foxex: Apple Delivers and the Focus Shifts to the Fed

The Market Sum | Investopedia

Insight after the bell

By Caleb Silver, Editor in Chief

Tuesday's Headlines

1. Markets Slip on Earnings Weakness Blamed on China

Markets Close

Dow
24,579.96 +0.21%

S&P
2,640.00 -0.15%

Nasdaq
7,028.29 -0.81%

VIX
19.26 +2.07%

INV Anxiety Index
101.15 Neutral

US 10-Yr Yield
2.712 -1.17%

Markets Today

Markets ended the day mixed with the DJIA trading fractionally higher, while the S&P 500 ended flat and the Nasdaq down 0.8%. The real action was after-hours with one of the most anticipated companies reporting quarterly results.

Apple Delivers

Apple (AAPL) reported quarterly results after the bell today in one of the most anticipated earnings reports in recent memory. It managed to narrowly beat analysts estimates for both earnings per share and revenue. CEO Tim Cook warned investors several weeks ago that sales would be challenged by a slowdown in China, and today we found out just how much. Apple reported $13 billion in China sales, which is 27% lower than a year ago. China matters.

We also know that Apple has struggled with recent product launches - particularly its new series of iPhones. We got a breakdown of Apple's product sales, but this is the first quarter that Apple is not breaking down its sales by model. Instead, it is combining them into broader product categories.

iPhone: $51.98 billion vs. $52.67 billion estimated
iPad: $6.73 billion vs. $5.90 billion estimated
Mac: $7.42 billion vs. $7.42 billion estimated
Wearables, Home and Accessories: $7.31 billion vs. $7.33 billion estimated

This is what Tim Cook said in the company's press release:

"While it was disappointing to miss our revenue guidance, we manage Apple for the long term, and this quarter's results demonstrate that the underlying strength of our business runs deep and wide...Our active installed base of devices reached an all-time high of 1.4 billion in the first quarter, growing in each of our geographic segments.

A user base of 1.4 billion!

Cash on hand of $130 billion!

The stock is up 4% after-hours. I think Apple is going to be OK.

Fed in Focus

The Federal Reserve will wrap up a two day meeting on interest rates tomorrow and while no one expects any change to the federal funds rate, investors will be listening very closely for details on two very important items on FOMC Chair Jay Powell's list.

Does the Fed see a growing possibility for a recession in the next 6-18 months?
What is the status and the plan for the unwinding of the Fed's balance sheet.

Let's tackle the first question, first.

Fears of a recession are creeping into everyone's dreams of late. The economy is slowing, the trade war is still a real possibility, the U.S. government is in gridlock for the next two years and may shut down again in a couple of weeks, and companies are starting to tighten their belts given the downward pressure on earnings. All of this makes consumers more anxious. They respond by reigning in their own spending and investments, which reinforces the broader economic slowdown.

BeSpoke Investment Services tracks consumer sentiment (which has been strong) against consumer expectations for the future. They are heading in opposite directions. Every time the gap between confidence and future expectations is greater than 50 on this chart, the chances of a recession greatly increase. It's at 82 right now.

To be sure, consumer expectations for the future have been rattled by the stock market correction in the fall, the trade war and the recent shutdown. They can bounce back. They can also get worse.

Why it Matters

The Fed sees this and a lot more economic data from all parts of the country and decides how monetary policy can help avert a recession or lessen the blow of one should it come to pass. It can do this by holding rates interest steady or even cutting them to loosen lending and borrowing. It can also do this by slowing down the sale of Treasury bonds which are adding more supply to the bond market, which is already under pressure.

That brings us to the second question: What is the plan for the Fed's balance sheet unwinding project?

What does that even mean?

I'll give you the quick version, but if you want to dive deeper, read this:

(How Will the Fed Unwind its Balance Sheet?)

As part of its rescue efforts in the midst of the financial crisis, the Federal Reserve became a buyer of treasuries and toxic assets like poorly rated mortgage backed securities (the kryptonite that nearly destroyed the financial world.) This was part of the Quantitative Easing strategy you may have read about.

In all, the Fed bought as much as $2.24 trillion worth of securities in 2009 to prime the pump of the financial system by injecting liquidity into the banking sector. It became the buyer of last resort, and it worked. By 2014, the Fed's balance sheet stood at $4.5 trillion.

Between buying up Treasuries (U.S. bonds) and keeping interest rates close to zero, U.S. markets started a bull run that became the second longest in history. It's arguably still running, though its limping and gasping a bit as of late.

Then, in late 2017, the Fed announced that it would become a net seller of those bonds and reduce its balance sheet by about $50 billion per month. That's the more normal state of things, but the last ten years have been far from normal. Still, the Fed has been trying to offload a supply of U.S. Treasury bonds at a time when the appetite for those has not been strong. It's like a restaurant offering a special on steaks when most of its customers are trying to become vegetarians. There are buyers for those bonds because U.S. Treasuries are still considered some of the safest securities in the world, but the combination of the supply hitting the market as the Fed has gradually increased interest rates has had a very turbulent effect on the market.

TopDownCharts, a site I've become addicted to lately, showed the point when the Fed began selling or 'tightening' its balance sheet in late 2017, and the impact on the S&P 500. Granted, interest rates were still low and U.S. companies were about to gorge themselves on a tax break in 2018 - both of which drove the market higher until they wore off. However, the combination of the Fed unwinding its balance sheet, and raising interest rates, with companies lowering earnings expectations has had a very clear impact on the stock market. See below:

What's Next:

Investors will want to know the Fed's future plans for reducing its balance sheet. At his last press conference, FOMC Chair Jay Powell gave no indication it would change course on the $50 billion per month drawdown. But, if the Fed sees the economy slowing and consumers getting more anxious, it may decide to take a big breather on both interest rate hikes and deleveraging. That would light a bottle rocket under the markets.

(I'm exhausted!)

A Correction

An astute reader of Market Sum pointed out, I mistakenly referred to PG&E (PCG) as the utility for Southern California that was somewhat exonerated for causing the devastating fires that ravaged the region last fall. She was right. PG&E serves Central and Northern California, and while the company was deemed not responsible for the 2017 Tubbs fire (a deadly fire that ripped through NoCal wine country), that exoneration wasn't nearly enough to save the company from its fate. Today, PG&E filed for bankruptcy protection as it prepares to defend itself against lawsuits and fines connected to other disasters.

Sorry for the error and thanks for setting us straight.

Happy Tuesday

Chart of the Day: Stocks Trading Between a Rock and a Hard Place

The stock market has been meandering with no real direction since hitting its year-to-date peak over a week ago. During this time, the S&P 500 has formed a relatively tight consolidation pattern that appears to be coiling for a major breakout in one direction or the other.

While the benchmark index is currently doing much better than late December's -20% below the September all-time high - the definition of a bear market - it's still languishing around -10% from that high as of the market close on 1/29/2019. A more bearish technical theme has recently surfaced, with the S&P 500's line-up of three key moving averages displaying a typical downtrend - the longest moving average (200-day) on top, the middle moving average (100-day) in the middle, and the shortest moving average (50-day) on the bottom. Despite this bearish technical signal, though, stocks have been engaged in a sharp overall rally for the past five weeks.

As the S&P 500 continues to seek direction in an increasingly ambiguous market environment somewhere between bear and bull, the stock index is treading in a technical no-man's land between two key price levels. As shown on the chart, there's key support to the downside at the 50-day moving average - currently around the 2610 level - which is also a support level going back to the October low. And to the upside is major resistance around 2715 - the combination of the 100-day moving average and a key 61.8% Fibonacci level (measured from September's all-time high down to the late December low), as shown on the chart.

Where might stocks go from here? As long as the S&P 500 stays within this trading range, its likely that choppiness will remain and there will continue to be very little in the way of identifiable trend. But any breakout above or below the range could very well set the stage for a sustained move either back up to resume the long-term bull trend, or back down once again towards bear market territory.

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