February 4, 2018
Posted Sunday 11 AM ET - Friday's market decline has investors on edge so detailed analysis is warranted. The macro backdrop is extremely bullish. The tax bill is going to increase consumer spending and it will boost corporate profits. We have not seen a catalyst like this in decades. Business regulations are declining and for every new one that is added, two are rescinded. Companies are coming back to the United States and they are bringing $3 trillion in overseas cash back to the US. In the last 15 years corporations have not reinvested in plant and equipment. Low interest rates and sluggish economic growth have prompted them to repurchase shares. Over 50% of all outstanding shares have been retired since 2000. When you have the same number of people trying to buy fewer shares the price goes up. This is one of the most powerful market forces we've seen and it will prevent any major market declines. The credit issues that plagued the world 10 years ago are not a current concern. Lending practices are tight and the write-downs have been taken. Portugal had their credit ratings raised and Greece is no longer subjected to austerity requirements (two PIIGs countries). Credit is the only thing that can lead to a sustained market decline and it is not remotely an issue. Inflation has been below Fed targets for the last decade. Without higher wages prices have remained stable. This is the largest input cost for corporations. They are willingly paying employees more because there is a shortage of good workers and because they see robust business conditions. Higher wages are good for everyone and low unemployment is also good. Friday's Unemployment Report showed a .3% rise in hourly wages. This is not extreme and it is the first decent uptick we have seen in a long time. The United States accounts for 25% of the world's GDP. What is good for the US is good for global activity. The Atlanta Federal Reserve is projecting 5.3% GDP growth in Q1. We haven't seen numbers like that in almost 20 years. Central banks around the world are finally starting to tighten. The EU and Japan had negative interest rates a little more than a year ago. Only an idiot would claim that higher interest rates are going to strangle this economic boom – they are barely off the deck. By historical standards interest rates are extremely low. It will take years of tightening before they become an issue. From a valuation standpoint the S&P 500 is trading at a forward P/E of 18 and the NASDAQ is trading at a forward P/E of 21. Given the guidance we've seen this quarter I believe earnings estimates will be revised upwards. At current levels they are little rich, but not extreme. So why did the market tanked? I need to get a little granular to explain it. A number of influences fueled the rally. The tax cut broke us out to a new high and earnings season provided a nice tailwind. When the market made a new high bullish speculators rushed in. It is unusual to see as many gaps higher as we've seen in the first month this year. Typically a bullish market will open on the low (no gap higher) and close at the high of the day. This rally opened higher and closed higher on many consecutive days. From a technical standpoint this is extremely bullish long-term. Bullish speculators needed to be flushed out and it wasn't going to happen until we had a significant drop that lasted a few days. That "gut check" happened Friday and once this low is in we will see an excellent buying opportunity. Mega cap tech stocks had reported and the reaction was neutral (some up and some down). Once that news was out optimism waned. Wage inflation is something we've been hoping for since the financial crisis and we are finally seeing an uptick. Interest rates are steadily moving higher and that prompted some profit-taking. The debt ceiling/budget need to be extended this Friday and that is also weighing on the market. I believe an immigration deal is in reach, but it might take a couple of weeks. Given the compromises made by Trump and the favorable polls after the State of the Union address I feel that Democrats are on shaky ground. The House Intelligence Committee and possible surveillance improprieties against Trump during the election are not helping their case. All of these events converged and the market dropped. This is going to set up an excellent buying opportunity. The market needs to establish support and it might be tested the second time before we lift off. Next Christmas we will look back at SPY $275 as an excellent entry point. . .
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