Zeller Kern’s Investment Monitor

The Fight between the Bulls and the Bears Continues

Sept 12, 2018

By Steve Zeller                           

As we approach a potentially volatile season during the months of September and October, the question is who will prevail, the bulls or the bears? Are the cracks finally showing up in tech? Is the economy slowing and are investors beginning to realize it? If Trump slaps China with another $200 billion+ in additional tariffs, will it be the final straw that breaks the bull’s back? Is the estimated trillion dollars in share buybacks this year the peak, and will a decline in buybacks begin? Will the Fed “unwinding” its debt and raising interest rates fuel a slowdown in the economy?

Courtesy and permission of: Hedgeye.com

Two of the major market indexes broke through their previous highs posted in January, that being the S&P 500 and the NASDAQ 100. The other two, being the Dow Jones Industrial Average, and the NYSE, failed to accomplish that feat, so far. We will see if this is a pause to the continuing bull market cycle that is arguably in its late stages, or, as argued amongst the “bears”, that we are in the late stages of a countertrend rally from early February, as illustrated by the Dow Jones Industrial Average and the NYSE, with both averages failing to exceed their January tops – Meaning, this has been a temporary bounce back since January, and once exhausted, the market will begin to roll over and head downward.

Dow Jones Industrial Average Year-to-date


NYSE Year-to-date       


S&P 500 – Year-to-date


NASDAQ – Year-to-date


The S&P 500 broke through its previous January high, but it was propelled by the FAANG stocks which account for a significant amount of the S&P 500’s returns in the last two years. According to a July article from CNBC, Amazon, Netflix, and Microsoft together, up to that point, were responsible for 71% of the S&P 500 returns and for 78% of the NASDAQ 100. The three stocks make up 35%, 21%, and 15% of the S&P500 returns, respectively, while making up 41%, 21%, and 15% of the NASDAQ 100 returns (as of July 10th, 2018). Additionally, Apple also makes up a large portion of both indexes, contributing 12 percent of both indexes, while Facebook and Alphabet (Google) contributed 8 percent.

This market rally has been very narrow indeed and it could be the sword that the bull market lives and dies by, if tech begins to roll over. Since the two major market indexes have been driven by the FAANGs, if these stocks begin to tire out it could signal the top of the market.

But as of the market close last Friday, the S&P 500 was up 8.86%, the Dow Jones Industrial Average was up 6.58%, and the NASDAQ Composite (where the FAANGs hang out), was up 14.47% (source: Morningstar.com; includes reinvestment of dividends). We’ll see where these indexes lead us, but so far, we have wiggle room, with the positive performance year-to-date.

The rest of the world is a different story. As of Friday, excluding the reinvestment of dividends, the Euro Stoxx Index is down -3%, Emerging Markets is down -11.7%, Japan’s Nikkei 225 is down -4.8%, and China’s Shanghai Composite is down -21%. By some estimates, Europe’s economy appears to be slowing, measured by GDP, industrial production, and retail sales.

As far as the U.S. economy, it continues to hum along. Don’t be so sure that it has peaked either. Maybe it has or is about to, but we find no way to really call that one at this point, except for residential housing showing signs of weakness, the auto sector and some deceleration in wage growth. As far as economic activity, the August the ISM PMI Index rose and showed economic activity in the manufacturing sector expanded in August and the overall economy grew for the 112th consecutive month. The index came in at 61.3, an increase of 3.2 percentage points from the July reading of 58.1 percent. The New Orders Index registered 65.1 percent, an increase of 4.9 percentage points from the July reading of 60.2 percent. Other indexes showed growth including the Production Index, the Employment Index, the Suppliers Delivery Index, and the Inventories Index. This is all good, and we would rather be in a situation of wondering if the economy is entering a peaking stage or not, instead of being in a spiraling decline wondering how we’re going to get out of it. Remember those days?

The ISM Non-Manufacturing (service sector) Index   


ISM Manufacturing Index


But perhaps we will see a period of increased volatility anyway, with a potential for a knee-jerk reaction caused by the current administration’s tariffs on China. On the peripheral, even though the tech stocks are getting a little wobbly, risk seems to be tamed for now; at least that is a more bullish view. The bullish view can be fortified by the continued expansion of the economy, consumer confidence at an almost 18 year high, and the stimulus of fiscal and monetary policies, the tailwinds of the economy, and declining unemployment, all continue to fuel investor sentiment, which, along with record share buybacks, could push the market higher or at least keep the bid in the overall market for a little while longer, at least.

After a drop in July, business confidence made a recovery in August, which took us close to being back to the June numbers of 59.1, and came in above expectations. But one comment made about this by Brad McMillan of Commonwealth Financial, is that this bounce back likely indicates continued growth for the rest of the year, but possibly topping out and maybe declining going into next year. This will be one to watch.

Another plus was the August employment numbers which came in at 201,000, which was above expectations of 190,000, and well above July’s number of 147,000. The question is, is this as good as it gets, and will it begin to weaken sometime in the near future?

All of this data is thrown about among the bullish crowd, and it’s great to see. But others have recently expressed concern. A recent article in Market Watch, discussed the viewpoint of Peter Oppenheimer, Chief Global Equities Strategist, at Goldman Sachs, that suggests that this is an unusual period for Wall Street, characterized by loose monetary policy and a recent spate of fiscal stimulus, resulting in an unusual bull market cycle which is likely to come to a screeching halt. He isn’t suggesting to panic, rather to expect lower returns. But the firm’s bull-market indicator, which examines five market factors, indicates that the likelihood of a bear market occurring is at its highest point since around the early 1970’s, according to the article.


Looking at charts such as the ones shown above, including the Case Shiller Index, the fact that the current bull market cycle is now the longest in history, the notion that markets begin to correct ahead of any economic slowdown, and tech is driving most of the strong earnings which may be beginning to wane, are all arguments to support a coming bear market - We’re not here to call it either way, at this point.

Furthermore, the situation with record low unemployment could motivate the Fed to jump in and go into full throttle tightening mode and raise rates even further in December. The market has already baked in the assumption that the Fed is raising rates in September and December. However, it has not baked in more dramatic raises in interest rates. Though not out of control, wages are rising, and with record strength in employment, the Fed’s change in interest rate policy could disrupt the market upon this realization, if this would come to fruition.

The real elephant in the room, as we have been saying for several years now, is the issue of debt. World-wide, total debt now exceeds $247 trillion, by some estimates, and poses a notable risk to the financial system. Danielle DiMartino Booth of Quill Intelligence spoke very eloquently and spot on about this subject, in our opinion, as you can see her in recent appearance on “The Business News Network. She also makes a concerning point that BBB quality debt, and debt that is considered to be junk, now exceeds the levels of investment grade quality debt, which wasn’t the case pre-2008. It’s good to see more people within the mainstream beginning to talk about it.

In the meantime, and based on seasonality, if markets are higher coming into September for the year, they tend to continue to rise into the fourth quarter. Hopefully, the market still has some mojo left to carry it through the end of the year. But, maybe instead of being worried about the U.S. economy, perhaps we should start focusing on the rest of the world, because a number of countries are flashing warning signals.
This week is a typical week after unemployment is released as economic releases are minimal. On Monday, Consumer Credit is expected to show an increase. On Tuesday, the Job Openings and Labor Turnover survey will be released. Wednesday, Producer Prices, which will be significant, are expected to show a 0.2% increase and also the Federal Reserve beige book will be released. On Thursday, Jobless Claims are expected to show roughly 210,000, Consumer Price Index expected to show a 0.3% increase and on Friday, Retail Sales are expected to show a 0.5% increase. The Import Price Index, Industrial Production, and Capacity of Utilization will also be released. Most of this economic news will be focused on both the Producer Price Index as well as the Consumer Price Index releases as folks continue to become more concerned about inflation. We also saw a rise in interest rates on Friday as the 10-year moved up to 2.942%. This is likely to be close to the upper end of the range of expectations but we could see a move back towards the 3.016 level.

Looking back on last week 
As the market started on Tuesday after the Labor Day holiday, we saw a steady decline every day with Tuesday down 0.17%, Wednesday down 0.28%, Thursday down 0.37% and Friday down 0.22%. This accumulation of selling pushed the S&P 500 down 1% but the NASDAQ lead the way as it declined 2.6% for the week. There was some nervousness coming in as the Gulf Coast brace for a tropical storm Gordon to make landfall which triggered a slight rally in oil prices with the in anticipation of the storm disrupting crude production. But it quickly gave back those gains as the storm turned out to be less damaging. Further oil news showed a 4.3 million barrel drop in stockpiles while gasoline supplies increased by 1.8 million. This triggered the crude oil futures to decline 2.9% for the week settling at 67.76.

The big action was in the tech sector, as sharp declines occurred in Twitter and Facebook. We also saw weakness in Google, Apple, and Amazon as the FAANGs were definitely the leaders in negative market sentiment last week.

On the trade front, US China tensions resurfaced by the end of the week as many thought that the White House would impose tariffs on $200 billion worth of Chinese goods on Thursday night following the end of the public comment period. Friday’s action opened lower. Markets rebounded to trade positive before drifting for the balance of the session with the S&P finishing down 0.22% at 2871.68. The configuration continues to set up the pattern that is typically when the S&P penetrates a key number such as 2900. We did see the S&P 500 hit a high of 2916.50.

Our guess is that it is possible that we will continue to see a broad trading range on either side of the 2900 level with a range expected to continue between the 2855/2916 levels over the next 5 to 8 sessions. It appears that we are likely to see a very choppy week with markets rebounding toward some of the resistance between 2881 and 2892 on the upside. There is a 60% probability that the markets will hold last week’s low at 2864.12 but a penetration would indicate a further decline towards the 2856.10 level.

Last week’s action caused the short-term momentum to dissipate substantially and is currently neutral confirming this sideways trading range. Intermediate charts continue to suggest a strong underlying momentum will keep the upward trend in place. The key level on the downside is 2840 a penetration would indicate some issues and a possible pattern failure on intermediate charts but there is currently only a 30% probability for this to occur. The key level for this week will be the 2887.25 level. A close above this level will set the tone for a rally toward the 2902/2907 level.

With the technical damage that occurred on a short-term basis last week, there doesn’t appear to be the ability for the markets to move sharply higher this week but instead to continue the consolidation.

Best Wishes,

Zeller Kern Investment Committee