foxex: What are the Biggest Risks?

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Tuesday's Headlines

U.S. Markets Snap 4-day Winning Streak. FedEx fades on Global Slowdown.

Markets Close

Dow
25,887.38 -0.10%

S&P
2,832.57 -0.01%

Nasdaq
7,723.95 +0.12%

VIX
13.56 +3.51%

INV Anxiety Index
99.5 Neutral

US 10-Yr Yield
2.614 +0.46%

Markets Fade as Investors Await the Fed

U.S. markets snapped a 4-day winning streak as the DJIA and the S&P500 posted slight declines, while the Nasdaq managed to squeeze out a slight gain. Investors are waiting for the Federal Reserve to announce its decision on interest rates Wednesday, and while no changes are expected to the overnight lending rate, the commentary from Fed Chair Jerome Powell, will be closely followed.

The Fed (and Powell, in particular) has been outspoken about a global economic slowdown that could impact the U.S. economy in 2019 and 2020. The trade war is one of the uncertainties causing concern, but, according to Bank of America Merrill Lynch's recent survey of fund managers, a slowdown in China's economy tops the worry list for professional money managers.

Here are a few points from that survey:

Average cash balance fell 0.2ppt to 4.6% this month, showing improved risk appetite; investors' allocation to cash falls 4ppt to net 40% overweight, down from last month's decade-long high.
Allocation to global equities continues to fall to just net 3% overweight, the lowest level since September 2016; note equity allocation has only been negative once in the past six years.
Net 30% of hedge fund investors surveyed say they are net long equities, the lowest level since December 2016.

Translation: After selling stocks and hiding in cash at the end of December and January, fund managers are putting that money to work. Because of global uncertainty, they are shunning global equity markets and focusing on the U.S. equity market, which is very close to reaching the record highs it hit in 2018. Hedge fund managers are shying away from stocks and staying defensive. Here is BofA ML's chart of the 'wall of worry' facing fund managers: (Note how the trade war and Brexit are fading as top concerns).

Brexit Latest

While investors' concerns about Brexit may have faded (for now), the political crisis in the U.K. is far from over. After having her Brexit plan rejected by Parliament for a second time last week, Prime Minister Theresa May now must appeal to the European Union commissioners for a delay of at least 90 days to come up with an alternate plan. EU Commissioners must vote whether to allow that delay, but Michel Barnier, the top negotiator for the EU said today that May must have a plan in place that has the support of British Parliament before granting approval to an extension of Article 50. Getting Parliament to agree on anything has been May's biggest challenge.

This is all bad news for the U.K., but some of the bad news is that all of this uncertainty has put pressure on the British stock market and its currency. The good news for the rest of the world, according to Jeff Kleintop, the Chief Global Strategist for Charles Schwab, is that the fallout from any of the Brexit scenarios may be limited to the U.K. "thanks to the isolated and self-induced nature of a resulting U.K. recession."

Kleintop thinks the odds are in favor of a 'No Deal Brexit', in which the U.K. leaves the EU without a deal in place. Here's his flowchart of the potential outcomes, which is pretty helpful for people like me who find this confusing.

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10 Tips for Successful Long-Term Investing

FedEx Misses

Speaking of risks, FedEx just reported a much weaker third quarter than analysts had forecast. The package delivery company, often seen as a bellwether for the global economy also missed its full-year earnings per share forecast for the second time, citing weaker global trade growth, sending its shares down 5 percent in after-hours trading. Remember, FedEx cut its 2019 forecast back in December citing weakness in Europe, the trade war and a cooling of China's economy.

Why it Matters

More than most companies, FedEx has its finger on the pulse of the global economy. It operates in most developed countries and has subsidiaries almost everywhere else. It touches small retailers, industrial conglomerates, consumers and governments everywhere, all the time.

Quick history lesson...When Charles Dow and Edward Jones, two of the founders of the Wall Street Journal and the creators of the Dow Jones Industrial Average, introduced their collection of stocks to the financial world in 1896, they also created the Dow Jones Transportation Index as a benchmark to track the performance of the publicly traded railroad and shipping companies that transported those industrial goods. Dow Theory soon followed, which was based on Charles Dow's premise that the market is in an upward trend if one of its averages (industrial or transportation) advances above a previous important high and is accompanied or followed by a similar advance in the other average.

FedEx, which is a key component of the Dow Jones Transportation Index, is in anything but an uptrend. Yet, the DJIA has staged a double-digit recovery since the beginning of the year. This, my friends, is what we call a 'disconnect'. Either FedEx's problems are unique to itself, or it is sensing something more ominous coming our way in the future and investors are just slow to react. Comparing FedEx with rival and fellow DJTI member UPS, one would think this a FedEx problem. I'm not so sure about that given everything else that is going on, but that's what makes a market.

Stay aware.

Read More: Comparing FedEx and UPS

Chart of the Day: Emerging Markets Turn Bullish

The downtrend in emerging market equities throughout 2018 was strong and unmistakable. As shown on the chart, the iShares MSCI Emerging Markets ETF, or EEM, was on a steady decline for much of last year until bottoming in late October. After forming a higher low in late December, EEM launched into a rebound and partial recovery that has endured thus far this year.

On Tuesday, EEM hit a new 6-month intraday high, surpassing the previous high of late February. Currently, the ETF has bumped up against a key resistance level around 43.50, which has been tested at least three or four times in the not-too-distant past. A sustained breakout above that level would confirm an extension of the recent bullish reversal.

Helping to support a bullish technical thesis, EEM is also tentatively in the midst of forming a "golden cross," where its 50-day moving average is crossing above its 200-day moving average. Generally considered a highly bullish technical pattern, a golden cross has not previously occurred for the ETF since May of 2016.

The rise of the EEM ETF is not surprising given that over 30% of its holdings are Chinese large and mid-cap equities (Korean, Taiwanese, and Indian stocks account for only around 10% each). Just a quick glance at the benchmark Shanghai Composite Index (SSEC) reveals the sharp surge in Chinese stocks since the beginning of the year. SSEC has risen around 24% year to date, far surpassing the S&P 500's already-impressive 14%. For its part, EEM has surged around 13% year to date, driven in large part by Chinese equities.

Of course, the emerging market rally could fizzle. U.S.-China trade concerns may contribute to that. But any strong technical breakout for EEM will increase the chances that the emerging market recovery extends further.