The Bullish Test Comes As Earnings Season Begins

In this issue of, “The Bullish Test Comes As Earnings Season Begins:”

• A Breakout Of Consolidation
• Updated Estimates As Earnings Begin
• A Quick Note On The Jobs Report
• Portfolio Positioning
• MacroView: The Fed Has Inflated Another Asset Bubble
• Sector & Market Analysis
• 401k Plan Manager

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Catch Up On What You Missed Last Week

Note:

I am on vacation this week for a quick break. However, I did want to post a short market and portfolio positioning update.

If you have any questions, I will continue to answer every question, every day. That is between sleeping on the beach, fishing, skiing, or eating. 

A Breakout Of Consolidation

Over the last few week’s we have noted the continuing consolidation of the market since the June peak.  When markets are overbought short-term, that condition is resolved through a correction or consolidation process. Such is what occurred during the last part of June and completed last week.

As shown below, the market broke out of that consolidation and triggered a “buy signals” across multiple measures. This breakout will give the “bulls” an advantage in the short-term with a retest of the June highs becoming highly probable.

The bulls will also gain some additional support from the “Golden Cross” (when the 50-dma crosses above the 200-dma). That “bullish signal” will likely occur over the next week or two depending on market action.

The “bullish supports” for the market are currently in play. Such keeps our portfolio allocations weighted towards equity risk. However, there are many fundamental and economic headwinds that could quickly derail the bullish thesis.

Seasonality In Play

In the short-term, the bulls remain in charge currently, and as such, we must be mindful of those trends. Also, the month of July tends to be one of the better performing months of the year.

As noted last week:

“With the sell-off on Friday, the short-term oversold condition, a reflexive rally next week would not be surprising.”

That rally reversed much of the short-term oversold condition. While the bulls are in control of the market currently, the upside is somewhat limited. However, the downside risks are reduced with the improvement in the technical underpinnings. Such puts the risk/reward dynamics to a more equally balanced, than opportunistic, positioning. As such, risk controls and hedges should remain for now.

• -1.4% to breakout level vs. +2.4% previous rally peak. (Neutral)
• -5% to 50/200 dma support vs. +4.9% to January peak (Neutral)
• -7% to previous consolidation peak vs. +6.5% to all-time highs. (Neutral)
• -13.4% to previous consolidation lows vs. +6.5% to all-time highs. (Negative)

Earnings Estimates Update

Over the next two weeks, we will enter the earnings season for all publicly traded corporations. Of course, we will mostly hear about those companies which comprise the S&P 500 index. I am writing a more comprehensive report on the earnings estimates for Tuesday’s “Technically Speaking.” Still, I did want to make a quick comment about what is coming.

As with every quarter, we are about to play “Millennial Soccer.” Such is where Wall Street analysts continually lower earnings estimates for the quarter until companies can beat them. When you see the analysis that 70% of companies beat their estimates, just remember analysts lowered the bar to a point where “everybody gets a trophy.” 

What will be important to pay attention to is “revenue,” which happens at the top of the income statement. Companies can do a lot to fudge bottom-line earnings by using accruals, “cookie jar” reserves, share buybacks, and a variety of other accounting gimmicks. It is much more difficult to manipulate revenue.

However, the market will focus on reported earnings. As stated, the estimates have fallen sharply over recent weeks, and are far lower than where they were set previously.

Importantly, while Wall Street has dramatically lowered estimates for the coming quarter, expectations remain for a rapid recovery in the economy. Given the rise in COVID-19 cases as of late, states pausing reopening, and depressionary levels of unemployment, it is highly likely those future estimates will ratchet sharply lower.

Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today even riskier.

“Price is what you pay, value is what you get.” – Warren Buffett

A Quick Note On The Jobs Report

While the BLS reported a massive 4.8 million in employment for June and a drop in the unemployment rate to 11.1%, these numbers remain distorted by bad data gathering and analysis.

As Mish Shedlock noted on Thursday:

“I question both the strength of the rise in jobs and the decline in the unemployment rate based on claims data and the reference week.”

I agree.

It’s hard to reconcile a 4.8 million increase in jobs in a month where you added over 4-million to initial jobless claims and continuing claims continued to remain near the highest levels on record.

More importantly, as noted by Zerohedge, there is a problem in the data when you have more people getting unemployment benefits than there are unemployed workers.

“As the DOL reported today, there were 19.29 million workers receiving unemployment insurance. And yet, somehow, at the same time, the BLS also represented that the total number of unemployed workers is, drumroll, 17.75 million.

If you said this makes no sense, and pointed out that the unemployment insurance number has to be smaller than the total unemployed number, you are right. And indeed, for 50 years of data, that was precisely the case.”

The main point here is that employment is what drives earnings, corporate profits, and GDP. Given the exceedingly high level of unemployment, in real terms, the recovery to earnings will much slower than expected.

Such suggests that expectations for the bull market to continue “to infinity and beyond,” will likely prove disappointing.

Portfolio Positioning Update

Let me restate our position from last week:

“With our portfolios almost entirely allocated towards equity risk in the short-term, we remain incredibly uncomfortable.”

Such remains the case this week.

As noted last week, with the market having gotten very oversold short-term, the reflexive rally off of support came as expected and achieved our first rally target.

Given that we are not yet to more extreme short-term overbought conditions and expectations of future earnings, the market can still retest the June highs. 

As noted last week, we used the counter-trend bounce to rebalance exposures. We took profits in CLX and UPS and rebalanced our “core positions” by reducing DIA and adding SPY. Our focus remains on capital preservation for the next couple of months, so our hedges in fixed income remain.

With the virus resurfacing, the potential risk of disappointment to the earnings and economic recovery story has risen. Our job remains the same, protect our client’s capital, reduce risk, and try to come out on the other side in one piece.

While we are certainly more bullish on markets currently, as momentum is still in play, it doesn’t mean we aren’t keenly aware of the risk.

Pay attention to what you own, and how much risk you are taking to generate returns. Going forward, this market will likely have a nasty habit of biting you when you least expect it.

The MacroView

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO

Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

S&P 500 Tear Sheet

Performance Analysis

Technical Composite

Sector Model Analysis & Risk Ranges

How To Read.

• The table compares each sector and market to the S&P 500 index on relative performance.
• The “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
• The risk range is a function of the month-end closing price and the “beta” of the sector or market.
• The table shows the price deviation above and below the weekly moving averages.

Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels.

Sector-by-Sector

Improving – Financials (XLF), Industrials (XLI), and Energy (XLE)

Last week, Financials moved into the improving quadrant of the rotation model, but will likely be short-lived. However, performance in the sector is weak. Energy and Industrial performance overall remains inadequate with a failure at the 200-dma. Energy is oversold and cheap on a value basis; we hold our exposures for now.

Current Positions: XLE

Outperforming – Materials (XLB), Technology (XLK), Discretionary (XLY), and Communications (XLC)

Discretionary, which had gotten very extended, corrected, and rallied this past week again. The sector is back to very overbought so that upside may be limited. After suggesting profit-taking previously, Communications has corrected a bit, reducing the overbought condition. Communications may provide an opportunity to add to the position. Technology remains short-term overbought. The opportunity may be to reduce Technology and add to Communications and Discretionary.

Current Positions: XLC, XLK, XLC

Weakening – Healthcare (XLV)

Previously, we added to our core defensive positions Healthcare. We continue to hold Healthcare on a longer-term basis as it tends to outperform in tougher markets and hedges risk. Healthcare is now sitting on support and is getting decently oversold. We may see a counter-trend rally in healthcare as it begins to catch some rotation.

Current Position: XLV

Lagging – Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Our defensive positioning in Staples, Real Estate, and Utilities has lagged but remains part of the “risk-off” rotation trade. We see early signs of improvement, suggesting it is the right place to be. If it turns up meaningfully, we will add to our current holdings.

Current Position: XLRE, XLU, & XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Two weeks ago, both of these markets were extremely overbought and susceptible to a pullback. Even with the pullback, neither market is oversold. Both markets are sitting on the last line of support. We maintain no holdings currently.

Current Position: None

Emerging, International (EEM) & Total International Markets (EFA)

Emerging and International Markets have performed better recently, and have not declined as much as the market. However, with the virus on the rise, there is a risk in these markets. Both of the markets are very overbought, so take profits and rebalance if needed. Pay attention to the dollar for your cue as to what to do next.

Current Position: None

S&P 500 Index (Core Holding) – Given the broad market’s overall uncertainty, we previously closed out our long-term core holdings. We are currently using DIA and SPY as a “Rental Trades” to pick up some bulk exposure for trading purposes. 

Current Position: None

Gold (GLD) – We currently remain comfortable with our exposure through IAU.  Gold is a bit overbought short-term, so we are looking to potentially take some profits and look for a pullback to rebuild exposures.

Current Position: IAU, UUP

Bonds (TLT) –

As we have been increasing our “equity” exposure in portfolios, we have added more to our holding in TLT to improve our “risk” hedge. However, with yields so low, and with the Fed supporting the mortgage-back and corporate bond markets, we swapped our near zero-yielding short-term Treasury funds for Mortgage-Backed and Broad Market bond funds with 2.5% yields.  No change this week.

Current Positions: TLT, MBB, & AGG

Sector / Market Recommendations

The table below shows thoughts on specific actions related to the current market environment.

(These are not recommendations or solicitations to take any action. Such is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)

Portfolio / Client Update

As noted last week, we used this week’s rally to rebalance portfolios a bit. Over the next couple of weeks, we will enter into earnings season where volatility will likely pick up a good bit.

We currently remained focused on protecting capital first, but we also want to mindful of performance. While our performance did drag in the during the last quarter, that drag came from the conscious choice of maintaining our fundamental discipline and not chasing bankrupt and fundamentally unsound companies. In the short-term, we did sacrifice some performance. Still, we believe that you will appreciate our attention to our discipline in the long-term and focus on fundamentals.

Changes

Last week we trimmed gains in both CLX and UPS. We were also overweight energy in the ETF Portfolio, so we sold XLE but are maintaining our holdings of XOM and CVX in both portfolios.

With States now starting to reverse reopening procedures, there is a risk to corporate outlooks as we enter earnings season. Also, with Congress not returning from break until the 20th of July, there is a chance of not getting an extension to unemployment benefits passed promptly. Such could cause a pick up in volatility in the short-term.

In the meantime, we are doing our best to maintain some risk controls to avoid being forced to sell emotionally. In the meantime, please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO