After hitting an intra-day high of 2,941 on 21 Sep 2018, S&P500 has tumbled 17.9% or 525 points to close 2,416 on 21 Dec 2018. In fact, S&P500 has just logged the worst monthly performance in Dec since 1931! Dow has also fallen 3,535 points from the intraday high of 25,980 on 3 Dec 2018 and 4,507 points from the intraday high of 26,952 on 3 Oct 2018. What is happening? Is Armageddon coming?
Most things have not changed since 21 Sep, except for…
In Sep, when S&P500 hit 2,940, the usual concerns were also there, namely trade tensions; U.S. 10Y treasury yields above 3%; Brexit; concerns on Europe; peak in earnings growth in U.S. market; slowing global growth etc. Since then, nothing much has changed except that
a) Part of the yield curve has inverted
On 3 Dec 2018, the yield curve for U.S. 3Y note and U.S. 5Y note inverted. According to the chief economist of North America at The Conference Board, he wrote in an article posted on MarketWatch 10 Dec 2018 that from the time that the above yield curve inverts, a recession typically starts from nine to 69 months, with an average of 27 months (i.e. more than 2 years).
For the more closely watched indicator i.e. the spread between the 10-year note and the 2-year note, it is still positive and not inverted. Although the spread between the 10-year note and the 2-year note has been narrowing / flattening, some strategists have noted that a flat curve can last for years and the economy can still be strong. According to an article by BMO Capital Markets in June 2018, BMO found that the S&P 500 has appreciated an average 12.3% when the yield curve was flattening vis-à-vis a 7.9% gain amid a steepening yield curve for all periods since 1980. In addition, BMO found that the S&P 500 can still rise an average 14.3% during the later stages of flattening cycles (from 50 bps to 0 bps).
b) U.S. and China have agreed on a trade truce for 90 days
U.S. and China have agreed on a “cease fire of sorts” on trade for 90 days. Notwithstanding the arrest of Huawei’s CFO in Canada and other negative headline news, it seems that China and U.S are still making some progress on the trade front post the dinner between President Trump and President Xi (i.e. it seems relatively better now than in Sep on the trade front)
c) U.S. 10Y treasury yields have dropped from >3% to 2.79%
U.S. 10Y treasury yields have dropped from >3% in Sep 2018 to 2.79% on 21 Dec 2018. This seems to be a net positive for stocks as this may reduce long term borrowing costs and increases the appeal of equities vis-à-vis bonds.
Has the bull market ended?
Nasdaq has slipped into a bear market with the 3% drop on last Fri. Most readers will be wondering whether the 9 or 10 year bull market has ended.
According to most strategists, the equity bull market typically ends when some of the conditions happen. For simplicity, I only list three conditions below (i.e. the list is not exhaustive).
a) Inverted yield curve
As per above, the yield curve is flattening but has not inverted yet. According to Blackstone, they do not believe that the yield curve is going to invert soon.
b) Negative earnings growth
It is common knowledge that 2018 likely marks the peak in earnings growth for U.S. corporates. However, it is noteworthy that a peak in earnings growth in 2018 does not necessarily mean a decline in earnings in 2019. For CY 2019, based on Factset, analysts estimate earnings growth of 8.3% and revenue growth of 5.5%.
Chart 1: Earnings and revenue growth in 2019
Global growth is slowing which is not new. However, based on data, it is unlikely that U.S. may slip into a recession in 1H2019. According to findings from Blue Chip Economic Indicators (see Chart 2 below), most economies are still likely to post some economic growth in 2019. Furthermore, according to the Conference Board’s Leading Economic Index, it still indicates good growth through mid-2019. Moreover, the surveys from the Institute for Supply Management are still reflecting continuous new orders of goods and services. Economic growth is important as according to Nuveen Asset Management, recessions have historically been associated with 20%+ drops in equity markets.
Chart 2: Global economic growth projections for 2019
What does the chart say?
S&P500 has slumped 17.9% from an intra-day high of 2,941 on 21 Sep 2018 to close 2,416 on 21 Dec 2018. This is the lowest close since 6 Jul 2017. Previously, I have informed my clients on 17 Dec Mon morning that a break below 2631, if sustained, is bearish and may point to an eventual technical measured target 2,467 – 2,473 This has already attained and overshot. Some chartists view 2,440-2,445 as target which is already attained.
It is evident that S&P500 chart is bearish as it has broken both the short-term uptrend line established since Jun 2018 and the long-term uptrend line established since Feb 2016. However, oversold pressures have built with a 13.7% fall from an intraday high of 2,800 on 3 Dec 2018 alone. This is the largest drop in Dec since 1931! ADX closed 33.6 on 21 Dec 2018 amid sharply negative placed directional indicators (“DIs”). RSI closed at an oversold level of 22.4 on 21 Dec 18. MFI closed at 19.1 on 21 Dec 18 which is very near to the low of 18.9 on 4 Nov 2017, which is also the low last seen on May 2012. MACD has hit a 10-year low last seen on Oct 2008.
Near term supports: 2,408 / 2,400 / 2,393 / 2,381 / 2,367 / 2,353 / 2,327
Near term resistances: 2,441 / 2,450 / 2,465 / 2,473 / 2,490
Chart 3: S&P500 is oversold
Source: InvestingNote 21 Dec 2018
Other notes – Santa rally?
According to an article on MarketWatch (see Chart 4 below), from 26 Dec to the first two trading days of the new year (six-day period), Dow has risen 76% of the time since 1896 with an average performance of +1.5%. With the S&P500 clocking the worst Dec performance since 1931, I believe this sets a good environment for the Santa rally to occur (at least the risk to reward is better as compared to three months ago).
Chart 4: Good seasonal trend betting on Santa
My personal strategy – may have a short term rebound
Although I am not an economist, I doubt we will slip into a recession in the near term. Furthermore, the current extremely bearish tone seems to be setting up a favourable risk to reward environment for a trade on a potential rebound in the next few weeks. I have been taking the chance to pare positions in Nov 2018 through 3 Dec 2018, thus I was <50% invested on 17 Dec. I have since started to use some of the cash to accumulate Singapore blue chip stocks on 20 & 21 Dec and long U.S. S&P500 indices on 22 Dec morning. I am currently around 131% invested (with leverage from CFDs), but may raise to 150-200% invested on further weakness. I have also been accumulating selective small caps on weakness. Please refer to the important caveats below.
As some of my private banking clients have enquired for a list of interesting SGX listed stocks to take a look, I have compiled a list of stocks based on Bloomberg’s data as of 21 Dec 2018. Table 1 shows only the top five stocks with the highest estimated total potential return.
Table 1: Top 5 stocks with the highest estimated total potential return
Source: Bloomberg as of 21 Dec 2018
Noteworthy points on Table 1 above
1. This compilation is based on Bloomberg’s data as of 21 Dec 2018, sorted with my set of criteria namely,
a) Estimated dividend yield for the next 12 months >=2.0%;
b) SGD Market cap >= S$500m;
c) Presence of analyst target price i.e. covered by analysts
2. The above data is sourced from Bloomberg i.e. I have not checked the above data for accuracy etc.
3. Even though I put “ave analyst target price”, some stocks may only be covered by one analyst hence may be subject to sharp changes. Also, analysts may suddenly drop coverage. In addition, analyst target prices and estimated dividend yield may be subject to change anytime, especially after results announcement or after significant news announcements;
4. Table 1 above is for reference and only shows the top 5 stocks with the highest estimated total potential return. Do note that these 5 stocks have smaller market capitalisation, and some are illiquid. Such stocks may arguably have a higher potential risk component vis-à-vis the likes of DBS and UOB. Therefore, readers should exercise their independent judgement and take into account of their percentage invested, returns expectation, risk profile, specific company developments and current market developments. It is best to research extensively before you make any investment decisions.
5. The entire list comprises of 90 stocks which I will send to my clients.
Meanwhile, merry Xmas and a happy 2019 ahead!
Naturally, my market outlook and trading plan are subject to change as charts develop. My plan will likely not be suitable to most people as everybody is different. My above basis is to trade on a potential small retracement in this huge sell-off, and not a reversal in the bearish trend. Do note that as I am a full time remisier, I can change my trading plan fast to capitalize on the markets’ movements. Furthermore, I wish to emphasise that I do not know whether markets will definitely rebound or continue to drop. However, I am acting according to my plans. In other words, my market outlook; portfolio management; actual actions are in-line with one other. Notwithstanding this, everybody is different hence readers / clients should exercise their independent judgement and carefully consider their percentage invested, returns expectation, risk profile, current market developments, personal market outlook etc. and make their own independent decisions.
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