What happened this past week? Global stock exchanges experienced quite a bit of volatility but didn’t make much net movement (the SPX was about flat; the Nasdaq lost 70 bps; the major European bourses were higher by 50 bps; and, although the Shanghai Composite did rally ~2.5% on Friday this only cut the week-to-date lose to ~ 2.2%). The makeup of the U.S. market though wasn’t terrific – important sub-groups like banks, semis, cap goods, transports, materials, and autos all underperformed badly while utilities, telecoms, staples, and REITs surged. U.S. economic growth is still on a strong path and the FOMC policy bias has become quite hawkish (a large majority of Fed officials seem comfortable taking the Fed Funds rate into restrictive territory according to the minutes this week) but the rest of the world is on a more nebulous economic footing (China’s data wasn’t awful this week but growth is clearly decelerating). The U.S.-China trade backdrop has actually improved quite a bit in the last couple of weeks (if anything this may now be an upside risk to the extent Trump and Xi meet at the G20 and some type of a détente is achieved) but Italy is still a very severe macro overhang (the S&P hasn’t paid too much attention to Italy but woke up to the problem this week as the Bund-BTP 10 year spread blew through 300bps). Corporate earnings has been a powerful firewall, acting as a shield for the S&P from the multitude of macro headwinds, but it’s been fraying at the margin of late and this more than anything explains why the S&P has traded so poorly since the start of October (PPG is far from a bellwether of Corporate America but its preannouncement back on October 8 did more than anything to blow a hole through the EPS firewall and that breach made the S&P much more sensitive to macro problems). The first half of October gloom is probably overdone and the Q3 reporting season when all is said and done will likely look better than it does at the end of this week (and the ~$179 consensus for 2019 should stay intact which means the PE below 2800 is attractive at sub 16x). Meanwhile, U.S.-China at this point is turning into an upside risk. However, the reports during the week of October 22 will be crucial to re-establishing the EPS firewall (and specifically, CAT/MMM/PHM/PNR/UTX/VZ (Tuesday morning), TXN (Tuesday night); BA/FCX/GD/ITW/T/UPS (Wednesday morning), AMD/F/MSFT/V/XLNX (Wednesday night); and, AMZN/CY/EXPE/GOOGL/INTC/WDC (Thursday night) and until that shield is back in place the S&P will churn between 2750-2800 (and if the earnings firewall attenuates further, the index could revisit its lows or worse).
The big focus in the coming week will be on earnings (the week of October 22 is the peak volume period of the Q3 season with a third of the Dow index and 30% of the S&P 500 reporting) although a few macro catalysts will be important, including the flash PMIs for October (Wednesday, October 24), the ECB meeting (Thursday, October 25), U.S. Q3 GDP (Friday, October 26), and Italy (the EU and rating agencies are expected to weigh in on the budget).
The bottom line is, the non-fundamental stage of the recent sell-off may take a few more days to shake out, but the equity markets have a compelling risk/reward around the world and this October correction should be thought of as an opportunity. Your BSD Global Tech investment mandate is 100% fully invested across 10 tech vendor sectors and a number of legitimate technology end-users, while carrying a substantial slightly out-of-the-money put option position to protect us from those unexpected market drawdowns. If the market’s fundamental / technical / capital flow foundations suffer a material change, We will adjust our long biased stock portfolio and our derivatives hedge. We have a ‘shopping list’ of technology vendors and end-users ready to invest when those inevitable pullbacks occur. Meanwhile, our technology stock portfolio still permits us to participate in the melt-up of this secular bull market.