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Capital 19 Catch-Up

Weekly Index Movement

S&P500+2.6%
Nasdaq+3.4%
Aussie All Ords+3.1%

To say this week was an eventful one for the market would be an understatement.  Major equity indices crossed some key technical thresholds, and interest rates and commodities pulled back sharply as economic concerns really start to pile up ahead of what is expected to be a hawkish Federal Reserve interest rate decision this week.  It’s not often that you see the Fed tighten monetary policy into an economic backdrop that’s clearly weakening, but that’s where we stand.  

It’s hard to get too excited about the prospects for the economy or the market from these levels, but as sentiment surveys and positioning clearly indicate, the negative view is as crowded as a rush hour bus in 2019.  The markets can always see further over the horizon than any of us, which makes it hard to ignore the moves higher we’ve seen over the last month.

We’re still not out of the woods, but as we get through the peak of earnings season this week, we should have a much better idea of where things are going in the second half. And if you think this week was eventful, just wait until next week.  

After nearly three months of trading below its 50-day moving average (DMA) and a steady string of lower highs, the S&P 500’s rally off the June low broke the downtrend from the late Q1 high and took the index back above its 50-day moving average.

The higher high and higher low off of the June low is encouraging from a technical perspective, but the S&P 500 still remains well below its downward sloping 200-DMA and the downtrend from the January high.

We would also note that the late Q1 rally also made a higher low and higher high which proved to be a major disappointment just weeks later

Classic Dow theory monitors two markets. Industrials and Transports. The classic theory is you only have a bull market when both are trending higher. The idea being the transportation of goods increasing shows increasing economic expansion.

But in today’s online world, transportation is less important. That’s why we like to replace the Transports in Dow theory with Semiconductors.

The Philadelphia Semiconductor Index (SOX) managed to break above its 50-DMA this week. But still remains in a well-defined channel.

On a relative strength basis, semis have really outperformed during the rally off the June lows, but the starting point of that rally was a 52-week low, and at this point, it remains in a well-defined downtrend on both a short and long-term basis.

Based simply on the performance of the semis, there’s not much at this point to suggest that the market is gearing up for a major rally.

Bear markets are typically thought of as periods of relentless declines in the market where stocks do nothing but trade lower. The reality is that they often include periods of extreme countertrend rallies, sucking investors in along the way. That’s what can make them so painful. Just when an investor thinks the market may be starting to turn, new positions quickly turn into losers. The last three periods of major declines for the stock market since 2000 illustrate this trend.

Starting with the dot-com bust, from its peak in March 2000 to the ultimate low in October 2002, the S&P 500 lost nearly half of its value (49%), but along the way, the S&P 500 experienced rallies of 5%+ eleven different times (green lines).

Shortly after making a new all-time high in 2007, the S&P 500 peaked again in October 2007, and from that point to its low in March 2009, it lost 57% of its value. Along the way, though, the S&P 500 experienced 12 different rallies of at least 5%.

Even during the five-week COVID crash from mid-February through late-March 2020 when the S&P 500 lost more than a third of its value, there were three different rallies of at least 5%.

Takeaway – recent market action does not mean we are out of the woods yet. Whilst nice to see stocks rally, the move we have seen is very typical of bear market rallies. We are still cautious and would recommend using this rally to sell down positions into strength rather than loading up for the next leg higher.

In specific company news, ANZ caught our attention last week with its announcement that it is buying the retail arm of Suncorp. We’re a bit worried ANZ management is making snap decisions on the fly faster than a NRL ref interprets the rules.

In March of this year, ANZ completed a $1.5bn share buyback at an average price of $27.77 a share.

Now, to fund the Suncorp purchase, they have just raised $1.7bn from institutional investors by issuing 89m new shares at $21.65 a pop.

Punching these numbers into our trusty Casio Financial Calculators tells us they just threw away $330million with poorly timed decisions. (Buy 54million shares at $27.77 and sell them at $21.65.)

Then at the same time they are closing down branches to increase profits, they go and buy a whole load more branches. Probably so they can close them down next year and give all those managers working from home something to do.

No wonder Suncorp were happy to offload them, they were probably going to close them down anyway.

Looking over at the US, Snap’s stock cratered 39%, after the company pointed to slowing ad demand. Other social media and technology stocks got caught in the slump. Shares of Meta Platforms (META) and Pinterest (PINS) fell about 7.6% and 13.5%, respectively, while Alphabet (GOOG) lost more than 5%.

Twitter also posted disappointing quarterly results across revenue, profit, and user growth on Friday. The company chalked some of that up to lagging advertising spending, but also blamed Elon Musk’s fluctuating interest in buying Twitter – and the resulting uncertainty – for the slump. Sounds like a scapegoat play to us.

This does not bode well for the big reports coming this week, and this next week will definitely be a BIG week.

175 S&P500 companies will announce Q2 results. The big ones being Microsoft (MSFT) on Tuesday and Apple (AAPL) on Thursday.

We are not especially concerned about MSFT’s quarter and guidance. Street expectations are for consistent growth in Q2 and Q3, and the company already pre-released a small miss to prior expectations due to the strong dollar

Apple is another matter. Analysts expect a negative earnings comp for calendar Q2 ($1.16 vs. $1.30 last year) but think AAPL management will support their expectations for a return to earnings growth in Q3 ($1.31 vs. $1.24/share last year). That seems aggressive, but we’ll just have to wait for the earnings release and conference call to know for sure.

On Wednesday the US Fed will announce whether they will be increasing interest rates or not. They will. And it will be 75Bps. There was talk of a possible 100bps but this will not happen. Oil is down to $93 a barrel, which is a good way from the highs of $120. This alone will be enough to temper inflation. The Fed knows this and won’t be pushing a 100bps on a weakening economy. We think there is a chance they only do 50bps which would send tech stocks higher.

Tuesday will see the release of the first cut of US GDP. We are expecting this to be negative, and when added to the first quarter of -1.6% will confirm the US is in a technical recession and has been since January.

Announcement of a recession would normally see stocks tank. But we don’t think this will happen this week. For, whilst economists might say the economy is in recession, companies are not. Companies are growing profits.

Analysts are expecting Q2 to be a record earnings quarter at $55.88/share expected. Up from $55.38 in Q1.

So far, 21% of companies have reported. 68% have beaten earnings expectations and 65% have beaten revenue expectations.

Which all sounds very positive.

But these numbers are below the 1-year (81pct), 5-year (77pct) and 10-year (72pct) averages, so things are slowing down.

But a beat is a beat and growth is growth regardless of what the economists say.

Hold onto your hats this week. It is going to be a wild ride, but at the end of it we will have a much better idea of where things stand.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.

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