foxex: Waiting in Vain

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Monday's Headlines

1. Stocks Stall as Investors Wait on China and the Shutdown

Markets Close

Dow
25,053.11 -0.21%

S&P
2,709.80 +0.07%

Nasdaq
7,307.90 +0.13%

VIX
15.97 +1.59%

INV Anxiety Index
103.43 High

US 10-Yr Yield
2.661 +1.10%

The Trade Fade

Stocks did a whole lot of nothing today, as investors waited for resolutions on multiple fronts. The trade talks between the U.S. and China seem to have been at a standstill as of last week. Sunday, Axios reported that trade representatives from Washington and Beijing may actually meet at Trump's Mar-a-Lago resort in mid March to hammer out a deal. We'll have to wait and see.

Another looming deadline may be more serious - at least in the short term. Unless Congress and President Trump can agree on a budget resolution to fund the government by February 15th, we may have another shutdown in the U.S. There were reported signs of progress last week, but those seem to have faded over the weekend. Today, the WSJ reported that key leaders of both major parties in the U.S. are negotiating again, and that Trump may indeed get some of the $5.7 billion in funding he seeks to build a border wall. We'll have to wait and see.

Why it Matters - Especially China

We write a lot about China and the impact it has on the global economy and the investing landscape. It's the second biggest economy in the world, next to the U.S., and will eventually become number one. China's economy, which has been on fire for the past decade, is slowing. It's still expected to grow 6-6.5% this year, which is still strong, just not as strong as it was. If the trade war doesn't get resolved and actually intensifies, it will impact growth for the U.S., China, and everyone who trades with them.

IHS Markit, which tracks global economies, projects a cascading of global GDP if there is no resolution to the trade war and protectionism escalates.

Here's how they put it:

In the protectionism scenario, the level of global real GDP is reduced 0.8% in 2019, and 1.4% in 2020. Thus, global economic growth in 2019 and 2020 is only marginally above our 2.0% threshold for a world recession.

There's nothing like the "R" word to make you sit up straight and pay attention. We know there have been many predictions about a coming recession towards the end of 2019 or in 2020. Technically speaking, a recession is two quarters of negative growth. That's negative growth - not just declines. The IMF projects global growth to be 3.5% in 2019 and 3.6% in 2020. Those figures have already been revised downward due to the current trade war. The biggest risk to further declines is...you guessed it...more trade war.

What's Next

Global companies are well aware of these sensitivities and have to model their own forecasts accordingly. We already know that many of them have been cutting their 2019 earnings and revenue forecasts as the tax cuts are in the rear-view mirror, market volatility has cut their market values down to size and the China issue is still looming. As companies cut their forecasts and analysts follow suit, we are entering into an 'earnings recession', as we wrote about last week:

How to Prepare for an Earnings Recession

Companies prepare for slowing growth by slowing down their spending and hiring, cutting back on R&D and marketing, and looking for other ways to tighten their belts so they can still deliver their numbers. The problem, as Morgan Stanley points out, is that by cutting back today in anticipation of a slowdown, actually makes it harder to hit forecasts several quarters down the road, as you can see in this chart. It forces companies to really deliver in the third and fourth quarter, or face the wrath of shareholders.

But the Consumer is Still Strong

In the U.S., at least, consumer spending remains strong. We'll get the actual numbers for December and January on Wednesday and Friday when the Consumer Price Index (CPI) and the Consumer Sentiment Index (CSI) are released. The 2017 tax cuts helped a little, as did low unemployment and small, but real wage growth. Remember - consumer spending is 70 percent of the U.S. economy, so it's important.

However... if you are looking for the main reason consumers have been holding up so well, despite the market volatility, the trade war and the shutdown, look no further than your nearest gas station.

The chart, courtesy of gasbuddy.com, shows the radical decline in the price of retail gasoline. The average price fell from around $2.85 per gallon for most of 2018, to an average of about $2.25 so far in 2019. You can thank lower oil prices for that, although those come with their own consequences. We'll take a deeper dive into that in another note. But if you are ever wondering how the price of gas is derived from the price of oil, this chart from the Energy Information Administration has made me the smartest guy at a bunch of cocktail parties. I hope it works for you, too.

Chart of the Day: Dow Theory Closer to a Bullish Signal

(Courtesy of Investopedia's Chart Advisor Newsletter - John Jagerson)

Many of the basic tenets of technical analysis can be traced back to "Dow Theory" which was first developed by Charles Dow (of Dow Jones fame) in a series of editorials published in the Wall Street Journal. Dow Theory considers a breakout in a broad index (like the DJIA or S&P 500,) confirmed if transportation stocks have also broken to new highs. If you think about it this should make sense: if large industrial firms are growing (especially during Dow's day), then the transportation companies that ship goods and commodities to and from the industrial firms should also be growing.

At this point, neither the S&P 500 nor transportation indexes have broken to new highs so we haven't experienced a confirmation signal like we did in November 2016 or January 2013 prior to those dramatic rallies. However, we can still use transportation stock performance to provide a heads up when momentum is more likely to strengthen.

Today, Norfolk Southern Corporation (NSC) gave an investor presentation showing how the rail company would reduce its operating ratio to 60% by the year 2021, through a combination of technological efficiency, capital investment, and cost reductions (reducing headcount). Investors liked what NSC's management had to say and the announcement had a "halo effect" on other stocks in the industry. As a result, the S&P Road and Rail sector closed at a new short-term high today. While this isn't fully representative of the entire transportation sector, it's a positive sign that investors may be pricing in more growth opportunities in the market.