The Week Ahead in Stocks – Jul 30th

At Matrix we try to anticipate the questions that our subscribers want to, or indeed do, ask. This weekend’s newsletter starts to address the issue why, when the stock market is so stable, are we obsessed with a comparison to the run into the 1929 and 1987 stock market crashes. There are an increasing number of reasons most notably fundamental that help explain why the intermarket, technical and sentiment drivers are so similar. So too with stocks. Why, you may ask, are we monitoring the conditions for a similar potential downturn in stocks when earnings appear so healthy? The answer is both simple and several.

Earnings season is more than half way through and the big story so far is the failure of the FAANGs. Or more specifically, “FAN”: Facebook (FB), Amazon (AMZN) and Netflix (NFLX). These are not the bullish earnings move we are so used to.

This is a potentially serious blow to the market as a whole.

However, the earnings problems in these three stocks aren’t related to a macro theme affecting all stocks. The issues are all quite specific to each company. And while market sentiment could take a hit, Google (GOOGL) showed us earnings in big tech can still impress in this environment.

Of course the big macro theme dominating the headlines is the trade war, and this earnings season will tell us more about how this is affecting US companies.

On one hand we have this Bloomberg article with the headline “U.S. Companies Feel the Pain From Surging Metal Prices”. But away from the headlines, the “pain” is not so apparent. 87% of industrial companies have beat so far.

But this only compares the results to what the market expected. Industrials have been underperforming the broader market and expectations were low. This is in stark contrast to the likes of Facebook, Amazon and Netflix which have outperformed and had extremely high expectations.

Also the pain for Industrials may still come at a later date. Many companies have lowered forecasts for 2018 earnings and tariffs have not been in place long enough to get a real idea of their effects. With steel and aluminium prices surging, it is a question of “when” not “if” earnings will take a hit.

With markets near all-time highs, earnings strong, and no apparent dent to hard macro data, it is tempting to dismiss the trade war as just another bearish narrative that has no lasting effect. Yet it is just one piece in a complex matrix and the effects will take time to filter through. At Matrix we try to anticipate the questions that our subscribers want to, or indeed do, ask. This weekend’s newsletter starts to address the issue why, when the stock market is so stable, are we obsessed with a comparison to the run into the 1929 and 1987 stock market crashes. There are an increasing number of reasons most notably fundamental that help explain why the intermarket, technical and sentiment drivers are so similar. So too with stocks. Why, you may ask, are we monitoring the conditions for a similar potential downturn in stocks when earnings appear so healthy? The answer is both simple and several.

It FITS.

Fundamental: It is not necessarily a downturn in earnings that triggers major retracement. It is the rate of earnings increase ie a flattening compared to continued price rises that creates the conditions for a downturn.
Intermarket. It is also therefore the lack of breadth. We have had almost a year now of significant rotation between indices, sectors and stocks. In our previous sector analysis we showed that industrials are one of the earliest sectors to reflect such deterioration. We are seeing that now.

Technical: These fundamental and intermarket factors help explain why we are also seeing a sequence of very similar but not simultaneous sell offs that dent the fabric and certainly the momentum and sustainability of the current bull market. This is something we will cover in more depth next week.

Sentiment: The fact that aggressive and fundamentally inspired sell offs (TESLA, NFLX, AMZN and FB) are being bought back up shows how the market is becoming complacent about this uptrend and determined to buy any dip.. whatever the cause.

The increasing failure of individual stocks to justify their current if not increasing valuations is the reason why they will eventually all turn down. Eventually? Timing is everything.

Good luck and good trading.

Andrew McElroy
Chief Stocks Analyst
MatrixTrade.com