Small Caps Coming to Life

Stocks moved slightly higher this week as we can check on the chart for the S&P 500 index below – not much of a change. The price action has been choppy and has held in a range through all of last week. As you can see by the technical indicators on the bottom, this index is working off an overbought condition.

Overbought conditions can be resolved in one of two ways. The first is a pullback (correction) where a portion of the previous uptrend is retraced. The second is a consolidation period where prices move sideways before breaking out to higher prices which is what may be happening now with the S&P 500.

I say this because the Russell 2000 (small caps/growth) looks to be breaking out from a consolidation period that began in early February. At first, it looked as though this index was stalling out but after three months of sideways action we should have corrected by now. The last bar in the chart below is from Friday and is a significant development as this is the best close since last October when the S&P 500 topped. You can also see how this index has not made new highs in recent weeks like the NASDAQ and S&P so this is the index to watch right now. Normally, you want to see growth indices like the Russell and NASDAQ leading the pack higher so maybe the Russell will exert some leadership into the summer months. The Russell’s recent chart pattern may be foreshadowing a consolidation period and a move higher for the other major indices which would put the October correction firmly in the rearview mirror.

Aside from the technicals, there are a lot of cross-currents in the macro markets these days. Europe is weak, China is injecting stimulus, the US policies for capital investment may (or may not) be coming to fruition while nobody cares about Japan’s central bank overreach (for now). Sprinkle in a Fed that is leaving the yield curve alone and maybe a melt-up scenario is in the works. I read that a trade deal with China may be announced in early June so that bit of good news is in the pipeline, too.

Chart of the Week!

In 2018, total global military expenditures rose 2.6% to $1.8T, according to new data from the Stockholm International Peace Research Institute (SIPRI). It has reached its highest level since 1988 as well as being 76% higher than the post cold war low of 1998. 

Economic & Central Banking Snippets 

  • US consumer spending bounced back in March as Personal Spending rose 0.9% (MOM) but inflation remains sluggish. The figures, released on Monday morning by the Department of Commerce, add to the run of data out in recent weeks that pit firm economic growth and a resilient labor market against perplexingly soft inflation. (FT)
  • The April ISM manufacturing index fell to 52.8 from 55.3 in March which marks the softest print since October 2016. ISM said “Many respondents reported Europe as a source of lower demand….Bottom line, we’ve been seeing a slowdown in global trade all year and a slowing pace of US manufacturing that is now being reflected in the numbers.” Weaker readings on new orders, production and employment weighed on the index. (Boock/FT)
  • The Federal Reserve flagged signs that inflation has weakened despite solid growth, as it reiterated its determination to be “patient” before moving interest rates again. The US central bank kept the target range for the federal funds rate unchanged at 2.25 to 2.5 per cent on Wednesday. The Fed declared that the economy is advancing at a “solid” rate overall, but it also observed that household spending and business investment decelerated in the first quarter, and inflation is now “running below” its 2% target. “We do think our policy stance is appropriate right now — we don’t see a strong case for moving in either direction,” said Chairman Powell during a news conference after the bank’s rate decision was announced. (FT)
  • US hiring rose at a brisk pace in April, according to data released on Friday, in the latest sign of strength in the world’s most important economy. Non-farm payrolls rose 263,000, according to the labor department, comfortably above the median forecast of 190,000. Average hourly earnings increased 3.2% year-on-year. The annual pace was unchanged from the previous month, against expectations for a slight rise. The unemployment rate fell to 3.6%.

Macro Snippets

  • Boeing didn’t advise airlines or federal authorities it had shut off a safety system on its 737 MAX jets that warns pilots about malfunctioning sensors. Accident investigators have linked such bad data to two deadly crashes. US and European airlines have warned that the grounding of Boeing’s 737 Max will shave hundreds of millions of dollars from their combined profits this year, raising the prospect that the aircraft manufacturer will face significant costs for compensating customers. (WSJ)
  • Saudi Arabia is seeking to open up its government bond market to retail investors as part of sweeping reforms intended to develop a savings culture. Riyadh has increased its borrowing to finance its budget deficit and help fund Crown Prince Mohammed bin Salman’s economic reform program. The kingdom’s debt to GDP ratio has risen from 1.4% in 2014 to more than 20% in 2019.
  • For the first quarter, the S&P 500 is reporting a year-over-year decline in earnings of 2.3%, but year-over-year growth in revenues of 5.1%. Given the dichotomy in growth between earnings and revenues, there are concerns in the market about net profit margins for S&P 500 companies in the first quarter. So far, this margin stands at 10.9% which may mark the first year-over-year decline in the net profit margin for the index since Q4 2016. It will also mark the lowest net profit margin reported by the index since Q4 2017. (WSJ)
  • Samsung Electronics says it expects “limited improvement” in the second quarter with price declines and chip oversupply likely to persist, renewing concerns after the technology giant reported its worst net profit in more than two years. (FT)
  • Apple reported another quarterly decline in profit and revenue, its first back-to-back dip in those key metrics in more than two years, as the tech titan continued to battle weak iPhone sales broadly and in particular a slowdown in China. Apple said profit for the three months through March 30 tumbled 16% to $11.56 billion, while revenue fell 5% to $58.02 billion. (WSJ)

That is all for now until next week’s Market Update. Thanks for reading!  


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.