Weekly Market Guide RAYMOND JAMES & ASSOCIATES Fed … · 2019-07-11 · the economy or financial markets over the next year), central bank policy support, low inflation, and technical

PORTFOLIO STRATEGY | PUBLISHED BYRAYMOND JAMES & ASSOCIATES

Michael Gibbs, Director of Equity Portfolio & Technical Strategy | (901) 579-4346 | [email protected] Madere, CFA | (901) 529-5331 | [email protected] Sewell, CFA | (901) 524-4194 | [email protected]

JULY 11, 2019 | 4:24 PM EDT

Weekly Market GuideShort-Term Summary: The S&P 500 has held its post-G20 meeting gains at new highs and reached 3,000 for the first time this week. Investors havelargely looked through global macro softness and potential trade headwinds, while focusing on the Fed's message of loose policy with the beliefthat the US and China will continue to kick the can down the road on trade. Although we feel a comprehensive trade deal is unlikely anytime soon(no indication that progress has been made on any of the structural issues), it is unlikely that President Trump digs in too long or too deep giventhe negative impact on the markets and economy in the lead-up to his 2020 re-election campaign. The lack of a specific timeline gives negotiatorsand investors breathing room as well.

The Fed has largely telegraphed a rate cut at its July FOMC meeting (100% market-implied odds of a cut on 7/31). At his testimony this week,Fed Chair Powell stated that inflationary pressures are low (core CPI remained muted at 2.1% this week), trade tensions continue to impact theeconomic outlook (global manufacturing expectations are negative), and the Fed stands by to "act as appropriate to sustain the expansion."Following the G-20 "trade truce" and last Friday's strong jobs report, the market has shifted toward the expectation of a 25 bp cut in July (fromdecent odds of a 50 bp cut previously). This has resulted in a slight uptick in bond yields, stalling the plunge of the U.S. 10-year yield which stillremains 18% lower (at 2.08%) than it was in early May.

2Q earnings season begins next week and is the next major catalyst for individual stocks. The consensus S&P 500 estimate reflects -1.4% earningsgrowth for the quarter. As is normal, estimates have been revised lower into the print and should start to move higher following the first actualreports. For example, 1Q earnings estimates trended lower to -3.5% into the prints and finished at +1.1%. A similar trend would put 2Q earningscloser to 3% when all is said and done. For the full year 2019, the consensus earnings estimate has trended toward our $166 estimate (3.3% y/ygrowth) that we have held for months. This week, we raised our next 12-month earnings estimate to $168 (~4% below consensus due to slightlymore conservative sales and margin assumptions).

Technical momentum is positive with the S&P 500 breaking out to (and holding) new all-time highs. This is a positive indication of intermediate-term performance, as well as the improved stability beneath the surface (rising % of stocks above their 200 DMA). For the short term, the S&P500 is 8% above its 200 day moving average, which has generally reflected overbought conditions and has historically been followed by someconsolidation. Seasonality is another factor to consider in that the August-October time period is the weakest three month period of the calendaron average since 1954. We remain buyers of pullbacks given the more attractive risk/reward set-up one would provide to our next 12-month basecase S&P 500 fair value estimate of 3108.

In sum: The positives (Fed support, delay with trade, technical momentum) outweigh the negatives (macro softness, fundamental slowdown,potential trade headwinds). We view the market as overbought in the short term, but would be buyers on pullbacks given the positive intermediate-term backdrop.

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Source: FactSet, RJ Equity Portfolio &Technical Strategy

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MACRO: US

June nonfarm payrolls bounced back from the slower 72k in May. While the overall pace of job gains has slowed over the past several months, the jobs market remains solid. This is also reflected in initial jobless claims, which remain at historically low levels. Inflation remains muted. June CPI rose 0.1% m/m, which was lowered to 1.6% y/y. Core CPI (which is not impacted by lower oil prices) ticked slightly higher to 2.1% (just above expectations of 2.0%). Average hourly earnings also did not show signs of acceleration, remaining at 3.1% y/y (below expectations of 3.2%). The net of this data likely keeps the Fed on track to cut by 25 bps in July. The bond market is currently implying a 100% chance of a Fed cut at the July 31st FOMC meeting, made up of a 82.5% chance for 25bps cut and 17.5% chance for a 50bps cut. The increased odds of a 25bps cut (and less of a 50bps cut) since the G-20 meeting, strong jobs report, and Fed commentary has resulted in a tick higher in short and long term bond yields- some relief to bond yields following their plunge lower since early May (US 10 year yield dropped from 2.55% on May 2 to a recent low of 1.95% on July 3rd). US economic data reported in the past week (actual vs estimate): Change in Nonfarm Payrolls (Jun): 224k vs 160k, 72k prior Unemployment Rate (Jun): 3.7% vs 3.6%, 3.6% prior Average Hourly Earnings m/m (Jun): 0.2% vs 0.3%, 0.3% prior Average Hourly Earnings y/y (Jun): 3.1% vs 3.2%, 3.1% prior NFIB Small Business Optimism (Jun): 103.3 vs 103.1, 105.0 prior Wholesale Inventories m/m (May F): 0.4% vs 0.4%, 0.4% prior CPI m/m (Jun): 0.1% vs 0.0%, 0.1% prior CPI Ex Food and Energy m/m (Jun): 0.3% vs 0.2%, 0.1% prior CPI y/y (Jun): 1.6% vs 1.6%, 1.8% prior CPI Ex Food and Energy y/y (Jun): 2.1% vs 2.0%, 2.0% prior Initial Jobless Claims (Week): 209k vs 221k, 222k prior

Source: FactSet, Bloomberg, Raymond James Equity Portfolio & Technical Strategy

Odds of a 50bp cut in July had gone to roughly 0% following G-20 and good jobs

report, but have increased this week following Fed Chair Powell’s comments

Market pricing in a July Fed rate cut

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PAGE 2 OF 10 PORTFOLIO STRATEGY

FUNDAMENTALS

Earnings: Q2 earnings season begins next week, with the current consensus S&P 500 earnings growth estimate currently reflecting -1.4%. As you can see in the chart to the right, estimates typically trend lower into the reports- only for actual results to then beat those downwardly revised estimates. If Q2 earnings progress at a similar trend to Q1, we could be looking at ~3% earnings growth when all is said and done. This week, we raised our next 12 month earnings estimate to $168 (~4% below the consensus estimate) on more conservative sales and margin assumptions. For 2019, consensus estimates have trended lower toward our earnings estimate of $166 (that we have maintained for months) due to lower margin expectations. Our bull case earnings estimate over the next 12 months is $174 (closer to consensus) and our bear case estimate is $161 (4% hit if 25% tariffs go on all trade between US and China). Consensus earnings estimates:

• 2019: $166.66 (bottom-up analysts); $167.03 (top-down strategists) • 2020: $185.06 (bottom-up analysts); $180.64 (top-down strategists)

Valuation: The S&P 500 currently trades at a P/E (trailing 12M) of 17.6x. We raised our base case next 12 month P/E assumption to 18.75x this week, which is closer to the 19.1x median P/E when inflation is in the 2-2.5% range (core CPI is 2.1% right now). The catalyst for our move was the G-20 meeting passing without a blow-up (and our expectation that President Trump is unlikely to dig in too much to upset the economy or financial markets over the next year), central bank policy support, low inflation, and technical momentum. While a higher market multiple is possible than our 18.75x (given low inflation and a dovish Fed), trade uncertainty’s negative impact on sentiment and earnings growth decreases the odds of significant multiple expansion. We also use a 20x P/E as our new bull case P/E and maintain our bear case P/E at 15x. These estimates reflect next 12 month base, bull, and bear case S&P 500 price targets of 3108 (70% odds), 3408 (20% odds), and 2415 (10% odds) respectively. For more information on our S&P 500 price targets and assumptions, please see our recent report HERE.

Source: FactSet, Bloomberg, Raymond James Equity Portfolio & Technical Strategy

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Q1 earnings finished 4.5% higher than the slow -3.4% estimate heading in

Similar trend to Q2 would result in

~3% earnings growth when earnings season is done



https://consolidatedequityresearch.rjf.com/Cer/Document/ViewDocument?key=409729N

TECHNICAL: SHORT TERM Technical: Technical momentum is positive with the S&P 500 breaking out to (and holding) new all-time highs. This is a positive indication of intermediate-term performance. Additionally, there has been improved stability beneath the surface, as the percentage of S&P 500 stocks above their 200 DMA has expanded to 75%, above the market highs from September 2018 and May 2019. It is normal for the S&P 500 to rise 2-3% after breaking to new highs. This would be consistent with reaching technical resistance at the upper end of the ascending price range that the index has traded in since the beginning of 2018. Following a 9% rally over the past five weeks, odds are that the market consolidates some of these gains and lets the moving averages “catch up.” However, given the positive intermediate term backdrop, we would be buyers on pullbacks. We also continue to watch current divergences by the small caps, transports, and semiconductors. Given the rapid V-shaped recovery from the sell-off last year, it is not a surprise to see areas lagging the large cap more liquid S&P 500. For now, it is too soon to view the divergences as overly negative. Short term resistance levels: ~3050- upper end of ascending trend channel Short term support levels: 2954- horizontal support 2890- 50 DMA

Source: FactSet, Raymond James Equity Portfolio & Technical Strategy




TECHNICAL: SHORT TERM

S&P 500 is 8% above its 200 DMA. Can go higher, but over the

past year has typically preceded

some consolidation (where the market

can digest the gains).




TECHNICAL: LONG TERM The S&P 500 break out to new highs continues the current secular bull market that we have been in since breaking out to new highs in 2013. As you can see in the chart below, the market tends to go through secular trends historically with cyclical bull and bear markets within them. Within secular bull markets, bear markets have been smaller and much quicker to recover (relative to bear markets within secular bear markets). For example, the average bear market within a secular bull market has been 20% with an average duration to get back to the previous high of ~11 months- the most recent one being Q4 2018 where there was a 20% pullback and the S&P 500 was back at its highs within 5 months later.

Secular Bear: 25 yrs.

Secular Bear 16 Yrs.

Secular Bear: 13 yrs.

Secular Bull Avg. bear market decline:

-20%

Worst: ’87 -35%

Secular Bear Avg. bear market decline:

-30% ex-’29

Worst ’29-’32: -89%

Duration back to High:

10.7 months

Duration back to high:

17 months ex- ‘29




TECHNICAL: SEASONALITY Seasonality is another factor to consider in that the August-October time period is the weakest three month period of the calendar on average since 1954. While we do not recommend trading based on the calendar alone, it does contribute to our belief that the market is in need of consolidation in the short term.




TECHNICAL: CONSUMER DISCRETIONARY The Consumer Discretionary sector broke out to new highs on relative strength, as the next tranche of tariffs was held off, interest rates have dropped, and the consumer remains in good standing. The sector’s gains were led by the internet retail and hotels/restaurants/leisure industries, as well as strength from select specialty retail stocks. These would be our favored areas when looking to accumulate individual names within the sector.

Internet Retail

Hotels, Restaurants, & Leisure

Consumer Discretionary: break out to new highs



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Index Definitions

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.

The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market.

The MSCI World All Cap Index captures large, mid, small and micro-cap representation across 23 Developed Markets (DM) countries. With 11,732 constituents, the index is comprehensive, coveringapproximately 99% of the free float-adjusted market capitalization in each country.

MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States& Canada. The EAFE consists of the country indices of 21 developed nations.

MSCI Emerging Markets Index is designed to measure equity market performance in 23 emerging market countries. The index's three largest industries are materials, energy, and banks.

Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with marketconditions.

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Weekly Market Guide RAYMOND JAMES & ASSOCIATES Fed … · 2019-07-11 · the economy or financial markets over the next year), central bank policy support, low inflation, and technical