increased 0.82%. Real estate was up 0.51%. 

As you can see from the chart above, the utilities have been trouncing emerging markets. The sector is now up 15.21% year to date which is way better than the S&P 500’s year to date gain of 12.58%. It’s amazing how much utilities have outperformed the market this month. S&P 500 is down 4.2% in May and the utilities sector is up 2.06%.

The worst sectors were energy and technology which fell 3.13% and 1.73%. SOXX semiconductor ETF fell another 1.56% as it is now down 16.48% since April 24th

Oil fell 5.7% to $57.91 as investors feared what could happen to demand if the trade war gets worse. Plus, there is the cyclical weakness which I discussed earlier.

Weak Economic Reports - Earnings Estimates Support The Bearish Thesis

Earnings estimates fell less than average in April which supported the stock market’s run in that month. May hasn’t been as great which explains why stocks have fallen. 

As you can see from the table below, the estimates for Q2 growth fell from 1.47% to 0.1% in the first 23 days of May. That’s a 1.37% drop. That’s more than the 0.57% drop in April and this month isn’t even over yet. Investors always knew that Q2 estimates would fall negative and go negative earlier in the quarter than Q1’s estimates did. But even I didn’t see estimates falling this quickly. 

It makes sense because of how bad the economic reports have been as it seems likely that Q2 GDP growth will be below 2%.

Q3 estimates are very close to where Q2 estimates were at this point in last quarter which means if estimates continue to fall at this clip, Q3 estimates will also go negative. Because estimates are almost always beaten, I still think Q2 and Q3 earnings growth will be positive. This is based on Earnings Scout’s calculations, but growth will be lower than Q1.

Target Reports Fabulous Earnings

Weak Economic Reports - we've reviewed the bad earnings reports from J.C. Penny, Nordstrom, and Kohl’s. Now let’s look at Target’s great report which came out Wednesday morning. 

Since Target is bigger than all those firm’s combined, it carries much more weight in determining the health of the consumer. Target reported $1.53 in EPS which beat estimates by 10 cents. It reported revenues of $17.63 billion which beat estimates by $110 million. Same store sales growth was 4.8% which beat estimates for 4.2%. This blowout quarter caused the stock to increase 10.34% in the past 2 days.

The company was helped by Valentine’s day and Easter. But keep in mind other retailers did bad with the same calendar set up. Target’s baby and toys business outperformed in the quarter. 

The company’s digital business was dominant as it grew 42% which makes it now 7.1% of the business. I expect that to get to the double digits very quickly. Target company stated the economic backdrop was healthy. That goes against Q1 real consumption growth which was only 1.2%. The economy almost always looks good to a firm that is taking market share. 

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1 Comment

  • Joseph G Krestan

    May 25, 2019

    Thanks for your work & information.