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Volatile days until Trade War meeting this Friday

After multiple downbeat economic reports earlier in the week, the SP500 SPX finally recovered little to finish the week down only 0.3%, thanks to Friday Jobs Report. Early week, poor numbers out of the manufacturing and services sectors, pushed the SPX down more than 1% for consecutive sessions for the first time this year. Friday’s jobs report showed that the U.S. economy added 136,000 jobs in September which was slightly below expectations, and the jobless rate dropped from 3.7% to 3.5%.  This marked a 50 year low in the figure.  

ISM indexes drive the markets

We already knew that the manufacturing sector has been struggling. Still, the ISM came in at 47.8, which is worse than expected. It’s the lowest number in more than 10 years, but not yet a recession (comes below 45). But last week it seems there was a "contagion". The ISM Non-Manufacturing Report was also below expectations. The reading was 52.6, which was the lowest in three years. Wall Street had been expecting 55. Since it’s above 50, we know that the Non-Manufacturing is still expanding, but it challenges the theory on Wall Street that the consumer is holding up the economy while the factory sector is in a recession.

This ISM Services number initially sent stocks sharply lower, but then quickly rebounded to finish higher on the day, when the SP500 touches its SMA200 average.  Some felt that the recent data was bad enough to induce the Fed to lower rates twice by the end of the year (thanks to this week’s news, the odds of a rate cut are now up to 88% from 40%) making the bizarre case that Wall Street rallies on bad news. 

According to Nomura Bank, usually very accurate in their technical analysis, the action level for the algos in the SP500 chart are setting this week in 2,970 for buy orders and 2,858 for sell orders and open shorts, that's near the SMA200 average. Today SPX is dropping 0.8% but is still ranging between those levels, waiting Trade War decisions, likely in Thrusday.

Trade War resolution: key to defining a future recession

The markets will be patiently awaiting the results of the US-China trade negotiations on Thursday and Friday. And it is all very clear, it is now up to Donald Trump to decide what will happen with the trade agreement, with the exchanges, and with the economy.

The Chinese have changed their attitude and now they see Donald Trump in a weak position, because his economy is already affected, because financial markets threaten to give problems, because they know he may have re-election problems if a recession is reached before the elections, and of course because he has many political problems (impeachment). 

The Chinese Trade Minister has made it clear that they will not make any concessions. Without any doubt, they will not accept any of the great reforms that the United States poses. He has even expressly said that intellectual property laws will not change, one of the most conflicting points. But on the other hand, they have made it clear that they are willing to sign a interim or a "mini-agreement" immediately. 

So, the definition is clear: Trump admits a "mini agreement" or there will be nothing. And evidently, the Chinese will stop buying agricultural products.  If Trump accepts it, Wall Street will rally, but if Trump does not accept we can get into another descent of great proportions as much as he responds aggressively to all this.

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Rotation: Value Stocks are overperforming in September

In a week plenty of important economic news (Fed rate cut decision at Wednesday, Trade War concerns, Crude Oil price /CL spike after a drone attack, the recent ECB stimulus, the Friday Quadruple Witching, the huge spike in Repo Market rates yesterday), one is going unnoticed and I think it's crucial for exchanges in the mid-term: the "Great Rotation", as it has already been baptized by investors.

As you know, the Value stocks are those with low PE (Price/Earnings) and very stable fundamentals, and are opposite to the Momentum (or Growth) stocks, more focused on the aggressive growth of its value in the mid and long-term. This last, that have driven the bullish Wall Street rally for almost 10 years, is followed by the iShares Edge USA Momentum Factor ETF MTUM and includes giants companies such as Visa V, Mastercard MA, Microsoft MSFT, Disney DIS, among others. Meanwhile, the value stocks are followed by the iShares Edge USA Value Factor ETF VLUE which portfolio contains stocks like AT&T T, Intel INTC, IBM, and Bank of America BAC. Its average PE is 11.47 vs. 18.40 of the SP500. That's very undervalued, as you can verify in the chart above, a comparison between both ETFs performance in the last 5 years.

While MTUM has outperformed VLUE in the last 5 years, that began to change in August and VLUE's rally has accelerated month-to-date, as its risen 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM.   

What happened?

However, the previous week a great move was seen in the positions of the "smart money", the great investors that drive the stock market. Their portfolios have moved (rotate) from active momentum to value stocks, and in an abrupt, almost atypical way. Why? Only they know... The fact is that these changes (the last rotation was in 2011) always impact in the markets, although we don't know the direction it will take. In numbers: while MTUM has outperformed VLUE in the last 5 years, but since August' last week the VLUE's rally has accelerated month-to-date, rising 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM.   Here more technical details, with amazing charts.

Already some investors fear a downturn soon. But the fact is that this data only suggests that momentum stock are ready for a correction, and a rally in value stocks, but only depending on the economic behavior and next Fed decisions. A recession, or a slowing economy until 2020 invite the Fed to more rate-cuts to boost the economy and steepen the yield curve. 

Russell 2000: time for an entry?

This rotation explains the divergence between the main indexes of the market: the last days of the Russell 2000 RUT, plenty of value stocks, has shown, by far, a much better performance than their pairs SP500 and Nasdaq. Undoubtedly, the Trade War affected and continues to affect much more these small companies with their production costs increase to the detriment of their margins and profits, but the index increase is there and seems nice.

On the other hand, the next sure Fed' rate-cut this week, which will reduce loans, will also favor Russell companies. This is understood as investors consider that increase in interest rates is especially expensive for smaller companies that tend to receive financing through adjustable-rate bank loans, rather than fixed-rate debt financing at which larger companies can access through capital markets. Their balance sheets may be adjusted in the short-term, and thereby improve the price of its shares and then the whole performance of the RUT index that in its last 52 weeks is still down 4.5%. These facts make IWM and IWN, ETFs that follow the Russell, great candidates for a buy in a mid-term, considering that, unlike the previous ones, they haven't reached their previous highs.

Technical analysis also helps the Russell 200 stocks: the daily chart of the IWM shows its price is breaking the resistance of a strong 52-week down trendline with heavy volume. Now above its 3 main SMA averages and the Ichimoku cloud, only need to retest this line at $155 to confirm the bullish breakout. Keep an eye on IWN, the ETF that follows only value stocks from the Russell. I presume a better performance there.

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World Economic News, at a glance

- Retail Sales just doubled estimates at 0.4% along with a bonus revision in the month previous to solidify the overall staying power of the consumer. 
- The good news may be enough to inch the SP500 SPX closer to its all-time high of 3,027.98 which is now less than 20 points away. 
- The ECB announced plans to cut its bank rate by 10 basis points to an unfathomable 0.50% yesterday as stagnant growth persists in much of the region. 
- Monthly QE purchases will begin in November at a rate of 20B Euros in an attempt to jumpstart the latency. 
- European markets appear to be ending the week on a positive note other than the UK which is off modestly as the Brexit hash-out continues.  
- Encouraging news on the trade front indicated that China just exempted some agricultural products like soybeans and pork from enforceable tariffs as sure appeasement to further negotiations. The largest soy purchase since June was also ordered which will hopefully open the floodgates to more sizeable purchases.  
- The Japanese Nikkei has approved of the latest efforts considering a 9th straight winning session now secured. 
- Overall, volatility has contracted measurably over the past weeks with a 14 handle, registered in today’s session for a 4th consecutive drop in the CBOE Volatility Index (VIX). 
- The yield on the 10-year Treasury Bond TNX continues to snap back with a current reading of 1.836% after the latest economic figures broke. A higher close on the day would mark a 5th straight jump in rates after bottoming at 1.429% just last week. 
- Oil futures /CL remains little changed with crude sitting at $55.50 a barrel despite agreements from major producers to keep production in check ahead of the weekly rig count.  
- Gold /GC has held its ground the last few sessions with a minuscule gain appearing ahead of the open as central banks grapple with the reality of negative rates. 

(Text is taken from TradeWise Market Blog.)

Is this the main reason for the latest, and desperate, Trump tweet "rate cuts to zero"? A recession is likely coming, and could cost its re-election next year. Now he is open to an interim trade deal with China, and markets react positively with that news, touching the SPX its all-time highs.

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Trader Notes: Importance of the Yield Curve

(Update from August 2018 post)

The Basics:

Mentioned here in several posts, the yield curve,  take importance in these weeks because it's reaching a flat level that had not since 2007, with possibilities to invest for 2019, this with clear damage to the stock market. Why? Let´s briefly explain you.

Understanding how this curve is drawn, its types (normal-reverse-flat-humpback), its inclination (steep or flat) and its relationship with the market, will allow us to make better trades. Also knowing its basic principle: the direct influence of the short-term yield bonds is the i-rate assigned by the FED, while the long-term ones depend, also directly, on inflation and how it is eroding the value of the bonus in time.

The yield curve is formed on an XY chart with the maturity times of the US Treasury Bond on one axis and the interest rates on the other. In an expansive cycle, there is a growing slope, as it is obvious that, at a longer time, higher yield is expected through a higher interest rate. Flattening occurs when the differential or spread between the extremes approaches. 

In StockCharts you can observe the yield curve and the SPX index at any moment. Verify its flattened form today, here: https://stockcharts.com/freecharts/yieldcurve.php

On the stockcharts link: just choose a year in the SPX to see how the yield curve was that moment.

Yield Curve behavior

Depending on the state of the economy, four cases can occur:

1. Bull steepener: occurred after the crisis in 2008 when the FED became dovish and in order to heat the economy, began to lower rates, so the short-term i-rate fell faster than the long-term. Notice that a bubble was created in the price of the short bonds, whose consequences are seen until today.

2. Bear steepener: it´s seen only the first months after Trump's victory, when an increase in inflation and FED Rate Hikes were foreseen. The steep slope was a sign of an expanding economy.

3. Bear flattener: occurs this year, when the FED adopts a more hawkish tone and short-term rates rise faster than long-term rates. The slow pace with which inflation advances flattens the curve, with the risk that it will reverse, which is a sign of the beginning of a recessive cycle.

4. Bull flattener: after a recession, reactivation is appreciated when the influence of inflation decreases in long-term rates and these fall faster than short-term ones. It is usually a good time to buy long-term bonds.

Understanding the rate curve is decisive to invest taking advantage of the inflation and i-rate data. Check this didactic article by Felix Baruque for more information.

Divergences in Wall Street and a crucial chart

Already since January 2017 I wrote about the beginning of the flattening. With the months it was accentuated and today its investment is a worrying possibility. Some important FED members express their opinion: for example the dovish James Bullard consider the yield curve inversion a real possibility and a bearish signal for markets. On the other side, a hawkish John Williams said yesterday that FED shouldn't be afraid, because he considers that wages are still slow and with the field to continue growing.  Also Steven Mnuchin, the Treasury Secretary and promoter of the Trump's tax reform, said he´s perfectly content the flat yield curve...

The fact: a way to see graphically what can occur to economy, and therefore the stock market, is checking the differential between the bond rates. It is usually used as a spread data, the 2-year and 10-year bond yields, although other authors prefer to use the 3-month and 10-year bond. On this Bloomberg chart the spread is shown between the 2 and 10 year bonds since 1977. Look: whenever there was a recession cycle (in green) the spread became negative a few months earlier.

Also Wall Street main banks, Citibank C, Bank of America BAC and JP Morgan JPM, had been having a tough year, this flat yield curve not benefit them, despite the tax reform and the 10-year Treasury Bond TNX near to the 3% rate, its higher since 2013 . The financial etf XLF also had a negative YTD. 


Consider the following:
- The current flattening is due to successive FED Rate Hikes, in addition to the slow progress of inflation. 
- In the US more than 50 years ago, this behavior has meant the preamble of recession, which usually pulls down in the stock market. 
- There is almost consensus that two consecutive quarterly GDP decreases signals the start of a recessive cycle.
- Today the jump in Average Hourly Earnings (2.9% vs 2.8% consensus) tell us a lot about how inflation and wages are moving, and fears of more Rate Hikes.

From the point of view of the bonds, which always anticipate the stocks, it does not seem time to enter long on stocks, because the historical statistics shows that when the curve is reversed the recession begins, and that event is close to occur.So my best advice is to check the evolution of this spread in the next days and weeks. Swing trading, with risk management emphasis is, in my vision, the best option for the market today

 >>> Update:

The investment between the 3-month Treasury bill rate and the 10-year Treasury yield, which some economists believe is a more reliable recession indicator, has been underway since May to date. That curve was reversed in March, became more pronounced in April and then reversed again.

And finally this month the main spread, the 2/10, inverts. Now investors aren't being paid to take on more risk and that's a bad signal for an economy. Why lend my money ten years, if with only two years I get more yield? As the 2/10 has a decent record tracking forward recessions, is likely that the U.S. will begin to show the first signals of it next year or in 2021.

History also indicates that the inversion may be brief before a more sustained and severe change occurs. So, a big challenge is in the hands of Trump and his economic team with its Trade War cooling the economy and slowing inflation, and Powell and the Fed lowering interest rates more quickly for revert the curve. 

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Main 15: Stock Watchlist for October 2019

Main 15: Stock Watchlist for October 2019
Update: August 30th, 19:51 EST
Important Notes: https://www.xgreedandfear.com/p/watchlist.html