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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 to 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:

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.

Understand 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 considers 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) tells 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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Important FED Speaks this week

(Update from January 2019 post)

A Hawk and a Dove.

A preamble: a hawk, in monetary policy, is generally in favor of higher interest rates and less stimulus. He believes that inflation is already high and he needs to adjust the monetary policy to avoid it, even at the expense of unemployment, and thus maintain stable prices. A dove is quite the opposite: it prefers to maintain or reduce rates and favors more stimulus because he fears the high rate of unemployment and does not believe that the current inflation rate is high enough to worry about. 

FED Board of Governors

The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the FED. It is charged with overseeing the Federal Reserve Banks and with helping implement the monetary policy of the United States. The Republican Jerome Powell is the current Chairman. The other 15 current members of the Board of Governors, and mainly its position (hawkish, dovish or neutral) are as following:

This year the voting members are Bullard, Brainard, Powell, Bowman, Quarles, Clarida, Evans, Williams, Rosengren and George. Meaning more hawks (4) than doves (1), with 5 neutrals. Next years voting members change.

And this week, the FED Speaks

The Fed communicates through speeches, press releases and testimony to Congress. Each event is analyzed as to any indication of a change in policy. Even the smallest change in a phrase, including a single word, can impact the markets. And this week a number of FED speeches will get market attention, as investors watch for further clues on interest rates.

When the Fed member indicates that there will be an expansion in monetary policy, it is a positive sign for stock prices in the future, and a buy signal for many traders, because a growing economy will increase revenues and the value of publicly-traded companies. If the Fed indicates a contraction in the monetary policy, which means it is trying to get the economy to slow down, it is a negative sign for future equity prices, as business growth will likely slow in the near term.

My tip for days of FED Speaks to take advantage in our trades: the market follows little to the members of neutral tendency, so be attentive to the following: see if some connoted dovish member makes a slightly hawkish speech, or vice versa. That is to say, the unexpected. That moves quickly the market in one direction, bullish or bearish, as the case may be. Quick profits there, mainly trading the volatility VXX or UVXY. So, watch out carefully for Neel Kashkari, Esther George, and John Williams this week.

>>> Update:

Fed Chairman Jerome Powell will speak on Friday in Switzerland. Powell will be accompanied by other panel speakers including, Fed Governor Michelle Bowman and four regional presidents: Boston Fed's Eric Rosengren, New York Fed's John Williams, Minnesota Fed's Neel Kashkari and Chicago Fed's Charles Evans.

With expectations running high the Fed is set to cut rates in just under two weeks, Powell's speech will likely be parsed for clues on whether the central bank is leaning more dovish in the run-up to the Fed meeting on Sept. 17-18.

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Technical levels for my Watchlist Stocks

1. Cree CREE, $42.93

Its low 2019 guidance in its last earnings report (despite beats sales and EPS inline) plunged the stock from its comfortable $55-65 ($69.21 at highs) range since May to $43-45 levels, evaporating all its year gains. Its year pivot point is at $41.78 so it's worth keeping an eye there for its reaction at that level: if it rebounds or continues its falling to $40.84, its YTD low.

2. Dropbox DBX, $17.90

Same as Cree, lowered its guidance in its last earnings report, and the stock price sank more than 20%, verifying that Wall Street is yet reluctant this year to these cloud companies like Box or VMWare, both at year lows. Its recent all-time low at $17.20 is the level to check. Last week MACD bullish cross with low volatility gives some hope that this stock is rebounding now.

3. Disney DIS, $137.26

A winner-stock for this year, completes its pullback from $147.15, its all-time highs, and last week began its bouncing. At $137.60 is it month pivot point, the next resistance for this week. Hold this stock, even until 2020.

4. Fiserv FISV, $106.94

I continue long in Fiserv since I recommend this stock in January when they complete its First Data acquisition. Great performance this year. Is natural next resistance is its all-time highs at $108.57. In its 1-hour chart, an ascendant triangle was formed, so we have here also a support for the next sessions.

1-hour chart of Fiserv FISV, showing a bullish ascendant triangle. It's great to do trading when a pattern appears in a chart because support and resistance levels are very clear.

5. Gilead Science GILD, $63.54

All 2019 its price is ranging in a symmetrical triangle with very strong support, below its SMA200 average. Its year pivot point is at $70.80. I look a bearish bias for this biotech stock, as all this subsector (XBI flat all the year).

6. Illumina Inc. ILMN, $281.34

Now in a bearish trend due to its recent earnings report that didn't satisfy Wall Street. It beats EPS (but less YoY), miss revenues and widely lowers its guidance for 2019. Analysts punished the stock with several cut-price targets and a downgrade by Cannacord. Now is trading more than 25% below its July all-time highs, and below its year pivot point at $293.35, being $268.62, its YTD lows, its next support.

7. The Kroger Co. KR, 23.68

Keep an eye on retail sector, I wrote recently, as it could fuel the next bullish rally in Wall Street support in good July Retail Sales reports. Despite increasing tension in the Trade War, this sector seems improving last week, and the food retail Kroger, due to its less exposition to China, seems an interesting choice. Recently breaks the resistance of its bearish downtrend channel in its daily chart, also retesting it. Now price moves above its Ichimoku cloud and two main SMA averages: 50 and 100. September 12th. reports its Q2 earnings and could mean a turn in its bias. $24.82 is my target, before earnings.

Daily chart of Kroger KR, showing recent break of its bearish channel. Next days the price returns to that level with lower volume (reaction) and then rebounds there (resolution) filling the three phases of a successful breakout.

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