The G-20 conference is in full swing this weekend as the US stock market awaits news on progress with a trade deal with China. As of today, there was some progress released this morning where both sides agreed to dial back the rhetoric and proceed in earnest towards a long-term resolution. Nice but there will be uncertainty around our trade status with China until there is a deal inked which may not come until next year or beyond given the complexity around issues such as intellectual property. The 2020 election is coming up so the administration may end up caving on some issues to make the politics look good going into next year so maybe that pushes the timeline forward.
The financial markets have been trading around the G-20 and our trade status with China over the last two weeks. The butterfly effect is progressing through supply chains and how the world conducts business through various trading partners (see Vietnam below). Maybe this is a good thing as we won’t rely on China so much but it can be easy to cause dislocations in financial markets when such changes are happening. So, which way is the next big move for the S&P 500?
To review, the December 2018 low was a significant event as the Fed pivoted to being dovish creating a “V” bottom with many sectors of the stock market participating (great breadth). Recently, many market technicians have been identifying a “triple-top” in the S&P chart as a warning sign but I think the technicals from the December low are too compelling to ignore further upside.
If the news from this weekend is taken as a positive, the S&P will likely gap higher on Monday and keep going for many weeks or months. If disappointed, stocks will remain in a corrective mode and likely complete a “Flat Correction” as illustrated below:
Stocks advance in 5-wave sequences so the move from the December low to the May high is likely wave “1” in completion. However, if wave “2” were to complete as of the June 3rd low (labeled wave “A”), it would look less than proportional to the size of wave “1” – a warning sign that the correction is not over. Given that the S&P has completed three waves down from the May high and then three waves up, the flat pattern may be unfolding. If we open down on Monday in a “sell the news” event then the “C” wave is unfolding which will lead to a completion of the flat pattern over the summer to complete a larger wave “2”. New all-time highs would follow afterwards.
I am wrong if the S&P 500 corrects below 2,583 (now 2,940) on a big disappointment in the coming weeks. However, my base case is the next big move is higher but not without additional corrective price action.
What to look for next week:
- The reaction on Monday morning should give a good indication on whether the flat pattern is in play or not.
- Gold has caught a bid. Could the gold mining stocks be a new market leader? Nothing good has happened in this sector since 2011 but it is worth watching if the Fed is going to lower rates.
- Semiconductors do big business with China and have traded poorly for most of 2019. This sector is also a potential market leader when all the corrective price action is complete.
Chart of the Week!
The chart below shows how the price of a commodity can trade at different prices among countries.
Granted, heroin is an illicit drug that is highly addictive but it is an opioid much like prescribed painkiller medications. So why the price differentials if heroin represents a commoditized asset? For one, heroin is illegal in the U.S. which means criminals charge a premium to deliver the product domestically. On the flip side, heroin is totally legal in Portugal and is one-tenth the price so we can observe the differential mostly in terms of the legal structure (ignoring things like storage and transportation costs).
This also brings into focus the future of cannabis if it is fully legalized in the United States. Cannabis has never been produced on a mass scale which means its price will fall and be traded as a commodity, if legalized. This warns that the myriad of newly minted publicly traded cannabis companies may have a tough time generating profits if mass producers emerge. The valuations carry a lot of risk, here are a few examples (none of these companies are profitable and do most of their business in Canada right now):
- Tilray (TLRY): Market Capitalization $4.5B with revenues of $58mm.
- Canopy Growth (CGC): Market Capitalization $13.8B with revenues of $226mm.
- Cronos (CRON): Market Capitalization $5.3B with revenues of $19mm.
- Aurora Cannabis (ACB): Market Capitalization $7.9B with revenues of $168mm.
Economic & Central Banking Snippets
- A closely watched gauge of US manufacturing activity fell for a second straight month in May, in the latest sign that the economy may be losing momentum. Durable Goods Orders — items such as cars, appliance and aircraft that are meant to last three years or more — fell 1.3% last month to $243.4bn from April, according to the US commerce department. However, the core rate which excludes the volatile transportation sector showed a positive 0.3% rise. (FT)
- The U.K. experienced a deterioration in consumer confidence in June across a range of sectors including consumer, retail and construction according to the GfK consumer index released on Friday, renewing concerns and reversing signs of improvement in May. (FT)
- Vietnam‘s economy expanded faster than expected in the second quarter as the country reaps the benefits of the ongoing trade war between China and the US as manufacturers have moved production from China to avoid tariffs. Gross domestic product rose 6.71% year on year in Q2 according to Vietnam’s General Statistics Office (GSO). Imports from Vietnam to the US surged nearly 40% per cent year on year in the first four months of 2019 while imports from China over the same period fell 13%.
- Migration consultants have seen a sharp rise in interest from Hong Kong citizens following recent mass protests against a controversial proposal that would allow extradition to China. John Hu, director of John Hu Migration Consulting, said his office has been fielding 100 calls a day from people enquiring about gaining citizenship abroad — almost three times the number of calls he was receiving before the protests started. Even before the recent surge, Mr Hu’s consultancy said he had seen a “constant” increase in inquiries since the 2014 Umbrella Movement: “Certainly the political pressure on Hong Kong citizens has activated them to consider immigration overseas. In the past five years, we’ve been having double-digit growth in our sales volume,” he said, adding that the top choices are Australia, Canada, the UK and US with increasing interest in other European countries.
- The U.S. Department of Justice is pursuing a criminal investigation into the nation’s chicken industry, following allegations that top poultry processors colluded to keep prices artificially high. Justice Department lawyers are seeking a six-month halt in evidence collection in a long-running civil lawsuit against chicken processors including Tyson Foods Inc., Pilgrim’s Pride Corp., Sanderson Farms Inc. and Perdue Farms Inc. (WSJ)
- Drive.ai, a self-driving startup that was once valued at $200M, has been scooped up by Apple, as well as dozens of its engineers. The deal confirms that Apple hasn’t given up its autonomous driving project, called Project Titan. (Seeking Alpha)
- Ford detailed plans to close factories and reduce its workforce across Europe, saying the moves would affect about 12,000 jobs, or about 20% of positions in the region, through measures such as layoffs and shift reductions. (WSJ)
That is all for now until next week’s Market Update and thanks for reading! You can contact me below if you would like a copy of the firm’s brochure.
Paul J. McCarthy, III
President – Kisco Capital