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Market Again To Excessive Overbought
With earnings season in full swing, shares continued to push larger this previous week. Even disappointing earnings from (NASDAQ:), (NASDAQ:), and (NASDAQ:) couldn’t maintain the bulls down a lot. To this point, the earnings season has just about aligned with expectations. As famous by FactSet:
“Total, 56% of the businesses within the have reported precise outcomes for Q3 2021 up to now. Of those firms, 82% have reported precise EPS above estimates, which is above the five-year common of 76%. If 82% is the ultimate share for the quarter, it can mark with the fourth highest share of S&P 500 firms reporting a optimistic earnings shock since FactSet started monitoring this metric in 2008. In mixture, firms are reporting earnings which are 10.3% above estimates, which can also be above the five-year common of 8.4%.”
Earnings have certainly been very spectacular, however as we are going to focus on, this quarter will seemingly mark the height of development for some time.
The extra important concern, nevertheless, stays the underlying technical situation of the market. Whereas the rally has been spectacular, rising virtually 6% from the latest lows, the market is now again to extra excessive overbought ranges, buying and selling 2-standard deviations above the 50-dma, and breadth stays troubling.
Chart up to date by Friday.
As famous final week, our “cash circulate purchase sign” is close to a peak and is near triggering a “promote sign.” With the MACD nonetheless optimistic, the sign suggests extra consolidation than correction. Nonetheless, a confirming MACD typically aligns with short-term corrections at a minimal. Additionally, as proven, this complete rally from the latest lows has been on very weak quantity, which suggests an absence of dedication.
In the intervening time, the bulls management the , and draw back danger is considerably restricted. Nonetheless, that positioning is getting very aggressive.
Aggressive Positioning
As famous, the present spat of financial weak point, mixed with rising inflationary pressures, doesn’t bode nicely traditionally for asset markets. Nonetheless, the latest 5% correction did little to reverse extra aggressive positioning. As proven beneath, the NAAIM Index (Fund supervisor positioning) has surged again ranges which have beforehand aligned with short-term corrections or worse.
Such isn’t a surprise given the large inflows of capital into the market this yr alone which have now exceeded $1 trillion. (Chart courtesy of Zerohedge)
International Liquidity Fund Flows
Moreover, with the window for company share buybacks opening in November, the first patrons of equities will return to the market. Share buybacks are already at a report and will add as a lot as $90 billion to the entire by year-end.
Share Buybacks
Whereas capital flows definitely help the bullish narrative within the short-term, such can get simply reversed with a change in sentiment. As famous, with financial development weakening and inflation rising, the chance of a reversal is rising. Furthermore, the chart exhibits that earlier spikes in inflation haven’t been type to fairness returns.
In fact, inflation additionally hurts financial development which impacts revenue margins.
Financial Development Weakens
In March of this yr, I penned an article entitled “,” whereby we mentioned the financial system would run “sizzling” after which “crash.” On the time, I obtained a number of “pushback” on my “dire predictions” of financial development later within the yr. Moreover, I adopted that evaluation asking if Q2 was the “” To wit:
“Was the second quarter the height of financial development and earnings? If estimates are appropriate and the year-over-year ‘base impact’ fades, such suggests danger to present earnings estimates. The chart from a“,” makes use of the Atlanta Fed’s present estimates for Q2-2021 GDP. The total-year estimates are from JP Morgan. Notably, the financial system rapidly slows to 2% heading into 2022.”
At the moment, we estimated lower than a 4% development fee for the financial system, with the Atlanta Fed nicely above 6%. On Thursday, the preliminary launch of Q3 got here in nicely beneath even our lowered expectations of simply 2%.
“Actual gross home product (GDP) elevated at an annual fee of two.0 p.c within the third quarter of 2021 (desk 1), in response to the “advance” estimate launched by the Bureau of Financial Evaluation. Within the second quarter, actual GDP elevated 6.7 p.c.” – BEA
Notably, the “advance estimate” is derived from a sampling of economists’ estimates. As precise knowledge will get factored into the GDP calculation throughout the subsequent two months, the expansion estimates will get revised. As mentioned in “” the weak point within the financial knowledge suggests these GDP revisions will likely be decrease.
The implications of weak financial development are broad. Client sentiment will stay weak as inflationary pressures undermine consumption. Moreover, the detrimental impression on earnings appears to elude traders presently.
Earnings Expectations Approach Forward Of Actuality
Regardless of financial development weakening as inflation will increase, liquidity decreasing, and revenue margins beneath strain, analysts proceed to extend their earnings estimates. At the moment, estimates for the This fall-2022 are $207/share in response to S&P. As proven, that stage will exceed the historic 6% exponential development pattern that contained earnings development since 1950.
At the moment, earnings expectations exceed the annual exponential development pattern by one of the crucial important deviations on report. The one different two intervals with comparable deviations are the “Monetary Disaster” and the “Dot.com” bubble.
With analysts extraordinarily exuberant, there appears to be little concern for traders. Nonetheless, I might warning towards such complacency.
The chart beneath is the Financial Output Composite Index. The index contains the CFNAI, Chicago PMI, ISM Composite, the Fed surveys, Markit Financial Index, Markit PMI, NFIB, TIPP Confidence, and the LEI. In different phrases, this indicator is the broadest indicator of the U.S. financial system there may be.
The final full set of information is thru September. Notably, the index peaked on the second-highest stage on report. When October will get totally accounted for, the index will decline additional.
There are two crucial takeaways from the EOCI index: 1) the inventory market tends to both appropriate or fall right into a bear market throughout reversals, and 2) there’s a excessive correlation between the index and the annual change in earnings.
As we’ve famous beforehand, with the Fed starting to “taper” bond purchases, the chance to traders continues to rise as earnings peak and revenue margins contract.
Portfolio Replace
Whereas something is feasible within the close to time period, complacency has returned to the market in a short time. As famous, whereas traders are very bullish, there are quite a few causes to stay aware of the dangers.
- Earnings and revenue development estimates are too excessive
- Stagflation is turning into extra prevalent (weak financial development and rising inflation)
- Inflation indexes are persevering with to rise
- Financial knowledge is shocking to the draw back
- Provide chain points are extra persistent than initially believed.
- Stock issues proceed unabated
- Valuations are excessive by all measures
- Rates of interest are rising
Moreover, as famous above, there may be restricted upside because the annual fee of change available in the market declines.
So what do you do?
As mentioned not too long ago, we consider further fairness publicity will get warranted as a result of bullish case. Nonetheless, the longer-term dynamics are extra bearish.
For now, we stay optimistic concerning the markets as a result of liquidity, seasonality, and bullish sentiment. As such, we maintained our fairness exposures once more this week.
Nonetheless, we’re starting to hedge danger barely heading into the Fed assembly subsequent week. With extraordinarily prolonged, we rebalanced vitality shares again to mannequin weights. We additionally began constructing a place in “volatility” to hedge our long-equity holdings towards a sudden decline.
What may trigger such a decline? Nobody is aware of. Nonetheless, everybody appears to consider it could possibly’t occur.
That’s often simply concerning the time it does.
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