Friday’s mixed performances by U.S. equity market indices left investors with a sense that more negative price action is in the offing this week. We began the trading session on positive footing as a result of Fed Chair Yellen’s interest rates comments on Thursday but saw early morning strength reverse, allowing for markets to close mixed.
Though the Dow Industrials managed to gain 0.70%, the NASDAQ lost 1.01% while the S&P 500 closed largely unchanged. More telling however was the performance posted by the Russell 2000 which lost 1.30% on the session. The clear bifurcation in performance between the Dow Industrials and S&P 500 versus the NASDAQ and Russell 2000 speak to shifting priorities for institutional investors as capital rotates away from the growth sector and into what are perceived to be more stable and established stocks. Volume on the NYSE slipped by 8.46% and edged modestly higher on the NASDAQ by 2.51%. The market outlook has shifted from “uptrend under pressure” to “correction.”
From a sector standpoint, Friday saw significant out performance to the upside by Consumer Discretionary, Financials, Materials and Consumer staples. Do you see a theme there? The theme is best summed up by the comments delivered by Chair Yellen on Thursday; assurances of a move in interest rates as a result of a continued improvement in our economic health.
Our Economic Calendar today will be dominated by Federal Reserve officials. Though we get Personal Income and Outlays, Pending Home Sales and the Dallas Fed Manufacturing Survey data, there will be three Fed officials speaking. We start the day with William Dudley at 7:45 AM. Charles Evans is speaking at 1:30 PM and John Williams is speaking at 5:00 PM.
Three powerful themes
The caution that I have relentlessly expressed in Kenny‘s Commentary for nearly three months is not likely to change in the near term. There are three principle domestic themes that buttress my outlook and they do not directly include the interest rate narrative or the geo-political/global economic themes that have riled markets this year. I have touched on them in recent notes but thought that with Q3 wrapping up this week, it might be a good time to summarize.
Q3 Corporate Earnings results and Guidance
The third quarter ends this Thursday and from the looks of things, the upcoming Q3 earnings season will be disappointing. Though it is entirely too early to call for an earnings recession out right, it is clear that there is a significant likelihood that Q3 earnings will decline between 3% and 4%. For nearly three months now analysts have been reducing earnings estimates across the entire S&P 500. For the S&P 500 as a whole, estimates have been reduced by roughly 4%. An out right decline in earnings for the S&P 500 is being fueled by continued trends lower in crude prices as well as a stronger dollar in the face of weak global demand. That combination is likely to be a source of constant headwind to U.S. corporate earnings and as a result U.S. equity markets – at least through the end of 2015. Additionally, from the looks of most recent guidance, the profit landscape for the S&P 500 is likely to be challenged well into 2016.
Rotation out of growth stocks into dividend-centric investing themes
On Friday we saw a very interesting bifurcation of equity performance registered by the 30 Dow Industrials versus the NASDAQ Composite and Russell 2000. On the day, the Dow gained 113.35 points or 0.70% while the NASDAQ lost 1.01% and the Russell 2000 lost 1.30%. That divergence is worth paying attention to because it speaks to a shifting mindset on the part of institutional investors. In short, capital rotated out of growth names and into more secure dividend paying names. Though this has been a fixture for months now, Friday’s relative price action was the clearest example of this rotation in our most recent pullback in equity prices. For example, over the past 3 months the Russell 2000 has lost 12.22% while the S&P 500 has lost 7.65%.
On August 24th, in an article written by Adam Samson for Yahoo Finance, I was quoted; “Great stocks get sold, and in some cases punished, not because of their lack of value but simply because the trend line for the broader market has faltered.” Another way of framing that, loosely speaking, is “Return Dispersion.” This past weekend Goldman Sachs Chief Market Strategist David Kostin pointed to this very theme as a source of concern for the near term prospects for US equities. The difference in returns between classic growth stocks and more predictable dividend paying stocks has closed markedly with the most recent downdraft in the market. Broader economic and geo-political themes have effectively neutralized any appeal that growth stocks would normally have in a healthy equity market. This was clearly the type of price action we saw on Friday and mentioned above.
Market outlook is now decidedly negative.
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